Exercise - Statement 12B.

4 (CG)
Incremental analysis / decision-making
Exercices et solutions
e
5 dition

Burning Sun Ltd, a young business in Quebec, manufactures and distributes a sun-tanning lotion,
the RX-20, sold exclusively in tanning salons.

The forecast for next year seems to predict that sales should reach a level of 440,000 containers
and manufacturing specifications would be the following:

the direct material cost would be constant throughout the year at $ 1.80 per container.
However, if production exceeds 500,000 containers, a 15 % rebate would be applicable
to all the direct material purchased to manufacture the units for the year;

the manufacturing process produces 40 containers per hour and the hourly direct labour
rate is $25 ;

a foreman is responsible for the operations supervision at an annual remuneration of

$ 72,000 (should not be considered since it will remain the same under both scenarios)

manufacturing is done over a 10 month period, employees enjoy 8 weeks of paid vacation
in the first 2 months of the year;

the business policy is to hold no direct material inventory, no work-in-process inventory

and no finished goods inventory;

the annual rent for the building used by the business is $ 12,000 per month, plus 7 % of
annual sales over $3,000,000. The plant uses half of the building;

At the beginning of the year, a long-time client contacted Burning Sun Ltd and proposed to purchase
a quantity of 200,000 lotion containers at a unit price of $ 5.25, which is $ 1.50 less than the normal
selling price. Since actual production can barely satisfy the regular sales, this proposition can be
accepted only after an analysis of its profitability and impacts.

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 Exercise - Statement 12B.4 (CG) (contd)

To help in this analysis, you gathered the following information:

production of the special order would be distributed over a 20 week period in the summer
months and would be added to regular production;

since the level of productivity cannot be increased to satisfy this additional need, a
temporary team of workers will be hired. However, it will be possible to hire unemployment
beneficiary workers and save $ 3 per hour on the actual hourly rate; 40 containers per
hour will be manufactured by this team;

the manufacturing overhead costs will increase by $ 65,000; ( specific fix cost)

2 additional blenders will need to be rented in order to manufacture this special order. The
rental cost for each one of these blenders is $ 950 per week;

the actual manufacturing space is sufficient to accommodate the temporary installations

without any problems and it will not be necessary to hire additional supervising staff;

the administrative expenses budgeted at $ 330,000 should not be modified significantly

by the acceptance of this order. (anything that remains the same under the both oprions
should not be considered)

Required:

a) Providing a quantitative analysis, advice the Burning Sun Ltd managers on the acceptance
of this special order.

b) Based on the information you have, what is the minimum sale price the Burning Sun Ltd
managers could accept for this special order?

c) State three qualitative factors the managers should take into consideration before accepting
the special order.

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 Source: Service de lenseignement des sciences comptables de HEC Montral

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