Huang Automotive is presently operating at 75% of capacity. The company recently
ID: 2445969 • Letter: H
Question
Huang Automotive is presently operating at 75% of capacity. The company recently received an offer from a Korean truck manufacturer to purchase 20,500 units of a power steering system component for $195 per unit. Peter Wu, vice-president of sales, notes that although there will be an additional $2.50 shipping cost for each component, he thinks that accepting the order will get the company's "foot in the door" of an expanding international market.
Huang's production and cost information for the last two years for the component are as follows:
T.J. Chan, vice-president of engineering, feels that any new market should first show its profitability and that the $195 per unit offer is not only below the regular $260 selling price, but it's below the unit cost of the component. She also points out that there will be additional setup costs of $275,000 and that Huang will have to lease some special equipment for $255,000.
Questions
1. What would the expected profit be on the special order (use a negative sign for a loss)?
Explanation / Answer
Calculation of expected profit / (loss) on the special order:
Calculation of Variable costs per unit :
Level
Difference
Variable Cost per unit
201,000 units
238,000 units
37000 Units
A
B
C = A-B
C / 37000
Direct material costs
$ 16,381,500.00
$ 19,397,000.00
$ 3,015,500.00
$ 81.50
Direct labor costs
$ 4,723,500.00
$ 5,593,000.00
$ 869,500.00
$ 23.50
Overhead costs
$ 23,751,000.00
$ 25,638,000.00
$ 1,887,000.00
$ 51.00
Selling and administrative costs
$ 11,711,500.00
$ 12,137,000.00
$ 425,500.00
$ 11.50
Calculation of Relevant cost of Order:
Units
Cost per unit
Total Cost
Variable Costs:
A
B
A*B
Direct material costs
20500
$ 81.50
$ 1,670,750.00
Direct labor costs
20500
$ 23.50
$ 481,750.00
Overhead costs
20500
$ 51.00
$ 1,045,500.00
Selling and administrative costs
20500
$ 11.50
$ 235,750.00
Shipping cost
20500
$ 2.50
$ 51,250.00
Fixed Costs:
Additional setup costs
275000
lease of special equipment
255000
Total Relevant Cost of the order (A)
$ 4,015,000.00
Total Selling Price of the order (20500*195) (B)
$ 3,997,500.00
Expected profit / (loss) on the special order = B-A
$ (17,500.00)
Hence there shall be expected loss
Calculation of expected profit / (loss) on the special order:
Calculation of Variable costs per unit :
Level
Difference
Variable Cost per unit
201,000 units
238,000 units
37000 Units
A
B
C = A-B
C / 37000
Direct material costs
$ 16,381,500.00
$ 19,397,000.00
$ 3,015,500.00
$ 81.50
Direct labor costs
$ 4,723,500.00
$ 5,593,000.00
$ 869,500.00
$ 23.50
Overhead costs
$ 23,751,000.00
$ 25,638,000.00
$ 1,887,000.00
$ 51.00
Selling and administrative costs
$ 11,711,500.00
$ 12,137,000.00
$ 425,500.00
$ 11.50
Calculation of Relevant cost of Order:
Units
Cost per unit
Total Cost
Variable Costs:
A
B
A*B
Direct material costs
20500
$ 81.50
$ 1,670,750.00
Direct labor costs
20500
$ 23.50
$ 481,750.00
Overhead costs
20500
$ 51.00
$ 1,045,500.00
Selling and administrative costs
20500
$ 11.50
$ 235,750.00
Shipping cost
20500
$ 2.50
$ 51,250.00
Fixed Costs:
Additional setup costs
275000
lease of special equipment
255000
Total Relevant Cost of the order (A)
$ 4,015,000.00
Total Selling Price of the order (20500*195) (B)
$ 3,997,500.00
Expected profit / (loss) on the special order = B-A
$ (17,500.00)
Hence there shall be expected loss
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