Baker has been regularly making two products, X and Y. Demand has grown steadily in past years, but is expected to remain stable over the next 3 years. Baker is currently experiencing a shortage in its production capacity, and is not able to meet the entire demand for its two products. Its existing machinery limits capacity to 40,000 machine hours per year, while current estimated demand is 6,000 units of X and 5,000 units of Y per year.

To help in production planning, Baker's accountant supplies the following cost information drawn from its cost accounting records.

X Y

Direct materials and labor $26 $32

Support costs:

Machine maintenance 6 12

Supervision 3 5

General administration 8 5

Costs per unit $43 $54

Selling price $60 $75

Profit per unit $17 $21

Realizing that some of the support costs, in the above statements, may be fixed costs, Baker's accountant and engineer had lengthy discussions about the structure of these costs. They conclude:

(a) Machine maintenance costs vary with machine hours at the rate of $1.50 per machine hour. This was indeed the cost driver rate used to assign maintenance costs to products X and Y.

(b) The nature and costs of supervision for the two products is quite different. Therefore if Baker decides to increase production of Y and decrease production of X, these costs will indeed go up.

(c) The general administrative cost has been assigned to X and Y on the basis of direct labor hours. These costs will not change if the product mix is changed, or even if production is expanded to meet demand.

Questions

1) Determine Baker's optimal product mix for the coming year.

2) Now, suppose that Baker has been approached by Young who wishes to place a special order for 1,000 units of product Z. Even though Baker does not regularly make this product, they are technologically equipped to make it, since product Z has many technological charactersitics in common with Baker's regular production. Baker's accountant estimates that the variable production cost of product Z will be $26 per unit, and Baker's engineer estimates that 6,000 machine hours will be needed to make this special order. What is the minimum price that Baker should quote Young?

3) For this question ignore the special order for product Z. Baker acquired its existing machines several years ago at a cost of $200,000, and the current book value of these machines is $120,000 after deducting accumulated depreciation. These machines have an economic life of another 3 years. Pitt Industrial Machines has offered to replace Baker's existing machines with comparable machines that have larger capacity; 60,000 machine hours per year rather than the 40,000 hours available on Baker's existing machines. The new machines will also have an economic life of 3 years. Since the machines are comparable, the structure of Baker's operating costs will remain unchanged. Pitt is quoting a price of $220,000. They will accept Baker's existing machines at a trade-in value of $100,000, which amount can be used to reduce Pitt's asking price. Baker estimates that it will additionally incur a one time installation and start up cost of $30,000 to have the new machines installed. Should Baker accept Pitt's offer?