Dawson Company Case

Dawson Company produces and sells 80,000 boxes of specialty foods each year. Each box contains the same assortment of food. The company has computed the following annual costs:

Cost Item Total Costs Total costs/box Total Costs-8000 boxes

Variable Production costs $ 400,000 $ 5 $ 40,000

Fixed production costs $ 480,000 $ 6 48,000+8000= $56,000

Variable selling costs $ 320,000 $ 4 $ 32,000

Fixed selling & admin. Costs $ 200,000 $ 2,5 $ 20,000

Total costs $ 1,400,000 $ 17,5 $ 148,000

Dawson normally charges $25 per box.

A new distributor has offered to purchase 8,000 boxes at a special price of $22 per box.

Dawson will incur additional packaging costs of $1 per box to complete this order.

Contribution Margin per Unit = Revenues per Unit - Variable Expenses per Unit

- Therefore the contribution margin per unit if Dawson sells each box at a $25 rate = 25 - ((400,000+320,000)/80,000) = $16

- If Dawson chooses to sell the box at a $22 rate, the contribution margin per unit will be: 22 - ((400,000+320,000)/80,000) = $13

EBT (Profit) for a year operating selling costs normally ($25/box) = (25*80,000) - (400,000+480,000+320,000+200,000) = $600,000

A) Suppose Dawson had surplus capacity to produce 8,000 more boxes. What will be the effect on Dawson's income if it accepts this order?

If Dawson chooses to forego the opportunity to accept the new distributor's offer, it will forego a contribution margin per unit of $13, or a total contribution of $104,000 (13*8,000).

If Dawson chooses to forego its initial normal charges with regular offers, it will forego a contribution margin per unit of $16, or a total contribution of $128,000.

Choosing the offer that provides the highest contribution margin or the offer that provides the lowest opportunity cost (sell at a normal rate $25) might look like the best option considering only the data provided.

Consequently, if Dawson accepts the special order, its income will decrease.

The EBT for a one-year period selling exclusively $25 boxes is $600,000.

With the special order, the EBT will be:

(25*72,000)+(23*8,000) - 1,408,000 = $576,000

Hence, the Earnings before tax for Dawson will be lessen by $24,000 with the new solution.

B) Suppose that instead of having a surplus he has surplus capacity to produce only 3,000 more boxes. What will be the effects on Dawson's income if it accepts the order for 8,000 boxes?

A surplus capacity of only 3,000 more boxes means that Dawson will have to give up 5,000 normal boxes sales in order to fill the order.

Incremental revenue (8000*22) 176,000

Incremental costs

Variable (8,000*9) 72,000

Fixed (6*8000)+8000+(2,5*8000) 76,000

Opportunity Cost (3000*(25-9)) 48,000

196,000

Therefore, if Dawson accepts the order for 8,000 boxes, its profits will decrease by $20,000. But it is also important to consider other factors that may influence the decision making, for instance: Is there potential for further orders in the future from the new distributor?

3-66 - Profitability of orders, opportunity cost & capacity

Hudson