Question

1. Assume that due to a recession, Polaski Company expects to sell only 41,000 Rets through regular channels next year. A large retail chain has offered to purchase 7,000 Rets if Polaski is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; thus, variable selling expenses would be slashed by 75%. However, Polaski Company would have to purchase a special machine to engrave the retail chain’s name on the 7,000 units. This machine would cost $14,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. What is the financial advantage (disadvantage) of accepting the special order? (Round your intermediate calculations to 2 decimal places.)

Answer 1

Answer:

Polaski Company

Accept or Reject a Special Order:

1) Accept:

We assume that the regular price is $50 and the product costs $30 per unit, with $5 variable selling expense per unit.

Discounted price = $42 ($50 x 84%)

Sales value = $294,000 ($42 x 7,000)

Product cost = $210,000 ($30 x 7,000)

Gross Profit       =     $84,000

Variable selling expense = $8,750 ($5 x 7,000 x 25%)

Differential Cost of machine $14,000

Net Income = $61,250

2) Reject:

Net Income from no sale of 7,000 units = $0

3) Financial Advantage:  Accepting the special order will increase the net income marginally.  Our calculated breakeven point is 933 units based on the stated assumptions.  Since the special order is 7,000 units, there will be additional net income generated if the special order is accepted than if rejected.

Explanation:

a) Break-even point:

Contribution per unit = Selling price minus variable cost

Contribution per unit = $50 - $35 = $15

Where fixed cost = $14,000

Break-even point = Fixed cost/contribution per unit

= $14,000/$15 = 933 units

b) The question involves the differential analysis of accepting or rejecting a special order.  In a differential analysis, a sunk cost is not relevant.   The cost of the machine ($14,000) to be purchased is not a sunk cost, but a differential cost.  It could only be incurred when the special order is accepted.

c) We also utilized the break-even analysis to gauge the minimum quantity at which the cost of the machine will be fully recovered.  This helps to strengthen our adopted position that the special order should be accepted.

d) Note that we assumed the following as they were not provided in the question: the selling price per unit to be $50, the product cost per unit to be $30, and the variable selling price per unit to be $5.