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Acceptance of special order

3. (special Order) Catherine Chancellor Manufacturing, Inc. is presently operating at 50% of practical capacity producing about 50,000 units annually of a patented electronic component. Chancellor recently received an offer from a company in Yokohama, Japan, to purchase 30,000 components at $6.00 per unit, FOB Chancellor's plant. Chancelor has not previously sold components in Japan. Budgeted production costs for 50,000 and 80,000 units of output follow:

Units 50,000 80,000
Direct Material $75,000 $120,000
Direct Labour 75,000 120,000
Manf. Overhead 200,000 260,000
Total costs $350,000 $500,000

Cost per unit $7.00 $6.25

The sales manager, Jack Abbott, thinks the order should be accepted, even if the results in a loss of $1.00 per unit, because he feels that the sale may build up future markets. The production manager does not wish to have order accepted primarily because the order would show a loss of $0.25 per unit when computer on the new average unit cost. The treasure, Jill Abbott, has made a quick computation indication that accepting the order will actually increase gross margin.

a) Explain what apparently caused the drop in cost from $7.00 per unit to $6.25 per unit when budgeted production increased from 50,000 to 80,000 units.

i) Explain whether (either or both) the production manager and the treasure are reasoning correctly
ii) Explain why the conclusions of the production manger and treasure differ

c) Explain why each of the following may affect the decision to accept or reject the special order:

i) The likelihood of repeat special sales/and or all sales to be made at $6.00 per unit.
ii) Whether the sales are made to customers operating in two seprate, isolated markets or whether the sales are made to customers competing in the same markets.

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Solution Summary

The solution contains acceptance of special order at reduced price and the factors to be considered while taking the decision.