This is a special order problem that also requires that you use the high low met

Question

This is a special order problem that also requires that you use the high low method to estimate some cost function parameters. For guidance, you may want to review the high-low method lectures in Module 1 and the high-low study problem solutions. As with almost all of the analyses that we have done, determining variable and fixed costs, and knowing what to do with them, is critical.

Huang Automotive is presently operating at 75% of capacity. The company recently received an offer from a Korean truck manufacturer to purchase 29,500 units of a power steering system component for $190 per unit. Peter Wu, vice-president of sales, notes that although there will be an additional $3.00 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 $190 per unit offer is not only below the regular $270 selling price, but it's below the unit cost of the component. She also points out that there will be additional setup costs of $265,000 and that Huang will have to lease some special equipment for $230,000. Required 1. What would the expected profit be on the special order (use a negative sign for a loss)?

208,000 units 238,000 units Direct material costs $18,304,000 $20,944,000 Direct labor costs 4,576,000 5,236,000 Overhead costs 23,004,000 24,519,000 Selling and administrative costs 11,672,000 11,942,000 Total costs $57,556,000 $62,641,000 Total costs per unit $276.71 $263.20

Explanation / Answer

Using High-low method, we can calculate the variable cost per unit and the total fixed costs since the two operating levels of outputs are given

Variable cost per unit = Changes in Costs at two output levels / Changes in prodution volume

Similarly if this variable cost is applied to a production volume, the balance between the total cost and the variable cost will be the fixed costs

Hence the variable cost of the power steering system is only $169.5

Here is the calculation of the costing for the special order

208000 238000 30000 Variable cost per unit Fixed Cost Direct material costs $18,304,000 $20,944,000 $2,640,000                                  88.00 Direct labor costs 4,576,000 5,236,000 $660,000                                  22.00 Overhead costs 23,004,000 24,519,000 $1,515,000                                  50.50            12,500,000 Selling and administrative costs 11,672,000 11,942,000 $270,000                                     9.00              9,800,000 Total costs       $57,556,000 $62,641,000 $5,085,000 Total costs per unit   $276.71 $263.20 ($14)                                169.50

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