Case Study Gamma Company manufactures soft drinks. Its manufacturing plant has t

Question

Case Study

Gamma Company manufactures soft drinks. Its manufacturing plant has the capacity to produce 10,000 cases each month; current production and sales are 7,500 cases per month.

The company normally charges $150 per case. Cost information for the current activity level is as follows:

Variable costs that vary with units produced

Direct materials ---------------------------------------------$ 262,500

Direct manufacturing labour -------------------------------- 300,000

Variable costs (for setups, materials handling, quality control, and so on) that vary with number of batches, 150

batches x $500 per batch ---------------------------------------75,000

Fixed manufacturing costs ------------------------------------275,000

Fixed marketing costs -----------------------------------------175,000

Total costs ---------------------------------------------------$ 1,087,500

Gamma Company has just received a special one-time-only order for 2,500 cases at $100 per case. Gamma Company usually makes its soft drinks for its existing customers in batch sizes of 50 case (150 batches x 50 cases per batch = 7,500 cases). The special order requires them to make the cases in 25 batches of 100 each.

Required:

(a) Should Gamma Company accept this special order? Why? Explain briefly. (For this question, I'm assuming that comparative table is required).

(b) Suppose plant capacity was only 9,000 cases instead of 10,000 cases each month. The special order must either be taken in full or rejected totally. Should Gamma Company accept the special order?

(c) As in requirement (a) assume that monthly capacity is 10,000 cases. Gamma Company is concerned that if it accepts the special order, its existing customers will immediately demand a price discount of $10 in the month in which the special order is being filled. They would argue that Gamma Company capacity costs are now being spread over more units, and that existing customers should get the benefit of these lower costs. Should Gamma Company accept the special order under these conditions? Show all calculations.

Explanation / Answer

1 Revenue 250000 (2500*100) Variable cost Direct material 87500 (2500*35) Direct labor 100000 (2500*40) Other variable cost 50000 (100*500) Total variable cost 237500 Net increase in profit 12500 2 First 1500 1000 from regular Revenue 150000 100000 Cost involved Direct material 52500 35000 Direct labor 60000 40000 Other variable cost 30000 20000 Profit lost from regular sale 5000 (37500*1000/7500) Total cost 142500 100000 Net increase in profit 7500 0 Total increase 7500 3 Revenue 250000 (2500*100) Variable cost Direct material 87500 (2500*35) Direct labor 100000 (2500*40) Other variable cost 50000 (100*500) Decrease in price 112500 (7500*150*10%) Total variable cost 350000 Net decrease in profit -100000

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