QUESTION 3

Accept or Reject a Special Order

Drip-right Corporation manufactures faucets. Several weeks ago, the company received a special-order inquiry from MacDonald Incorporated. MacDonald desires to market a faucet similar to Drip-right's Model No. 32 and has offered to purchase 3,000 units. The following data are available:

• Cost data for Drip-right's Model No. 32 faucet: direct materials, $45; direct labour, $30 (2 hours at $15 per hour); and manufacturing overhead, $70 (2 hours at $35 per hour).
• The normal selling price of Model No. 32 is $180; however, MacDonald has offered Drip-right only $115 because of the large quantity it is willing to purchase.
• MacDonald requires a design modification that will allow a $4 reduction in direct-material cost.
• Drip-right's production supervisor notes that the company will incur $8,700 in additional set-up costs and will have to purchase a $3,300 special device to manufacture these units. The device will be discarded once the special order is completed.
• Total manufacturing overhead costs are applied to production at the rate of $35 per labour hour. This figure is based, in part, on budgeted yearly fixed overhead of $624,000 and planned production activity of 24,000 labour hours.
• Drip-right will allocate $5,000 of existing fixed administrative costs to the order as "part of the cost of doing business."

Required:

1. One of Drip-right's staff accountants wants to reject the special order because "financially, it's a loser." Do you agree with this conclusion if Drip-right currently has excess capacity? Show calculations to support your answer.

2. If Drip-right currently has no excess capacity, should the order be rejected from a financial perspective? Briefly explain.

3. Assume that Drip-right currently has no excess capacity. Would outsourcing be an option that Drip-right could consider if management truly wanted to do business with MacDonald? Briefly discuss, citing several key considerations for Drip-right in your answer.