Chapter 16, Problem 16.28P

Problem 16.28

LO 2, 3

Relevant costs, special sales order-idle versus full capacity Petro Motors, Inc. (PMI), produces small gasoline- powered motors for use in lawn mowers. The company has been growing steadily over the past five years and is operating at full capacity. PMI recently completed the addition of new plant and equipment at a cost of $6,000,000, thereby increasing its manufacturing capacity to 100,000 motors annually. The addition to plant and equipment will be depreciated on a straight-line basis over 10 years.

Sales of motors were 75,000 units prior to the completion of the additional capacity. Cost records indicated that manufacturing costs had totaled $76 per motor, of which $60 per motor was considered to be variable manufacturing costs. PMI has used the volume of activity at full capacity as the basis for applying fixed manufacturing overhead. The normal selling price is $100 per motor, and PMI pays a 10% commission on the sale of its motors.

LawnPro.com offered to purchase 20,000 motors at a price of $75 per unit to test the liability of distributing lawn mower replacement motors through its website. PMI would be expected to produce the motors, store them in its warehouse, and ship individual motors to LawnPro.com customers. As orders are placed directly through the LawnPro.com website, they would be forwarded instantly to PMI. No commissions will he paid on this special sales order, and freight charges will be paid by the customer purchasing a motor.

Required:

1. Calculate the cost per motor, for cost accounting purposes, after completion of the additional plant capacity.
2. Identify all the relevant costs that PMI should consider in evaluating the special sales order from LawnPro.com.
3. Should the offer from LawnPro.com be accepted? Why or why not?
4. If relevant cost analysis was not considered, is it likely that a correct special order analysis would have been made? Explain your answer.
5. Identify the key qualitative factors that PMI management should consider with respect to this special order.
6. Assume that with the additional plant capacity, sales of motors in PMI’s regular market are expected to increase by 20% in the coming 12 months. Identify all the relevant costs that PMI should consider in evaluating the special sales order from LawnPro.com. Why is your answer different than in requirement b?
7. Assume that sales of motors in PMI’s regular market are expected to increase by 20% in the coming 12 months.
Should the offer from LawnPro.com be accepted? Why or why ⁷ not?