Decision Analysis Example Problem Solution

Special Order Example

We have budgeted to produce 60,000 units and our capacity is 80,000 units. The normal selling price for our product is $21 per unit.

DM $5.10/unit DL $3.80/unit

VOH 1.00/unit FOH 4.20/unit

V S&A 1.50/unit F S&A 2.40/unit

A. Assuming the special order keeps us in the relevant range, should we accept a special order for 15,000 units at $14 per unit?

B. What is the minimum price we would accept on this order?

C. What if there were a $3.00/unit shipping cost for the special order?

D. What if our budgeted production were 80,000 units?

Solution

A. We have available capacity (60 + 15 ≤ 80).

Relevant costs: $5.10 per unit DM

3.80 per unit DL

1.00 per unit VOH

1.50 per unit VS&A

$11.40 per unit Total < $14

The Stage 1 analysis suggests accepting the order.

B. Is $11.40 the minimum? No, there are opportunity costs for the money we spend on those resources. We could also put it in the bank and earn interest. Let’s say we require a minimum 15% return; then the minimum price would be (1.15)*($11.40) = $13.11 per unit.

C. The relevant costs are now $11.40 + $3.00 = $14.40 per unit > $14, so now reject the order.

D. Now, in order to accept the special order we must switch output from our regular sales channels to the special order. Note that this is a choice we can make; we cannot just say “we are at capacity and cannot accept the order.” We simply compare the contribution from the special order to that for 15,000 units sold through regular channels. Since the relevant costs are identical but the revenue will be greater for the regular channel sales, the Stage 1 analysis favors rejecting the special order. If we very much wanted to begin doing business with this new customer, and were willing to incur some short-term cash flow reductions and regular customer ill-will, then Stage 2 analysis might lead us to override the Stage 1 analysis.

Make-or-Buy Example

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