Problem:
Differential analysis involves knowing which costs are relevant, i.e. future costs that vary among alternatives. It is important to know what information to use and not just how to execute the analysis.
Herrestad Company receives an offer to make a new product, called C, for a new customer. The customer wants to buy 1,000 units. Product C has the same cost structure as product B with three exceptions. The new customer is only willing to pay $150 per unit, direct materials costs will decrease by $12 per unit and Herrestad does not have to incur any variable selling and administrative expenses.
Make a list of the expenses and amounts that are relevant for this decision. How much with the sale of this product contribute to the profitability of Herrestad?
What if the company only pays $140 per unit? How does this change the contribution towards profitability?
If you were the manager, would you accept this order? What considerations, other than financial would enter into your decision?
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Current Costs of Product B: (see attached for better formatting of tables)
Product B
Sales $ 300.00
Variable costs:
direct material $ 120.00
direct labor $ 60.00
variable overhead $ 40.00
variable selling and admin $ 10.00
contribution margin $ 70.00