Question 5 OR (a)
Whether to accept an export order below the domestic price
9 marks
- Time to write
- About 18 minutes
Question
Question 5 OR (a) · 9 marksA manufacture has planned to operate at 50% of a planned capacity of 30,000 units. If 50% of plant capacity is utilized, his expenses are estimated as:
Direct Materials Rs. 9,000
Direct Wages Rs. 10,500
Variable and other manufacturing expenses Rs. 3,750
Total Fixed expenses irrespective of Capacity utilization Rs. 6,500
In the domestic market, the expected selling price is Rs. 2 per unit. The manufacturer has recently received a trade enquiry from an overseas organization interested in purchasing 5,000 units at Rs. 1.40 per unit. As a professional management accountant, would you suggest that the offer be accepted or rejected? Support your suggestion with suitable quantitative information?
Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- Would…?Support…?Two asks in one question: answer both.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Marginal cost per unit 3 marks 5 min
- 2 Contribution from the offer and effect on profit 4 marks 7 min
- 3 Recommendation with reasons 2 marks 4 min
- Check: arithmetic, units (₹, %), final answer underlined 1 min
Short on time? End with step 3's one-line decision, whatever happens: never leave the figures without it.
Try it first. About 18 minutes for 9 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Working: cost per unit at 50% capacity
Output at 50% of 30,000 units = 15,000 units.
| Cost | Amount at 15,000 units (₹) | Per unit (₹) |
|---|---|---|
| Direct materials | 9,000 | 0.60 |
| Direct wages | 10,500 | 0.70 |
| Variable and other manufacturing expenses | 3,750 | 0.25 |
| Total variable (marginal) cost | 23,250 | 1.55 |
| Fixed expenses (do not change with capacity) | 6,500 | 0.43 (rounded) |
| Total cost | 29,750 | 1.98 (rounded) |
The offer is for 5,000 units at ₹1.40 per unit. There is spare capacity of 15,000 units, so the order can be met without disturbing domestic sales, and fixed expenses will not change. The relevant cost of the order is therefore its marginal cost only.
- Marginal cost per unit = ₹1.55; export price = ₹1.40.
- Contribution per unit from the order = ₹1.40 − ₹1.55 = −₹0.15 (a negative contribution).
- Total effect of the order = 5,000 × −₹0.15 = −₹750.
| Particulars | Without the order (₹) | With the order (₹) |
|---|---|---|
| Domestic sales (15,000 × ₹2) | 30,000 | 30,000 |
| Export sales (5,000 × ₹1.40) | — | 7,000 |
| Total sales | 30,000 | 37,000 |
| Less: Variable cost (₹1.55 per unit) | 23,250 | 31,000 |
| Contribution | 6,750 | 6,000 |
| Less: Fixed expenses | 6,500 | 6,500 |
| Profit (loss) | 250 | (500) |
The offer should be rejected. Its price does not even cover the marginal cost of ₹1.55, so every unit sold would reduce profit; accepting it would turn the present profit of ₹250 into a loss of ₹500. A price below marginal cost could be considered only for strong non-financial reasons, for example, to enter a new export market, to dispose of perishable stock, or to keep skilled workers employed, and even then only for a limited period.
Where the 9 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Marginal cost per unit | 3 |
| 2 | Contribution from the offer and effect on profit | 4 |
| 3 | Recommendation with reasons | 2 |
| Total | 9 |
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