ACCEPT OR REJECT A SPECIAL ORDER:
Reid Company manufactures and sells a single product called a Lop. Operating at capacity the company can produce and sell 30,000 Lops per year. Costs associated with this level of production and sales are given below:
Per unit Total
Direct materials $15 $450,000
Direct labour 8 240,000
Variable manufacturing overhead 3 90,000
Fixed manufacturing overhead 9 270,000
Variable selling expenses 4 120,000
Fixed selling expense 6 180,000
Total cost $45 $1,350,000
The Lops normally sells for $50.00 each. Fixed manufacturing overhead is constant at $270,000 per year within the range of 25,000 through 30,000 Lops per year.
Required:
Question 1. Assume that due to a recession Reid Co expects to sell only 25,000 lops through regular channels next year. A large retail chain has offered to purchase 5,000 Lops if Reid is willing to accept a 16% discount off the regular price. There would be no sales commission on this order; thus variable selling expenses would be slashed by 75%. However Reid would have to purchase a special machine to engrave the customer’s name on the 5,000 Lops. Reid has no assurance that the retail chain will purchase additional units in the future. Determine the impact on profits next year if this special order is accepted.
Question 2. Refer to the original data. Assume that Reid Co expects to sell only 25,000 Lops through regular channel next year. The BC government would pay a fixed fee of $1.80 per Lop, and it would reimburse Reid Co for all costs of production (variable and fixed) associated with the units. Since the government would pick up the Lops with its own trucks, there would be no variable selling expenses associated with this order. If Reid Co accepts this order, by how much will profits increase or decrease for the year?
Question 3. Assume the same situation is (2) above, except that the company expects to sell 30,000 Lops through regular channel next year. Thus accepting the BC government’s order would require giving up regular sales of 5,000 Lops. If the government’s order is accepted, by how much will profits increase or decrease from what they would be if the 5,000 Lops were sold through regular channels?