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Budgeting Problem

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Herrestad Company sells two products and the details below will be used.

Background information
Total Prod A Prod B
Beginning inventory 0
Units produced 10,000 2,500 7,500
Units sold 8,000 2,000 6,000

Selling price per unit $250 460 180
Variable costs per unit
Direct material 100 280 40
Direct labor 50 50 50
Variable overhead 30 45 25
Variable selling and admin. exp. 10 13 9

Fixed costs
Fixed manufacturing overhead 200,000
Fixed selling and administrative 100,000

Production runs (not $) 100 65 35
Number of sales reps (not $) 25 15 10

Herrestad Company receives an offer to make a new product, called C, for a new customer. The customer wants to buy 1,000 units. Product C has the same cost structure as product B with three exceptions. The new customer is only willing to pay $150 per unit, direct materials costs will decrease by $12 per unit and Herrestad does not have to incur any variable selling and administrative expenses.

- Make a table of the expenses and amounts that are relevant for this decision. How much will the sale of this product contribute to the profitability of Herrestad?
- What if the company only pays $140 per unit? How does this change the contribution towards profitability? Make a table to show the difference.
- If you were the manager, would you accept this order? What considerations, other than financial, would enter into your decision?

See attachment for proper formatting.

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Solution Preview

Thanks for your question!

Please see the attached Word document and Excel spreadsheet for correct formatting of the charts.

To answer this question, it would be helpful to first make a chart of the information given to us in the problem. The following chart shows the cost structure of Product C:

(see attachment)

To see how the sale of this product will affect Herrestad's profitability, we must first calculate the contribution margin of each unit. Contribution margin is defined as: (Selling Price Per ...

Solution Summary

Complete explanation of a company manufacturing 2 products. Comparison of direct material and direct labor at different sales prices and resulting profits. Complete explanation with MS Word docs including graphs and MS Excel spreadsheet.