91Ó°ÊÓ

(CMA, adapted) The Award Plus Company manufactures medals for winners of athletic events and other contests. Its manufacturing plant has the capacity to produce 10,000 medals each month. Current production and sales are 7,500 medals per month. The company normally charges \(\$ 150\) per medal. Cost information for the current activity level is as follows: Award Plus has just received a special one-time-only order for 2,500 medals at \(\$ 100\) per medal. Accepting the special order would not affect the company's regular business. Award Plus makes medals for its existing customers in batch sizes of 50 medals \((150 \text { batches } \times 50 \text { medals per batch }=7,500\) medals). The special order requires Award Plus to make the medals in 25 batches of 100 each. 1\. Should Award Plus accept this special order? Show your calculations. 2\. Suppose plant capacity were only 9,000 medals instead of 10,000 medals each month. The special order must either be taken in full or be rejected completely. Should Award Plus accept the special order? Show your calculations. 3\. As in requirement 1 , assume that monthly capacity is 10,000 medals. Award Plus is concerned that if it accepts the special order, its existing customers will immediately demand a price discount of \(\$ 10\) in the month in which the special order is being filled. They would argue that Award Plus's capacity costs are now being spread over more units and that existing customers should get the benefit of these lower costs. Should Award Plus accept the special order under these conditions? Show your calculations.

Step by step solution

01

Analyze Current Capacity and Special Order Capacity

Currently, Award Plus has the capacity to produce 10,000 medals per month. They are only producing and selling 7,500 medals, implying 2,500 unused capacity. The special order for 2,500 medals fits within this unused capacity.

02

Calculate Incremental Costs for Special Order

Since the special order fits within the available capacity, the relevant cost is the variable cost of producing the additional 2,500 medals. Fixed costs will remain unchanged as they are already covered by the existing production.

03

Calculate Revenue from Special Order

The special order price is \(100 per medal. For 2,500 medals, revenue from the special order equals \(2,500 \times 100 = \\)250,000\).

04

Calculate Contribution Margin with Special Order

Award Plus should calculate the contribution from the special order: \(\text{Contribution} = \text{Revenue} - \text{Variable Costs}\). If only variable costs are considered, any positive contribution implies that the order should be accepted.

05

Consider Reduced Capacity Scenario

If capacity were only 9,000 medals per month, Award Plus could no longer fit the new order under the current production. Award Plus would need to forego 2,500 existing sales at \(150 per medal leading to a revenue loss of \(2,500 \times 150 = \\)375,000\), not offset sufficiently by $250,000 from the special order. The order should be rejected.

06

Evaluate Impact of Existing Customer Discount Demand

If existing customers demand a \(10 discount, the regular price drops to \)140. New revenue = \(7,500 \times 140 = \\(1,050,000\). Compare this with previous revenue \(7,500 \times 150 = \\)1,125,000\). The loss on existing sales \(\\(75,000\) offsets the special order revenue \(\\)250,000\), leading to just \$175,000 additional, but with reduced customer satisfaction, possibly leading to further implications.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Special Order Decision

When a company receives an offer to produce or sell products beyond its regular sales orders, it is considered a special order decision. This involves evaluating the short-term financial impact of accepting such an order. In our exercise, Award Plus Company has been offered a special order to manufacture 2,500 medals at a lower price of $100 per medal, compared to its usual $150 per medal.
To make this decision, it's important to first assess if the company has the production capacity to handle the special order without affecting its current operations. In this case, the current production is 7,500 medals, with a total capacity of 10,000 medals, leaving room for the special order. The next steps include analyzing incremental costs and incremental revenues to determine if the special order is financially beneficial.

Incremental Cost Analysis

Incremental cost analysis involves identifying and calculating the additional costs incurred if the special order is accepted. It focuses on variable costs, which change based on the level of production.
For Award Plus, accepting the special order of 2,500 medals involves increasing production without incurring additional fixed costs since they remain constant within the available capacity. The primary consideration will be the additional costs of materials, labor, and any other variable costs associated with manufacturing the extra medals.
To determine if the special order is beneficial, you calculate if the revenue from the order covers these incremental costs. The aim is to ensure that any extra revenue from the special order exceeds or at least equals these costs, ensuring a positive financial contribution.

Contribution Margin Analysis

Contribution margin analysis calculates how much of the revenue from a special order exceeds the variable costs, contributing to fixed costs and profits.
For the special order of 2,500 medals priced at $100 each, the total revenue from the order amounts to $250,000. By subtracting the variable costs for producing these extra medals from this revenue, Award Plus determines its contribution margin.
The higher the contribution margin, the more favorable it is to accept the order, as it indicates that the additional revenue helps cover fixed costs and potentially increases profits. If the contribution is positive, the financial benefit supports accepting the special order, assuming no impact on regular business operations.

Capacity Management

Capacity management is crucial when handling production decisions, especially for special orders. It involves planning and allocating resources so production capabilities align with demand without incurring inefficient costs.
Award Plus has a production capacity of 10,000 medals monthly, with current orders for 7,500 medals. Accepting the special order of 2,500 medals fits perfectly within this capacity, efficiently utilizing resources without overextending existing capabilities.
However, if the company only had a capacity of 9,000 medals, it would need to make decisions about which orders to prioritize. Reducing regular sales to accommodate the special order might lead to greater revenue loss than the special order provides, making it unwise to accept such an order. Effective capacity management ensures that all choices maximize profits while maintaining operational efficiency.