Assess A Business Opportunity Appropriately Using Relevant C

Assess A Business Opportunity Appropriately Using Relevant Cost

Consider the following scenario: You have received an order for 10,000 No. 9 widgets from a regular customer. They are prepared to pay US$10 per widget. The production manager points out that this is not enough to recover the overheads that will be allocated to the production run, and that the price must be increased to at least US$11 per widget to break-even. Overheads amount to US$3 per widget, with the remaining costs split equally between materials and direct labour. You haven’t manufactured No. 9 widgets recently as they are largely obsolete.

The order is expected to show a US$1 loss per widget in the management accounts. The widgets require a special material called “ninerate”, which is in stock and has no other use. Your decision whether to accept the order should be based on the relevant costs and benefits, considering whether doing so will benefit the business. Additional information needed before making a decision might include the long-term profitability of No. 9 widgets, the impact on existing operations, and potential future sales opportunities.

Write a short summary of approximately 300 words, analyzing the cost implications, considering relevant costs, and justifying whether to accept or decline the order based on your calculations and business considerations.

Paper For Above instruction

The decision to accept or reject a special order hinges fundamentally on an analysis of relevant costs and the potential impact on the business’s overall profitability. In this scenario, the customer’s offer of US$10 per widget results in a US$1 loss per unit without factoring in any additional considerations. The variable overheads of US$3 per widget are unavoidable, but since these overheads are allocated based on production volume, understanding whether these costs are truly relevant is critical. If the overheads are fixed in nature and do not increase with additional production, they may not be relevant to this specific decision. However, if they vary with production, their inclusion becomes essential in evaluating the order.

Materials, specifically “ninerate”, are in stock and will be used exclusively for these widgets, representing a relevant cost since it is a sunk inventory that we have already paid for and cannot recover. The direct labour cost, which is split equally with materials, must also be considered; if the labour costs are avoidable and incremental for this order, they should be included in the relevant cost calculation.

Calculating the relevant cost per widget involves subtracting the fixed overheads if deemed unavoidable, and focusing on variable costs like materials and labour. If these are less than or equal to US$10, accepting the order might be beneficial, especially if the incremental cost is below the price offered—otherwise, it would lead to a loss.

However, since the order results in a loss of US$1 per widget based on current assessments, accepting it would worsen overall profitability unless there are strategic reasons—such as clearing obsolete stock or maintaining customer relationships—that justify the short-term loss.

Further information needed includes the actual variable costs per unit, potential future sales, and strategic implications. If fixed overheads do not increase with this order, and variable costs are below US$10, accepting the order might be justified; otherwise, declining could preserve resources for more profitable endeavors.

References

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