Relevant Costs and Decision Making:
Englewood Machining Company of Illinois manufactures Part 524 (a component used in the diesel engines). The Company has a capacity to produce 150,000 units per month and is currently operating at 75 percent of the capacity. The cost structure is as follows
Per unit cost
Direct Materials $8.00
Direct Labor 6.00
Manufacturing overhead 12.00
Manufacturing cost $26.00
In addition, the company incurs $1.00 per unit on Freight and also pays 5% (on selling price) as sales commission. The regular selling price of Part 524 is $34.00 per unit. The manufacturing overhead rate is $24.00 per hour of which 1/3rd is variable and 2/3rd is fixed. It requires ½ an hour to manufacture one unit. The direct materials and direct labor are considered as variable costs.
Suzu Manufactuirng Company of Tokyo, Japan has approached the Englewood Machining Company for the purchase of 30,000 units of Part 524 next month at $20.00 per unit, FOB shipping point. Englewood Machining Company will not pay any sales commission on this special order. However, an additional fixed cost of $13,000 for the month will have to be incurred for additional administrative and clerical work. This cost is exclusively related to the special order.
The management of Englewood Machining Company has approached you to solve this problem.
Required:
1. Prepare an income statement to analyze accept / reject alternatives.
2. What is the minimum price at which Part 524 can be sold to Belfast Company by maintaining the current level of net income?
3. Calculate the contribution margin per unit and the break-even level (in units) disregarding the purchase offer from Suzu Manufacturing company.
4. Write a letter to the management of Englewood Machining Company giving your recommendation whether to accept this special order or to reject it. Give substantial reasons for your opinion.
5. In case, if this special order is to be accepted, how best you can convince the regular customers, who are paying $34.00 for Part 524.