Company A is operating a 70% capacity and is earning satisfactory Return on Investment. Company A has been approached by Company B with offer to purchase 120,000 units. Company B requires the 120,000 valves over the next 4 months. Company B is prepared to pay $19 each for the units.
Company A's product cost, based on current attainable standards, for the units are:
Direct Materials - 5.00
Direct Labor - 6.00
Manufac. Sup. - 9.00
total 20.00
Manufacturing support costs are applied to production at rate of $18 per standard direct labor hour and they pay for shipping. This rate is made up of following components:
Flexible man. support - 6.00
Capacity-related man. support - 12.00
so,
Cost driver rate - 18.00
Extra cost incurred in connection with sales of unit include sales commissions of 5% and freight expense of $1 a unit. Though, the company doesn't pay sales commissions on special orders which come directly to management.
In finding sales prices, Company A adds 40% markup to product cost. This gives a $28 suggest selling price for the units. Marketing dept, though, has set the present selling price at $27 to maintain market share.
Production management believes it can handle Company B order without disrupting its scheduled production. The order, would though, need additional capacity-related manufacturing support costs of $12,000 per month in form of supervision and clerks.
If management accepts order 30,000 units will be produced and shipped to company B for next 4 months. Shipments will be made in weekly consignments, with Company B paying for shipping.
Questions that I have are:
1. Determine the impact of accepting Company B's order on COmpany A's profits?
2. Determine the minimum unit price which Company A must accept for Company B's order without decreasing its profits?