IAF530N1A: Assignment 6
D1
30 marks
West Coast Electronics (WCE) produces high-quality audio and video equipment. One of the
company’s most popular products is a high-definition personal video recorder (PVR) for use with
digital television systems. Demand has increased rapidly for the PVR over the past three years,
given the appeal to customers of being able to easily record programs while they watch live
television, watch recorded programs while they record a different program, and save dozens of
programs for future viewing on the unit’s large internal hard drive.
A complex production process is utilized for the PVR involving both laser and imaging equipment.
WCE has a monthly production capacity of 4,000 hours on its laser machine and 1,000 hours on
its image machine. However, given the recent increase in demand for the PVR, both machines
are currently operating at 90% of capacity every month, based on existing orders from customers.
Direct labour costs are $15 and $20 per hour to operate, respectively, the laser and image
machines.
The revenue and costs on a per unit basis for the PVR are as follows:
Selling price $320.00
Cost to manufacture:
Direct materials $50.00
Direct labour—laser process 60.00
Direct labour—image process 20.00
Variable overhead 40.00
Fixed overhead 50.00
Variable selling costs 20.00 240.00
Operating profit $ 80.00
On December 1, Dave Nance, vice-president of Sales and Marketing at WCE, received a special-order request from a prospective customer, Jay Limited, which has offered to buy 250
PVRs at $280 per unit if the product can be delivered by December 31. Jay Limited is a large retailer with outlets that specialize in audio and video equipment. This special order from Jay
Limited is in addition to orders from existing customers that are utilizing 90% of the production
capacity each month. Variable selling costs would not be incurred on this special order. Jay
Limited is not willing to accept anything less than the 250 PVRs requested (i.e., WCE cannot
partially fill the order).
Before responding to the customer, Nance decided to meet with Dianne Davis, the product
manager for the PVR, to discuss whether to accept the offer from Jay Limited. An excerpt from
their conversation follows:
Required:
1. Is Davis’s general approach to calculating the opportunity cost in terms of the physical units involved correct? Explain. (5 Marks)
2. Assuming productive capacity cannot be increased for either machine in December, how many PVRs would WCE have to forgo selling to existing customers to fill the special order from Jay Limited? (5 Marks)
3. Calculate the opportunity cost of accepting the special order. (5 Marks)
4. Calculate the net effect on profits of accepting the special order. (5 Marks)
5. Now assume that WCE is operating at 75% of capacity in December. What is the minimum price WCE should be willing to accept on the special order? (5 Marks)
6. What are some qualitative issues that should be considered when accepting special orders such as that proposed by Jay Limited? (5 Marks)
