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Chapter 25: Q25-13RQ (page 1406)
What questions should managers answer when considering special pricing orders?
Answer
Managers must consider several factors, such as capacity required, qualitative factors, fixed costs, and more, before considering special pricing orders.
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Heavenly Dessert processes cocoa beans into cocoa powder at a processing cost of \(9,700 per batch. Heavenly Dessert can sell the cocoa powder as is, or it can process the cocoa powder further into either chocolate syrup or boxed assorted chocolates. Once processed, each batch of cocoa beans would result in the following sales revenue:
Cocoa powder \)14,500
Chocolate syrup 103,000
Boxed assorted chocolates 204,000
The cost of transforming the cocoa powder into chocolate syrup would be \(72,000. Likewise, the company would incur a cost of \)183,000 to transform the cocoa powder into boxed assorted chocolates. The company president has decided to make assorted boxed chocolates due to their high sales value and to the fact that the cocoa bean processing cost of $9,700 eats up most of the cocoa powder profits. Has the president made the right or wrong decision? Explain your answer. Be sure to include the correct financial analysis in your response.
Elm Petroleum has spent \(204,000 to refine 61,000 gallons of petroleum distillate, which can be sold for \)6.30 per gallon. Alternatively, Elm can process the distillate further and produce 58,000 gallons of cleaner fluid. The additional processing will cost \(1.80 per gallon of distillate. The cleaner fluid can be sold for \)9.10 per gallon. To sell the cleaner fluid, Elm must pay a sales commission of \(0.10 per gallon and a transportation charge of \)0.16 per gallon.
Requirements
1. Diagram Elm’s decision alternatives, using Exhibit 25-18 as a guide.
2. Identify the sunk cost. Is the sunk cost relevant to Elm’s decision?
3. Should Elm sell the petroleum distillate or process it into cleaner fluid? Show the expected net revenue difference between the two alternatives.
What are sunk costs? Give an example.
Priscilla Smiley manages a fleet of 250 delivery trucks for Daniels Corporation. Smiley must decide whether the company should outsource the fleet management function. If she outsources to Fleet Management Services (FMS), FMS will be responsible for maintenance and scheduling activities. This alternative would require Smiley to lay off her five employees. However, her own job would be secure; she would be Daniels’s liaison with FMS. If she continues to manage the fleet, she will need fleet management software that costs \(9,500 per year to lease. FMS offers to manage this fleet for an annual fee of \)300,000. Smiley performed the following analysis:
Retain in-house Outsource to FMS Difference
Annual leasing fee for \(9,500 \)9,500
Software
Annual maintenance of
Trucks 147,000 147,000
Total annual salaries of
Five laid-off employees 185,000 185,000
Fleet management
Service’s annual fee \(300,000 (300,000)
Total differential cost of
Outsourcing \)341,500 \(300,000 \)41,500
Requirements
1. Which alternative will maximize Daniels’s short-term operating income?
2. What qualitative factors should Daniels consider before making a final decision?
Sea Blue manufactures flotation vests in Charleston, South Carolina. Sea Blue’s contribution margin income statement for the month ended December 31, 2018, contains the following data:
SEA BLUE
Income Statement
For the Month Ended December 31, 2018
Sales in units 32,000
Net Sales Revenue \(608,000
Variable Costs:
Manufacturing 96,000
Selling and Administrative 108,000
Total Variable Costs 204,000
Contribution Margin 404,000
Fixed Costs:
Manufacturing 124,000
Selling and Administrative 94,000
Total Fixed Costs 218,000
Operating Income \)186,000
Suppose Overboard wishes to buy 4,600 vests from Sea Blue. Sea Blue will not incur any variable selling and administrative expenses on the special order. The Sea Blue plant has enough unused capacity to manufacture the additional vests. Overboard has offered \(15 per vest, which is below the normal sales price of \)19.
Requirements
1. Identify each cost in the income statement as either relevant or irrelevant to Sea Blue’s decision.
2. Prepare a differential analysis to determine whether Sea Blue should accept this special sales order.
3. Identify long-term factors Sea Blue should consider in deciding whether to accept the special sales order.
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