Question $3-$ Pricing and decision making

Part A

$(25$ marks$)$

Luzern Company will use absorption cost$-$plus pricing to set the selling price on a newly developed product. The company plans to invest $$280,000$ in operating assets to produce and sell $24,000$ units of this new product. Its required return on investment $($ROI$)$ in its operating assets is $15\%.$ The chief accountant has provided the following estimates for the new product at the activity level of $24,000$ units.

Required:

Direct materials

Direct labor

Variable manufacturing overhead

Fixed manufacturing overhead

Variable selling and administrative expenses Fixed selling and administrative expenses

$($Round all the answers to two decimal places$)$

$$3$

$$4$

$$1\mathrm{.}5$

$$3\mathrm{.}5($$$84,000$ total$)$

$$0\mathrm{.}75$

$$0\mathrm{.}5($$$12,000$ total$)$

$($a$)$

Compute the selling price for the new product using absorption cost$-$plus pricing.

$(5$ marks$)$

$($b$)$

Suppose that the company actually produced and sold only $21,000$ units at the selling price derived from $($a$).$ Compute the ROI that the company could actually earn at this sales volume $(4$ marks$)$

$($c$)$

Assume that the company decides to raise the selling price of the new product for achieving the company's desired ROI at this lower activity level of $21,000$ units. Compute the new selling price using ab sorption cost$-$plus pricing.

$(4$ marks$)$

$($Please turn to the next page$)$

Question $3($Con$\text{'}$t$)$ Part B

ClearAir Company is a manufacturer of air purifier. The company has the capacity to produce $8,000$ air purifiers per year. The normal selling price of an air purifier is $$450$ per unit. The company currently produces and sells $6,000$ air purifiers per year. The cost information for the current level of activity is provided as follows:

Direct materials

Direct labor

Variable manufacturing overhead

Fixed manufacturing overhead $($$$540,000$ total$)$ Variable selling expense

Fixed selling expense $($$$180,000$ total$)$

Per unit

$$120$

$$80$

$$60$

$$90$

$$40$

$$30$

Total cost

$$420$

The city government has offered to purchase $1,200$ air purifiers from the company for the city's public libraries. Accepting this special order would not affect the company's regular business nor its fixed costs. Given that there would be no sales commissions on this order, the variable selling expense would be reduced by $40\%.$ However, the city government requires the company to conduct an additional quality test of all $1,200$ air purifiers, which costs $$24,000$ in total.

Required:

$($Round all the answer to two decimal places$)$

$($d$)$

Compute the break$-$even price for this special order.

$(4$ marks$)$

$($e$)$

Assume that ClearAir wants to achieve an incremental profit of $$30,000$ from this special order, compute the minimum price that ClearAir should charge on this special order.

$(3$ marks$)$

$(1)$

Refer to the original data. Suppose that the production capacity of ClearAir were only $6,800$ purifiers instead of $8,000$ purifiers. Compute the break$-$even price for this special order. $(5$ marks$)$