Problem 1: Fashions, Inc. is a retail store that sells sweaters and jackets. In the past, it has bought all its sweaters from a supplier for $20 per unit. However, Fashions has the opportunity to acquire a small manufacturing facility where it could produce its own sweaters. The projected data for producing its own sweaters are as follows:
Sales price $30
Variable costs 15
Fixed costs 150,000
Required
a. If Fashions acquired the manufacturing facility, how many sweaters would it have to produce in order to break even?
b. To earn an after tax profit of $125,000, how many sweaters would Fashions have to sell if it buys the sweaters from the supplier? If it produces its own sweaters? Fashion's tax rate is 30%.
c. Fashions is indifferent between the two alternatives at sales of how many units (ignore income tax effects)? Show a computation of operating income to prove your answer.
Problem 2: Old Castle Vineyard produces premium wine. Its success in the industry is due to its quality, although all of its customers, wine shops and specialty grocery stores, are very cost conscious and negotiate for price cuts on all large orders. Noting that the wine industry is becoming increasingly competitive, Old Castle is looking for a way to meet the challenge. It is negotiating with Eastern Seasons, a regional specialty grocery store, to purchase a large order of wine. Old Castle is currently producing at under-capacity and would like to keep its production facilities gain better economies of scale by increasing production. Eastern Seasons has agreed to a large order but only at a price of $25 per bottle. The special order can be purchased in one batch with available capacity. Old Castle prepared these data:
Next month's operating information (per unit, for 10,000 units, made in 10 batches of 1,000 each)
Sales price $45
Per unit costs
Variable manufacturing costs 19
Batch-level costs 5
Variable marketing costs 8
Fixed manufacturing costs 5
Fixed marketing costs 2
Special order information
Sales 2,000
Sales price per unit $35
No variable marketing costs are associated with this order, but Old Castle has spent $2,500 during the past two months trying to get Eastern Seasons to purchase the special order.
Required:
a. How much will the special order change Old Castle's total operating income?
b. How might the special order fit into Old Castle's competitive strategy?