Solving Chapter four: problems

1. De Cesare Computers makes 5,200 units of a circuit board, CB76, at a cost of $280
each. Variable cost per unit is $190 and fixed cost per unit is $90. Peach Electronics
offers to supply 5,200 units of CB76 for $260. If De Cesare buys from Peach, it will
be able to save $10 per unit in fixed costs but continue to incur the remaining $80 per
unit. Should De Cesare accept Peach’s offer? Explain.

2. Special order, short-run pricing. Slugger Corporation produces baseball bats for kids
that it sells for $36 each. At capacity, the company can produce 50,000 bats a year. The costs
of producing and selling 50,000 bats are as follows:
Cost per Bat Total
Costs

Direct materials $13 $

650,000
Direct manufacturing labor 5
250,000
Variable manufacturing 2
overhead 100,000
Fixed manufacturing overhead 6
300,000
Variable selling expenses 3
150,000
Fixed selling expenses 2
100,000
Total costs $31 $1,
550,000

a Suppose Slugger is currently producing and selling 40,000 bats. At this level of
production and sales, its fixed costs are the same as given in the preceding table. Bench
Corporation wants to place a one-time special order for 10,000 bats at $23 each.
Slugger will incur no variable selling costs for this special order. Should Slugger
accept this one-time special order? Show your calculations.
b Now suppose Slugger is currently producing and selling 50,000 bats. If Slugger
accepts Bench’s offer it will have to sell 10,000 fewer bats to its regular customers.
(a) On financial considerations alone, should Slugger accept this one-time special
order? Show your calculations. (b) On financial considerations alone, at what price
would Slugger be indifferent between accepting the special order and continuing to
sell to its regular customers at $36 per bat. (c) What other factors should Slugger
consider in deciding whether to accept the one-time special order?

NB: Please solve the above mentioned problems, make sure your answers be correct and concise.
 Solutions
Relevant and irrelevant costs.
1.
Make Buy
Relevant costs
Variable costs $190
Avoidable fixed costs 10
Purchase price ____ $260
Unit relevant cost $200 $260

DeCesare Computers should reject Peach’s offer. The $80 of fixed costs is irrelevant because it
will be incurred regardless of this decision. When comparing relevant costs between the choices,
Peach’s offer price is higher than the cost to continue to produce.

2.Special Order

1.
Revenues from special order ($23×10,000 bats) $230,000
Variable manufacturing costs ($20×10,000 bats) (200,000)
Increase in operating income if Bench order accepted $ 30,000

1
Direct materials cost per unit + Direct manufacturing labor cost per unit + Variable manufacturing overhead cost
per unit = $13 + $5 + $2 = $20

Slugger should accept Bench’s special order because it increases operating income by $30,000.
Because no variable selling costs will be incurred on this order, this cost is irrelevant. Similarly,
fixed costs are irrelevant because they will be incurred regardless of the decision.

2a. Revenues from special order ($23×10,000 bats) $230,000

Variable manufacturing costs ($20×10,000 bats) (200,000)
Contribution margin foregone ([$36─$231] ×10,000 bats) (130,000)
Decrease in operating income if Bench order accepted $(100,000)

1
Direct materials cost per unit + Direct manufacturing labor cost per unit + Variable manufacturing overhead cost
per unit + Variable selling expense per unit = $13 + $5 + $2 + $3 = $23

Based strictly on financial considerations, Slugger should reject Bench’s special order because it
results in a $100,000 reduction in operating income.
2b. Slugger will be indifferent between the special order and continuing to sell to regular
customers if the special order price is $33. At this price, Slugger recoups the variable
manufacturing costs of $200,000 and the contribution margin given up from regular customers
of $130,000 ([$200,000 + $130,000] ÷ 10,000 units = $33). That is, at the special order price
of $33, Slugger recoups the variable cost per unit of $20 and the contribution margin per unit
given up from regular customers of $13 per unit.
An alternative approach is to recognize that Slugger needs to earn $100,000 more than
the revenues of $230,000 in requirement 2a, so that the decrease in operating income of
$100,000 becomes $0. Slugger will be indifferent between the special order and continuing to
sell to regular customers if revenues from the special order = $230,000 + $100,000 = $330,000
or $33 per bat ($330,000 ÷ 10,000 bats)
Looked at a different way, Slugger needs to earn the full price of $36 less the $3 saved on
variable selling costs.

2c. Slugger may be willing to accept a loss on this special order if the possibility of future
long-term sales seem likely at a higher price. Moreover, Slugger should also consider the
negative long-term effect on customer relationships of not selling to existing customers.
Slugger cannot afford to sell bats to customers at the special order price for the long term
because the $23 price is less than the full manufacturing cost of the product of $26. This
means that in the long term, the contribution margin earned will not cover the fixed costs and
result in a loss. Slugger will then be better off shutting down.