CMA Study Group

Kator Co. is a manufacturer of industrial components. One of their products that is used as a sub-component in auto manufacturing is KB-96. This product has the following financial structure per unit.



Kator Co. has received a one-time special order for 1,000 KB-96 parts. Assume that Kator is operating at full capacity and the next best alternative use of their capacity on existing equipment is LB-64 that would produce a contribution of $10,000. The minimum price that is acceptable, using the original data, for this one-time special order is in excess of

	The correct answer is: $60.00.
	Avoidable variable costs per unit = $20 direct materials + $15 direct labor + $12 variable manufacturing overhead + $3 shipping and handling = $50. The opportunity cost per unit is $10 ($10,000/1,000). Therefore, the minimum acceptable price is $60 ($50 variable costs + $10 opportunity cost) My Question is,   If Operating at full capacity (ie no excess capacity) why is minimal acceptable price not the same as selling price of $150 as it is the same product which is being manufactured and the all same costs incurred to manufacture it? Kator is foregoing selling 1000 units at $150 and accepting a special order at price $60 which will incur the same costs, what am I missing? Thanks for any feedback

The key factor in applying marginal analysis is in being able to isolate and identify relevant costs. As we all know, these are costs that DIFFER among options. Costs already incurred or have been committed are irrelevant. In any accept or reject special orders, the relevants costs are (1) variable expenses (2) avoidable fixed costs and (3) foregone CM (opportunity cost) arising from any lost sales. In the problem given, the relevant costs are the variable costs of $50, ZERO (nothing given in the problem) avoidable fixed costs, plus foregone contribution margin of $10. Thus, the minimum acceptable price is $60 to cover incremental costs (opportunity cost included). In the penultimate paragraph you mentioned that Kator is "accepting a special order at a price of $60 which will incur the SAME COSTS". Did you mean here that Kator would be incurring total costs of $90? You have to remember that this unit cost of $90 includes sunk (fixed) costs of $40, hence irrelevant to our decision making.

"next best alternative use of their capacity is producing contribution of 10000" for 1000 units + Variable cost = Acceptable Selling price per unit = 10+50.

The fixed cost are irrelevant in decision making as it will be incurred whether or not special order is undertaken, the contribution from the special order should cover the total fixed cost.

Regards/Sunil.