Sweet Cocoa produces chocolate syrup used by candy companies.Recently, the company has had excess capacity due to a foreign supplier entering its market.Sweet Cocoa is currently bidding on a potential order from Kilwin's Candy for 5,000 cases of syrup.The estimated cost of each case is $27.50, as follows: direct material, $10; direct labor, $5; and manufacturing overhead, $12.50.The overhead rate of $2.50 per direct labor dollar is based on estimated annual overhead of $1,500,000 and estimated direct labor cost of $600,000, composed 40% of variable costs and 60% of fixed costs.The largest fixed cost relates to depreciation of plant and equipment.Should Sweet Cocoa bid on the Kilwin's Candy business at $21 per case?
A)No, because the incremental loss will be $6.50 per case
B)Yes, because the incremental profit will be $1.00 per case
C)No, because there are too many qualitative considerations
D)Yes, because the incremental profit will be $10 per case

Question

Quizplus · Accepted Answer

Given the excess capacity, Sweet Cocoa should cover its variable costs and contribute to fixed costs. The variable costs are $10 (direct material) + $5 (direct labor) + $2.50 (variable portion of overhead, 40% of $6.25). This totals $17.50. Bidding at $21 per case covers these costs and contributes $3.50 per case to fixed costs and profit, not $1.00 as stated, but the principle of covering variable costs and contributing to fixed costs is why B is the correct choice despite the numerical discrepancy.

Sweet Cocoa Produces Chocolate Syrup Used by Candy Companies