NoFat manufactures one product, olestra, and sells it to large potato chip manuf

Question

NoFat manufactures one product, olestra, and sells it to large potato chip manufacturers as the key ingredient in nonfat snack foods, including Ruffles, Lays, Doritos, and Tostitos brand products. For each of the past three years, sales of olestra have been far less than the expected annual volume of 125,000 pounds. Therefore, the company has ended each year with significant unused capacity. Due to a short shelf life, NoFat must sell every pound of olestra that it produces each year. As a result, NoFat's controller, Allyson Ashley, has decided to seek out potential special sales offers from other companies. One company, Patterson Union (PU) - a toxic waste cleanup company- offered to buy 10,000 pounds of olestra from NoFat during December for a price of $2.20 per pound. PU discovered through research that olestra has proven to be very effective in cleaning up toxic waste locations designated as Superfund Sites by the US Environmental Protection Agency. Allyson was excited, noting that "This is another way to use our expensive olestra plant!"

The annual costs incured by NoFat to produce and sell 100,000 pounds of olestra are as follows:

Variable costs per pound:
Direct Materials $1.00
Variable Manufacturing Overhead $0.75
Sales Commissions $0.50
Direct Manufacturing Labor $0.25

Total fixed Costs
Advertising $3,000
Customer hotline service $4,000
Machine set-ups $40,000
Plant machinery lease $12,000

In addition, Allyson met with several of NoFat's key production managers and discovered the following information:

*The special order could be produced without incurring any additional marketing or customer service costs

*NoFat owns the aging plant facility that it uses to manufacture olestra

*NoFat incurs costs to set up and clean its machines for each production, run, or batch, of olestra that it produces. The total set-up costs shown in the previous table represent the production of 20 batches during the year.

*NoFat leases its plant machinery. The lease agreement is negotiated and signed on the first day of each year. NoFat currently leases enough machinery to produce 125,000 pounds of olestra.

*PU requires that an independent quality team inspects any facility from which it makes purchases. The terms of the special sales offer would require NoFat to bear the $1,000 cost of the inspection team.

REQUIRED:

1. Conduct a relevant analysis of the special sales offer by calculating:

a. The relevant revenues associated with the special sales offer
b. The relevant costs associated with the special sales offer
c. The relevant profit associated with the special sales offer.

2. Based soley on financial factors, explain why NoFat should accept/reject PU's special sales offer.

3. Describe at least one qualitative factor that NoFat should consider, in addition to the financial factors, in making its final decision regarding the acceptance or rejection of the special sales offer.

Explanation / Answer

For

For

For

Per Pound

100000

10000

110000

= $3.09

= $2.82

For

For

For

Per Pound

100000

10000

110000

Variable costs Direct Material 1 100000 10000 110000 Variable manufacturing overhead 0.75 75000 7500 82500 Sales commissions 0.5 50000 50000 Direct manufacturing labour 0.25 25000 2500 27500 Totala Variable costs - (A) 2.5 250000 20000 270000 Fixed Costs Inspection Team cost 1000 1000 Advertising 3000 3000 Customer hotline charges 4000 4000 Machine setups 40000 40000 Plant machinary lease 12000 12000 Total Fixed Cost - (B) 59000 1000 60000 Total Cost - (A + B) 309000 1000 310000 Total Cost per Pound

= $3.09

= $2.82

a. Selling price of Pound = $2.2 Variable Cost for 10000 pounds = 20000 Inspection cost = 1000 Total cost = 21000 Total Cost per pound (21000 / 10000) = $2.1 Revenue = $0.10 b. For 10000 Variable Costs pounds Direct Material 1 10000 Variable manufacturing overhead 0.75 7500 Direct manufacturing labour 0.25 2500 Totala Variable costs - (A) 2 20000 Fixed Cost Inspection team cost 1000 Total Cost 21000 Total cost per pound (21000 / 10000) = $2.1 c. If we prodece only 100000 pounds Cost per pound = $3.09 If we produce 110000 pounds Cost per pound is   = $2.82 We can save Per pound = $0.27 For 110000 pounds   (110000 * 0.27) = $29,700

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