Pea Ridge Corporation manufactures faucets. Several weeks ago, the company received a special-order inquiry from Galena, Inc. Galena desires to market a faucet similar to Pea Ridge's model no. 55 and has offered to purchase 3,000 units. The following data are available: · Cost data for Pea Ridge's model no. 55 faucet: direct materials, $45; direct labor, $30 (2 hours at $15 per hour); and manufacturing overhead, $70 (2 hours at $35 per hour).· The normal selling price of model no. 55 is $180; however, Galena has offered Pea Ridge only $115 because of the large quantity it is willing to purchase.· Galena requires a design modification that will allow a $4 reduction in direct-material cost.· Pea Ridge'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 labor hour. This figure is based, in part, on budgeted yearly fixed overhead of $624,000 and planned production activity of 24,000 labor hours.· Pea Ridge will allocate $5,000 of existing fixed administrative costs to the order as "part of the cost of doing business."Required: A. One of Pea Ridge's staff accountants wants to reject the special order because "financially, it's a loser." Do you agree with this conclusion if Pea Ridge currently has excess capacity? Show calculations to support your answer.B. If Pea Ridge currently has no excess capacity, should the order be rejected from a financial perspective? Briefly explain.C. Assume that Pea Ridge currently has no excess capacity. Would outsourcing be an option that Pea Ridge could consider if management truly wanted to do business with Galena? Briefly discuss, citing several key considerations for Pea Ridge in your answer.
What will be an ideal response?
A. No, the conclusion is incorrect because the order generates a net contribution of $66,000 for the firm. Note: The fixed administrative cost is irrelevant to the decision.
| Selling price | ? | ? | $115 |
| Less: Direct materials ($45 - $4) | ? | $41 | ? |
| Direct labor | ? | 30 | ? |
| Variable manufacturing overhead (2 hours × $9*) | ? | 18 | 89 |
| Unit contribution margin | ? | ? | $26 |
| ? | ? | ? | ? |
| Total contribution margin (3,000 × $26) | ? | $78,000 | ? |
| Less: Additional set-up costs | $8,700 | ? | ? |
| Special device | 3,300 | 12,000 | ? |
| Net contribution to profit | ? | $66,000 | ? |
*Fixed manufacturing overhead: $624,000 ÷ 24,000 labor hours = $26 per hour
Variable manufacturing overhead: $35 - $26 = $9
B. Yes, the order should be rejected. An environment of no excess capacity implies a very strong marketplace. Pea Ridge would be giving up sales at $180 per faucet, to be replaced with sales of $115 per unit and the need to incur additional set-up costs and the cost of a special device. Company profitability would suffer.
C. Yes, outsourcing is an option. Pea Ridge could have another manufacturer produce the faucets for Galena or perhaps even for another customer. Price, product quality, and supplier reliability would be important considerations in this decision. As in all special order decisions, if Pea Ridge's regular customers find out that Galena is purchasing the faucets at a lower price than them, there may be negative repercussions.
You might also like to view...
Those who embrace the ______ school believe a social entrepreneur is a change agent who produces change that improves the condition of people and society.
A. nonprofit sector B. corporate world C. social enterprise D. social innovation
Scrum uses a series of coordinated meetings to manage the development process. Which of the following is held at the start of each sprint? During this meeting the product owner and development team negotiate which product backlog items the team will attempt during the next sprint.
A. Release planning meeting B. Sprint retrospective meeting C. Sprint planning meeting D. Daily Scrum meeting E. Sprint review meeting
Which of the following property is NOT affected by a will?
a. life insurance b. personal property c. anatomical gifts d. individual bank accounts
Jake has asked Len to be a primary investor in his entrepreneurial start-up. Len first wants to carefully study Jake's business plan, in particular these key factors:
A. the clients, the opportunity, the competition, the context, and the risk/reward. B. the people, the threats, the partners, the context, and the risk/reward. C. the people, the other investors, the suppliers, the context, and the opportunities/threats. D. the clients, the other investors, the suppliers, the context, and the opportunities/threats. E. the people, the opportunity, the competition, the context, and the risk/reward.