West Coast Digital $($WCD$)$ produces high$-$quality audio and video equipment. One of the company$$s most

popular products is a high$-$definition personal video recorder $($PVR$)$ for use with digital television systems.

Demand has increased rapidly for the PVR over the past three years, given the appeal to customers of being able

to easily record programs while they watch live television, watch recorded programs while they record a

different program, and save dozens of programs for future viewing on the unit$$s large internal hard drive.

A complex production process is utilized for the PVR involving both laser and imaging equipment. WCD has a

monthly production capacity of $4,000$ hours on its laser machine and $1,000$ hours on its image machine.

However, given the recent increase in demand for the PVR$,$ both machines are currently operating at $90\%$ of

capacity every moth, based on existing orders from customers. Direct labor costs are $$15$ and $$20$ per hour to

operate, respectively, the laser and image machines.

The revenue and costs on a per unit basis for the PVR are as follows:

Selling price $$320\mathrm{.}00$

Cost to manufacture:

Direct materials $$50\mathrm{.}00$

Direct labour $$ laser process $60\mathrm{.}00$

Direct labour $$ image process $20\mathrm{.}00$

Variable overhead $40\mathrm{.}00$

Fixed overhead $50\mathrm{.}00$

Variable selling costs $20\mathrm{.}00240\mathrm{.}00$

Operating profit $$80\mathrm{.}00$

On December $1,$ Dave Nance, vice$-$president of Sales and Marketing at WCD$,$ received a special$-$order request

from a prospective customer, Scottie Barnes Limited, which has offered to buy $250$ PVR$$s at $$280$ per unit if the

product can be delivered by December $31$st$.$ Scottie Barnes Limited is a large retailer with outlets that specialize

in audio and video equipment. This special order from Scottie Barnes Limited is in addition to orders from

existing customers that are utilizing $90\%$ of the production capacity each month. Variable selling costs would not

be incurred on this special order. Scottie Barnes Limited is not willing to accept anything less than the $250$ PVR$$s

requested $($i$.$e$.$ EDC cannot partially fill the order$).$

Before responding to the customer, Nance decided to meet with Dianne Davis, the product manager for the

PVR$,$ to discuss whether to accept the offer from Scottie Barnes Limited. An excerpt from their conversation

follows:

Nance: I$$m not sure we should accept the offer. This customer is really playing hardball with its terms and

conditions.

Davis: Agreed, but it is a reputable company and I suspect this is the way it typically deals with its suppliers. Plus,

this could be the beginning of a profitable relationship with Scottie Barnes Limited since the company may be

interested in some of our other product offerings in the future.

Nance: That may be true, but I$$m not sure we should be willing to incur such a large opportunity cost just to get

our foot in the door with this client.

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BUSI $1043$ INTRODUCTION TO FINANCIAL ACCOUNTING $3$

Davis: Have you calculated the opportunity cost?

Nance: Sure, that was simple. Scottie Barnes Limited is offering $$280$ per unit and we sell to our regular

customers at $$320$ per unit. Therefore, we$$re losing $$40$ per unit, which at $250$ units is $$10,000$ in lost revenue.

That$$s our opportunity cost and it$$s clearly relevant to the decision.

Davis: I sort of follow your logic, but I think the fact that we$$re not currently operating at full capacity needs to

be taken into consideration.

Nance: How so$?$

Davis: Well, your approach to calculating the opportunity cost ignores the fact that we aren$$t currently selling all

of the PVRs that we could produce. So$,$ in that sense we aren$$t really losing $$40$ per unit on all $250$ units required

by Scottie Barnes Limited $.$

Nance: I see your point but I$$m not clear on how we should calculate the opportunity cost.

Davis: This really isn$$t my area of expertise either, but it seems appropriate to start by trying to figure out how

many of the $250$ units required by Scottie Barnes Limited we could produce without disrupting our ability to fill

existing orders. Then we could determine how many units we would have to forgo selling to existing customers

to make up the $250-$unit order. That would then be our opportunity cost in terms of the number of physical units

involved. Make sense?

Nance: I think so$.$ So$,$ to get the dollar amount of the opportunity cost of accepting the $250-$unit order from

Scottie Barnes Limited we$$d then simply multiply the number of units we$$d have to forgo selling to existing

customers by $$40.$ Correct?

Davis: I$$m not so sure about the $$40.$ I think we somehow need to factor in the incremental profit we typically

earn by selling each PVR to existing customers to really get to the true opportunity cost.

Nance: Now I$$m getting really confused. Can you work through the numbers and get back to me$?$

Davis: I$$ll try.

Nance: Thanks. And by the way, Scottie Barnes Limited is calling in an hour and wants our answer.

Required:

$1.$ Is Davis$$s general approach to ca