Considering three alternatives. (CMA) The Auer Company had just completed an order for a special machine from the Jay Company when the Jay Company declared bankruptcy, defaulted on the order, and forfeited the 10% deposit paid on the selling price of $79,750.

Auer’s manufacturing manager identified the costs already incurred in the production of the special machine forJay as follows:

Direct materials used Direct manufacturing labour incurred Overhead allocated:

Manufacturing:

Variable $11,770 Fixed 5,885 Fixed marketing and administration Total costs

$18,260 23,540 17,665 5,945

$65,400 Another company, the Kaytell Corporation, would be interested in buying the spe¬

cial machine ifit is reworked to Kaytell’s specifications. Auer offered to sell the reworked machine to Kaytell as a special order for a net price (price minus cash discount, if any) of

$75,240. Kaytell has agreed to pay the net price when it takes delivery in two months.

The additional traceable costs to rework the machine to Kaytell’s specifications are as follows:

Direct materials Direct manufacturing labour

$ 6,820 4,620

$11,440 A second alternative available to Auer is to convert the special machine to the standard model. The standard model lists for $68,750. The additional incremental costs to convert the special machine to the standard model are Direct materials $3,135 Direct manufacturing labour 3,630

$6/765 A third alternative for the Auer Company is to sell, as a special order, the machine as is

(that is, without modification) for a net price of $57,200. However, the potential buyer of the unmodified machine does not want it for 60 days. The buyer offers a $7,700 down payment with final payment upon delivery.

The following additional information is available regarding Auer’s operations:

The sales commission rate is 2% on sales ofstandard models and 3% on special orders. All sales commissions are calculated on net selling price (that is, list price minus cash discount, if any).

Normal credit terms for sales ofstandard models are 2/10, n/30 (2/10 means a discount of 2% is given if payment is made within 10 days; n/30 means the full amount is due within 30 days). Customers take the discounts except in rare instances. Credit terms for special orders are negotiated with the customer.

The allocation rates for manufacturing overhead and the fixed marketing and administra¬

tive costs are Manufacturing:

Variable 50% of direct manufacturing labour costs Fixed 25% of direct manufacturing labour costs Marketing and administration:

Fixed 10% ofthe total of direct materials, direct manufacturing labour costs, and manufacturing overhead costs Normal time required for rework is one month.
A surcharge of 5% ofthe selling price is placed on all customer requests for minor modifi¬
cations ofstandard models.
Auer normally sells a sufficient number ofstandard models for the company to operate at a volume in excess ofthe breakeven point.
Auer does not consider the time value of money in their analyses ofspecial orders whenever the period is less than one year, because the effect is not significant.
Required 1. Determine the dollar contribution that each of the three alternatives will add to the Auer Company’s operating income.
2. If Kaytell makes Auer a counteroffer, what is the lowest price Auer should accept from Kaytell for the reworked machine? Explain your answer.
3. Discuss the influence that fixed manufacturing overhead costs should have on the selling prices Auer quotes for special orders when

(a) the firm is operating at or below the breakeven point and

(b) the firm’s special orders constitute efficient utilization of unused capacity above the breakeven point.