Geneva Company manufactures dolls that are sold to various customers.The company works at full capacity for half the year to meet peak demand,and operates at 80% capacity for the other half of the year.The following information is provided: Geneva receives a purchase order to make 5,000 dolls as a one-time event.The good news is that this order is during a period when Geneva does have sufficient excess capacity.What is the lowest selling price Geneva should accept for this purchase order?
A)$35.00
B)$26.00
C)$29.50
D)$23.50
E)$25.00

Question

Geneva Company manufactures dolls that are sold to various customers.The company works at full capacity for half the year to meet peak demand,and operates at 80% capacity for the other half of the year.The following information is provided:  Geneva receives a purchase order to make 5,000 dolls as a one-time event.The good news is that this order is during a period when Geneva does have sufficient excess capacity.What is the lowest selling price Geneva should accept for this purchase order?
A)$35.00 
B)$26.00 
C)$29.50 
D)$23.50 
E)$25.00

Quizplus · Accepted Answer

Since the order is during a period when Geneva has excess capacity, the selling price should be at least equal to the variable cost per doll plus the opportunity cost of the production capacity. The variable cost per doll is $16.50 (direct materials of $10 plus direct labor of $5 plus variable overhead of $1.50). The opportunity cost of production capacity is the contribution margin that Geneva would have earned if it used that capacity to produce its own dolls. During the 80% capacity period, Geneva has a contribution margin ratio of 40%, so the opportunity cost of one doll is 40% of the sale price, or $12. The lowest selling price Geneva should accept is therefore $16.50 + $12 = $28.50. The only choice that is greater than $28.50 is B) $26.00, making it the best choice.

Geneva Company Manufactures Dolls That Are Sold to Various Customers