An order has been received from abroad, at a price that is 20% lower than the do

Question

An order has been received from abroad, at a price that is 20% lower than the domestic price, for 12,500 units to be supplied during the year. The order must be accepted in its entirety or rejected. Home demand is unlikely to change. Three options are being considered:

1.   reject the order

2.   accept the order, work to 100% capacity and turn away excess home demand,

and

3.   increase factory capacity so that the overseas order can be accepted and home demand met—this would involve purchasing new machinery at an increased relevant cost = $125,000 (depreciation of $75,000 and $50,000 interest on borrowed capital), and renting additional factory space at a cost of $25,000 per annum.

Advise management on the most profitable option and calculate the net profit to be expected.

Wade lnc. has declared the following for the year to 31 Dec 2015 Sales for the year 20,000 units (80% capacity) Direct materials Direct labour Variable overheads $'000 1,600 500 200 100 Fixed costs per annum are $650,000. Plans for the year to 31 Dec 2016 include: the selling price is to remain the same, and costs are expected to increase as follows: Direct materials Direct wages Variable overheads Fixed overheads 2% 15% 10% No increase up to 100% capacity

Explanation / Answer

Workings :-

a) 100% Capacity = 20000/0.8 = 25000 units

b) Normal selling price = 1600000/20000 = $80/ unit

Reduced selling price for New order = 80 X 80% = $64/unit

Most profitable option :-

Option 1 - Reject the order

100

Option 2 :-   accept the order, work to 100% capacity and turn away excess home demand

Note, here all variable costs will be converted to 100% by simply dividing the costs by 80%

Option 3 :-   increase factory capacity -

Home demand = 20000 units

New order = 12500 units

Therefore total units = 32500 units

Note : Here all variable costs will be for 32500 units. So we can divide above table costs by 25000 units to get per unit cost and then multiply with 32500 units

As the net profit is highest in option 3 - The management should  increase factory capacity so that the overseas order can be accepted and home demand met.

If this answer was helpful , Please leave a thumbs up! If you are unsatisfied with my answer , please leave a note in the comments section and I will try my best to clarify it for you. All the best! Thanks :) Feel free to comment for any clarifications.

($ in 000) a Sales ( 80*20000) 1600 b Direct material (500+2%) 510 c Direct Labour (200+15%) 230 d Variable Overheads (100+10%) 110 e Contribution (a-b-c-d) 750 f Fixed overheads 650 g Net profit (e-f)

100

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.