Special Order High Low Cost Estimates For Saferide Inc

Special Order High Low Cost Estimationsaferide Inc Produces Air Bag

SafeRide, Inc. produces air bag systems for North American automobile manufacturers and has received a special order from a German manufacturer for 60,000 units at $7.00 each. The company’s capacity is 300,000 units annually, with current production at 180,000 units. Budgeted costs for producing 180,000 and 240,000 units are provided, including direct materials, direct labor, factory overhead, and selling and administrative expenses. The normal selling price is $25 per unit, but there is a suggestion to accept the German order even at a loss of $5.75 per unit, to potentially open new markets. The general manager notes the company cannot absorb a total loss of $345,000 if the order is accepted. The problem is to evaluate the financial impact of accepting this order, both under current capacity constraints and if operating at full capacity.

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In the modern competitive automotive supply industry, companies like SafeRide, Inc. must carefully evaluate special orders to determine the financial and strategic implications. This assessment involves analyzing incremental costs and revenues, understanding capacity constraints, and considering the broader market opportunities. The decision to accept a special order at a lower price or even at a loss hinges on whether the incremental benefits outweigh the incremental costs, considering fixed and variable costs, and the potential to develop new markets.

Analysis of the Special Order

The initial step is to determine the net benefit or loss for accepting the order under current production levels and capacity constraints. The order is for 60,000 units at $7.00 per unit, which is significantly below the normal sale price of $25, but the decision is influenced by strategic considerations. The key is to compare the incremental revenue from the order to the incremental costs.

Variable costs per unit can be approximated based on the budgeted costs provided. For 180,000 units, direct materials are $450,000, equating to $2.50 per unit; direct labor is $315,000, or approximately $1.75 per unit; factory overhead is $1,215,000, approximately $6.75 per unit. The total variable cost per unit thus becomes roughly $11.00 + $4.25 (selling/admin) = $15.25, but since the analysis considers only incremental costs, fixed costs such as factory overhead and fixed selling/admin expenses are excluded from the decision. Therefore, the relevant unit costs are primarily variable costs associated directly with production.

Considering the order's unit price of $7.00 and the variable costs, the order would generate a contribution margin of approximately $(7.00 - 11.00) = -$4.00 if all costs were variable, but given the data, we focus only on the incremental loss per unit of $5.75, as suggested, and total it for 60,000 units: 60,000 x $5.75 = $345,000 loss.

Given the company's capacity of 300,000 units and current production at 180,000 units, accepting the order would increase production to 240,000 units, still within capacity. Hence, the fixed costs are likely allocated on a per-unit basis and do not increase with this additional order. The net benefit of accepting the order is the revenue ($60,000 x $7 = $420,000) minus the variable costs associated with these units and the potential loss of $5.75 per unit, which would total a loss of $345,000. Therefore, the net impact is a loss of $345,000, considering the operating costs and strategic benefits.

When operating at full capacity, the company cannot increase production without sacrificing existing sales. Since capacity constraints prevent additional units from being produced without reducing current production, accepting the order would require forgoing profitable sales or investing in capacity expansion. This scenario shifts the analysis. If the firm is operating at full capacity (300,000 units), accepting the low-price order would entail sacrificing more profitable orders, and the opportunity cost should be considered.

In this context, the decision relies heavily on incremental analysis. The fixed costs remain unchanged, and only variable costs and revenue inform the decision. Since accepting the order results in a net loss of $5.75 per unit, and the company cannot produce more units without sacrificing other profitable sales, accepting the order at full capacity is economically inadvisable unless strategic advantages such as market development outweigh the immediate financial loss.

Conclusion

In conclusion, accepting the special order at the stated terms results in a net loss of $345,000 if the company operates within current capacity. If operating at full capacity, the opportunity cost implies that the order might displace more profitable sales, leading to further financial disadvantages. Thus, the decision should consider both short-term financial impacts and long-term strategic benefits such as new market entry, brand recognition, or future sales potential, which might justify accepting the order despite the immediate loss.

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