Problem 8-60. Accept or Reject a Special Order Oblectlvel 2 Steve Murningham, manager of an electronics division, was considering an offer by Pat Sellers, manager of a sister division. Pat's division was operating be- low capacity and had just been given an opportunity to produce 8,000 units of one of its products for a customer in a market not normally served. The opportunity in- volves a product that uses an electrical component produced by Steve's division. Each unit that Pat's division produces re- quires two of the components. However, the price that the customer is willing to pay is well below the price that is usually charged. To make a reasonable profit on the order, Pat needs a price concession from Steve's division. Pat had offered to pay full manufacturing cost for the parts. 80 Steve would know that everything was above board, Pat supplied the fol- lowing unit cost and price information concerning the special order, excluding the cost of the electrical component: Selling price $32 Less costs: 'Ml Direet materials 1 Direct labor Variable overhead Fixed overhead l... .. 9'} DJ Operating prot The normal selling price of the electri- cal component is $2.30 per unit. Its full manufacturing cost is $1.85 ($1.05 vari- able and $0.80 fixed). Pat argued that paying $2.30 per component would wipe out the operating profit and result in her division showing a loss. Steve was inter- ested in the offer because his division was also operating below capacity. (The order would not use all the excess capacity.) Required: 1. Conceptual Connection Should Steve accept the order at a selling price of $1.85 per unit? By how much will his division's profits be changed if the order is accepted? By how much will the profits of Pat's di- vision change if Steve agrees to sup- ply the part at full cost? Answer i Check Figure: Increase Pat's rofit = $18,400 2. Conceptual Connection Suppose that Steve offers to supply the com- ponent at $2. In offering this price, Steve says that it is a firm offer, not subject to negotiation. Should Pat accept this price and produce the special order? If Pat accepts the price, What is the change in profits for Steve's division? Answer i Check Figure: Increase Steve's profit = $15,200 3. Conceptual Connection Assume that Steve's division is operating at full capacity and that Steve refuses to supply the part for less than the full price. Should Pat still accept the special order? Explain.Problem 8-63. Special-Order Decision, Qualitative Aspects Oblectlvel 2 Randy Stone, manager of Specialty Paper Products Company, was agonizing over an offer for an order requesting 5,000 boxes of calendars. Specialty Paper Products was operating at 70% of its ca- pacity and could use the extra business. Unfortunately, the order's offering price of $4.20 per box was below the cost to produce the calendars. The controller, Louis Barns, was opposed to taking a loss on the deal. However, the personnel manager, Yatika Blaine, argued in favor of accepting the order even though a loss would be incurred. It would avoid the problem of layoffs and would help to maintain the company's community im- age. The full cost to produce a box of cal- endars follows: Direct materials $1.15 Direet labor 2.00 Variable overhead 1.10 Fixed overhead 100 Toral $5.25 Later that day, Louis and Yatika met over coffee. Louis sympathized with Yatika's concerns and suggested that the two of them rethink the special-order de- cision. He offered to determine relevant costs if Yatika would list the activities that would be affected by a layoff. Yatika eagerly agreed and came up with the fol- lowing activities: an increase in the state unemployment insurance rate from 1% to 2% of total payroll, notification costs to lay off approximately 20 employees, and increased costs of rehiring and retraining workers when the downturn was over. Louis determined that these activities would cost the following amounts: 0 Total payroll is $1,460,000 per year. 0 Layoff paperwork is $25 per laid- off employee. - Rehiring and retraining is $150 per new employee. Required: 1. Conceptual Connection Assume that the company will accept the or- der only if it increases total profits (Without taking the potential layoffs into consideration). Should the com- pany accept or reject the order? Provide supporting computations. Answer l Check Figure: Loss per box = ($0.05) 2. Conceptual Connection Consider the new information on activity costs associated with the layoff. Should the company accept or reject the order? Provide supporting computations