Question

Rainy days Company manufactures designer umbrellas. Each line of umbrellas is endorsed by a high-profile celebrity and designed with special elements selected by the celebrity. During the most recent year, Rainy days Company had the following operating results while operating at 80 percent (96,000 units) of its capacity:
Sales revenue $960,000
Cost of goods sold 492,000
Gross profit $468,000
Operating expenses 36,000
Net operating income $432,000

Rainy days’ cost of goods sold and operating expenses are 80 percent variable and 20 percent fixed. Rainy days has received an offer from the MOMA to design an umbrella endorsed by the museum and produce 20,000 units for $8 each (total $160,000). These umbrellas would be sold at the museum in store and online. Acceptance of the order would require a $60,000 endorsement fee, but no other increases in fixed operating expenses.

Required:
a. Complete the incremental analysis of the special order.
b. Should Rainy days accept this special order?
c. If Rainy days were operating at full capacity, what price would Rainy days require for the special order?

Answer 1

Answer:

Rainy Days Company

a. Incremental Analysis of the Special Order:

Incremental Analysis         Normal         Increment

Sales revenue                 $960,000       $160,000

Cost of goods sold:

Variable costs (80%)          393,600          82,000

Fixed costs (20%)                 98,400         0

Total cost of goods sold    492,000         82,000

Gross profit                      $468,000         78,000

Operating expenses           36,000         60,000  

Net operating income    $432,000        $18,000

b. Rainy days should accept the special order.

c. Rainy days should charge $17.43 per unit for the special order

Explanation:

a) Data and Calculations:

Operating capacity (80%) = 96,000 units

100% capacity = 120,000 units (96,000/0.8)

Sales revenue                 $960,000

Cost of goods sold            492,000

Gross profit                      $468,000

Operating expenses           36,000

Net operating income    $432,000

At full capacity, price for the special order:

Cost of goods sold:

Variable costs (80%)             $82,000

Fixed costs (20%)                    98,400

Total cost of goods sold        180,400  

Operating expenses               60,000  

Total cost of special order $240,400

Units of the special order      20,000

Unit cost =                               $12.02

Net income margin (45%)          5.41

Total price to charge              $17.43

b) The full fixed cost was charged for the special order if Rainy days Company operates at full capacity before receiving the special order.  Fixed cost does not vary according to the level of activity.  It has a step-cost feature, which means that to increase capacity by 20,000 units, the company will incur additional fixed cost $98,400.