The GB Company manufactures a variety of electric motors. The business is currently operating at about 70 per cent of capacity and is earning a satisfactory return on investment.

International Industries (II) has approached the management of GB with an offer to buy 120,000 units of an electric motor. II manufactures a motor that is almost identical to GB’s motor, but a fire at the II plant has shut down its manufacturing operations. II needs the 120,000 motors over the next four months to meet commitments to its regular customers; II is prepared to pay £19 each for the motors, which it will collect from the GB plant.

GB’s product cost, based on current planned cost for the motor, is:

£

Direct materials 5.00 Direct labour (variable) 6.00 Manufacturing overheads 9.00 Total 20.00 Manufacturing overheads are applied to production at the rate of £18.00 per direct labour hour. This overheads rate is made up of the following components:

£

Variable factory overhead 6.00 Fixed factory overhead – direct 8.00

– allocated 4.00 Applied manufacturing overhead rate 18.00 Additional costs usually incurred in connection with sales of electric motors include sales commissions of 5 per cent and freight expense of £1.00 a unit.

In determining selling prices, GB adds a 40 per cent mark-up to the product cost.

This provides a suggested selling price of £28 for the motor. The marketing department, however, has set the current selling price at £27.00 to maintain market share. The order would require additional fixed factory overheads of £15,000 a month in the form of supervision and clerical costs. If management accepts the order, 30,000 motors will be manufactured and delivered to II each month for the next four months.

Required:

(a) Prepare a financial evaluation showing the impact of accepting the II order. What is the minimum unit price that the business’s management could accept without reducing its operating profit?

(b) State clearly any assumptions contained in the analysis of

(a) above and discuss any other organisational or strategic factors that GB should consider.

AppendixLO1