Problem:
(Special order) Hydraulic Engineering, located in Toronto, manufactures a variety of industrial valves and pipe fittings that are sold to customers in the United States. Currently, the company is operating at 70 percent of capacity and is earning a satisfactory return on investment. Prince Industries Ltd. of Scotland has approached management with an offer to buy 120,000 units of a pressure valve. Prince Industries manufactures a valve that is almost identical to Hydraulic Engineering's pressure valve; however, a fire in Prince Industries' valve plant has shut down its manufacturing operations. Prince needs the 120,000 valves over the next four months to meet commitments to its regular customers; the company is prepared to pay $19 each for the valves, FOB shipping point. Hydraulic Engineering's product cost, based on current attainable standards, for the pressure valve is
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Direct material
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$ 5
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Direct labor
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6
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Manufacturing overhead
|
9
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Total cost
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$20
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Manufacturing overhead is applied to production at the rate of $18 per standard direct labor hour. This overhead rate is made up of the following components:
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Variable factory overhead
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$ 6
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Fixed factory overhead-direct
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8
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Fixed factory overhead-allocated
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4
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Applied manufacturing overhead rate
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$18
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Additional costs incurred in connection with sales of the pressure valve include sales commissions of 5 percent and freight expense of $1 per unit. However, the company does not pay sales commissions on special orders that come directly to management. In determining selling prices, Hydraulic Engineering adds a 40 percent markup to product cost. This provides a $28 suggested selling price for the pressure valve. The marketing department, however, has set the current selling price at $27 to maintain market share. Production management believes that it can handle the Prince Industries order without disrupting its scheduled production. The order would, however, require additional fixed factory overhead of $12,000 per month in the form of supervision and clerical costs. If management accepts the order, 30,000 pressure valves will be manufactured and shipped to Prince Industries each month for the next four months. Shipments will be made in weekly consignments, FOB shipping point.
a. Determine how many additional direct labor hours would be required each month to fill the Prince Industries order.
b. Prepare an incremental analysis showing the impact of accepting the Prince Industries order.
c. Calculate the minimum unit price that Hydraulic Engineering's management could accept for the Prince Industries order without reducing net income.
d. Identify the factors, other than price, that Hydraulic Engineering should consider before accepting the Prince Industries order. (CMA adapted)