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Chapter 25: Q25-15RQ (page 1406)
When should special pricing orders be accepted?
Answer
Special pricing orders should be accepted when theunit sales price is higher than thevariable costper unit of the related product.
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Green Thumb operates a commercial plant nursery, where it propagates plants for garden centers throughout the region. Green Thumb has \(5,300,000 in assets. Its yearly fixed costs are \)625,000, and the variable costs for the potting soil, container, label, seedling, and labor for each gallon-size plant total \(1.70. Green Thumb’s volume is currently 490,000 units. Competitors offer the same plants, at the same quality, to garden centers for \)4.00 each. Garden centers then mark them up to sell to the public for \(9 to \)12, depending on the type of plant.
Requirements
1. Green Thumb’s owners want to earn an 10% return on the company’s assets. What is Green Thumb’s target full product cost?
2. Given Green Thumb’s current costs, will its owners be able to achieve their target profit?
3. Assume Green Thumb has identified ways to cut its variable costs to \(1.55 per unit. What is its new target fixed cost? Will this decrease in variable costs allow the company to achieve its target profit?
4. Green Thumb started an aggressive advertising campaign strategy to differentiate its plants from those grown by other nurseries. Green Thumb does not expect volume to be affected, but it hopes to gain more control over pricing. If Green Thumb has to spend \)135,000 this year to advertise and its variable costs continue to be $1.55 per unit, what will its cost-plus price be? Do you think Green Thumb will be able to sell its plants to garden centers at the cost-plus price? Why or why not?
Thomas Company makes a product that regularly sells for \(12.50 per unit. The product has variable manufacturing costs of \)8.50 per unit and fixed manufacturing costs of \(2.00 per unit (based on \)200,000 total fixed costs at current production of 100,000 units). Therefore, the total production cost is \(10.50 per unit. Thomas Company receives an offer from Wesley Company to purchase 5,000 units for \)9.00 each. Selling and administrative costs and future sales will not be affected by the sale, and Thomas does not expect any additional fixed costs.
1. If Thomas Company has excess capacity, should it accept the offer from Wesley? Show your calculations.
2. Does your answer change if Thomas Company is operating at capacity? Why or why not?
Oak Petroleum has spent \(202,000 to refine 63,000 gallons of petroleum distillate, which can be sold for \)6.00 per gallon. Alternatively, Oak 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, Oak must pay a sales commission of \(0.12 per gallon and a transportation charge of \)0.19 per gallon.
Requirements
1. Diagram Oak’s decision alternatives, using Exhibit 25-18 as a guide.
2. Identify the sunk cost. Is the sunk cost relevant to Oak’s decision?
3. Should Oak sell the petroleum distillate or process it into cleaner fluid? Show the expected net revenue difference between the two alternatives.
What questions should managers answer when considering selling a product as is or processing further?
Top managers of Video Avenue are alarmed by their operating losses. They are considering dropping the DVD product line. Company accountants have prepared the following analysis to help make this decision:
VIDEO AVENUE
Income Statement
For the Year Ended December 31, 2018
Total Blu-ray Discs DVD Discs
Net Sales Revenue \(437,000 \)308,000 \(129,000
Variable Costs 250,000 154,000 96,000
Contribution Margin 187,000 154,000 33,000
Fixed Costs:
Manufacturing 132,000 76,000 56,000
Selling & Administrative 65,000 51,000 14,000
Total Fixed Expenses 197,000 127,000 70,000
Operating Income (Loss) \)(10,000) \(27,000 \)(37,000)
Total fixed costs will not change if the company stops selling DVDs.
Requirements
1. Prepare a differential analysis to show whether Video Avenue should drop the DVD product line.
2. Will dropping DVDs add $37,000 to operating income? Explain.
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