Alert company sells a high quality watch at $750 per unit to specialty stores that provide various watches and auxiliary products. Alert Company is manufacturing and selling 25,000 units of its high quality watch a year using only 80% capacity. The variable cost is $500 per watch and the annual fixed cost is $2,000,000. If Alert Company would reduce its capacity size to the current production level, it could save 15% of the fixed costs. Alert Company was recently contacted by a department store who is willing to buy 6,000 units of the watch at $600 per unit. The Alert's managers strongly believe that the department store intends to sell several high quality watch items at lower prices than the prices charged by specialty stores from now on. Alert Company estimates that there will be 8% cannibalization of existing sales due to the department store's low pricing strategy on watches. Alert Company has to decide whether to accept or reject the department store's proposal.

A. Do you think fixed costs are relevant to this decision? Explain.

B. First, compute the contribution margin on the 8% cannibalized sales. Then, discuss whether or not this amount is relevant to the decision.

C. According to you answers in A and B, decide whether or not Diamond Company should accept the department store's proposal. Show the calculations supporting your conclusion. In the decision and calculation for C, you may want to add your own assumption -- for instance, another potential source of sales cannibalization.