Question 1 - In 2010, Duxon Company is operating at 80% of its maximum capacity (consistently all year) of 250 direct labour hours per day. The company makes a single product used in the plumbing industry and sells all of its regular production. They anticipate that they will be able to maintain this level of sales in the foreseeable future. The company is also seeking ways to fully utilize the excess capacity and is considering an offer from a plumbing retailer to supply 10,000 units as a special order at a price of $32 per unit. The order is due in exactly 60 days. The regular selling price is $40 per unit and the standard production costs are as follows:

Direct labour (per 1/2 hour)                    $12

Direct materials                                     $8

Variable manufacturing overhead            $6

Sales commissions                                 $5

Fixed over head per unit                         $1

The company will not consider overtime production as a matter of policy and the production manager must fill the special order, if it is accepted, from the available capacity. The company works only Monday through Friday, 50 weeks per year. There will be no commissions or other administrative costs associated with the special order. The customer will not accept the order if it is delayed beyond the 60-day deadline and will not accept an order quantity less than 10,000 units.

Required:

a) Indicate whether the special order should be accepted. Use incremental analysis and show all calculations.

b) Calculate at what price per unit for the special order will Duxon be indifferent between accepting and rejecting the special order.

c) Suppose that the customer is open to extending the deadline in exchange for a reduction in the purchase price of $0.10 per day until delivery. Calculate the profit or loss on this special order should they decide to accept this new proposal.

d) Assume that the offer above was withdrawn and Duxon concentrated on its regular sales for 2010. 2011 sales and production levels are expected to be the same 80% of capacity as in 2010. Variable costs will remain the same in 2011. Max Inc. has offered to supply Duxon in the coming year with all the units needed for the regular sales at a cost of $25 per unit. Fixed overhead would reduced by 20% and a portion of the warehouse could be rented out for $65,000. Explain whether Duxon should accept the Max offer.

Question 2 - The Vancouver Leisure Company (VLC) sells extreme outdoor equipment, specialising in downhill and cross-country bikes, kayaks etc. VLC has a bike frame manufacturing division (FMD) that manufactures frames for bikes, and an Extreme Bike Sales division (EBS) that adds all the other components imported from Europe (gears, wheels, seats etc.) The technology that FMD utilizes is highly sought after but they do not have a monopoly. Both divisions are fully decentralized and autonomous profit centres.

FMD's cost of making an F18 bicycle frame is:

Materials                                                            $150

Labour                                                               325

Overhead (based on maximum capacity)              145

Variable selling costs                                           90

 Cost per unit                                                     $710

Variable selling costs include a commission to an independent sales representative of $50, $30 in packaging costs and $10 in delivery. Any sales to EBS will avoid packaging and commission costs.

FMD has fixed overhead of $180,000 and is able to manufacture and sell 4,000 frames in 2008 at a market price of $1,200.

NOTE: Each bike requires one frame.

Required - Part 1

a) EBS has a product called the Hollyburn bike. The Hollyburn is a high-end downhill bike that utilizes an F18 frame. Assuming that demand for the Hollyburn bicycle is only 600 units this year and FMD has demand for 2,500 F18 frames from outside purchasers, what is the minimum transfer price that FMD is willing to accept from EBS?

b) If FMD was able to sell all of its F18 frames to outside purchasers, what would be the minimum transfer price that they would accept from EBS?

c) Assume that FMD has a demand of 3,500 F18 frames from outside purchasers. EBS has estimated that it can sell 1,100 Hollyburns this year. What is the minimum transfer price, per frame, that FMD will accept from EBS for all 1,100 frames.

Required - Part 2

Assume that FMD can sell all of its production of F18 frames to outside purchasers but is transferring frames to EBS at $1,200. EBS has just received a special order from a customer to buy 300 bikes at a price of $3,800 per bike. EBS would incur an additional cost of $200 per bike to paint the bikes in a special chrome paint. The manager of EBS has excess capacity so s/he would very much like to fill the order. Currently, EBS sells its bikes at $4,500 generating a contribution margin of $1,000 per bike. The Manager of FMD has asked the Manager of EBS to let him increase the transfer price by $150 per bike in an effort to help his division out this year.

a) What will be the change in the operating income of FMD assuming that the Manager of the EBS division agrees to increase the transfer price by $150?

b) Assume that EBS takes the order at $3,800 per bike and grants a transfer price of $1,350. What will the effect be on EBS's operating income?

c) Is the Manager of EBS likely to accept the proposed increase in transfer price? Provide an explanation.

d) Would this transaction be in the best interest of the company? Show your calculations.

e) The two managers cannot agree on a transfer price and the special offer may be lost. As the CEO of VLC, would you get involved in the negotiation? Provide TWO reasons to support your position. The company's net income last year was $900,000.