NoFat manufactures one product, olestra, and sells it to large potato chip manufacturers as the key ingredient in nonfat snack foods, including Ruffles, Lays, Doritos, and Tostitos brand products. For each of the past 3 years, sales of olestra have been far less than the expected annual volume of 125,000 pounds. Therefore, the company has ended each year with significant unused capacity. Due to a short shelf life, NoFat must sell every pound of olestra that it produces each year. As a result, NoFat’s controller, Allyson Ashley, has decided to seek out potential special sales offers from other companies. One company, Patterson Union (PU)—a toxic waste cleanup company—offered to buy 10,000 pounds of olestra from NoFat during December for a price of $2.20 per pound. PU discovered through its research that olestra has proven to be very effective in cleaning up toxic waste locations designated as Superfund Sites by the U.S. Environmental Protection Agency. Allyson was excited, noting that “This is another way to use our expensive olestra plant!”
The annual costs incurred by NoFat to produce and sell 100,000 pounds of olestra are as follows:
In addition, Allyson met with several of NoFat’s key production managers and discovered the following information:
Assume for this question that NoFat rejected PU’s special sales offer because the $2.20 price suggested by PU was too low. In response to the rejection, PU asked NoFat to determine the price at which it would be willing to accept the special sales offer. For its regular sales, NoFat sets prices by marking up variable costs by 10%.
If Allyson decides to use NoFat’s 10% markup pricing method to set the price for PU’s special sales offer,
a.
Compute price per unit.
Relevant Costs:
Costs that are relevant for making a decision are known as relevant costs. Relevant costs differ in different alternatives. For example, lease rent paid by an organization, which could not be avoided in any alternative, is ignored.
Computation of relevant revenue, relevant cost and relevant profit associated with special order:
Particulars | Amount ($) |
Variable costs per unit: | Â |
Direct material | 1.00 |
Variable manufacturing overhead | 0... |
b.
Compute relevant profit/loss.
c.
Explain whether company should accept or reject special sales offer.
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