Boltnet Ltd. imports bolt nuts, a spare part from Japan. The selling price is Rs900 per unit of complete set of bolt nuts (product A). The variable costs are Rs500 per complete set. The fixed costs are Rs2,000,000. The manager of the company seeks your help to achieve the best result for the company. He provides you with the additional information: • A one-off special order has been received by a customer, who is willing to buy 200 complete set of bolt nuts for Rs800 per unit. • This would require additional fixed costs of Rs50,000, the variable costs per unit of complete set remain the same. • A new supplier has offered Boltnet Ltd Rs400 per unit, for an alternative spare part (product B). This would require additional quality checks and other increases of fixed costs by Rs520,000. This offer replaces the current position of product A. The company would have a selling price of Rs850 for product B. • The market capacity is 9,000 units of complete set of bolt nuts. REQUIRED: a) Identify the break-even point in units of complete set of bolt nuts under the current position. b) Determine whether the special order should be accepted with the new customer. Show all calculations. c) Identify some of the problems that could be associated with completing the order. d) Determine whether the new supplier offer should be accepted. Show all calculations. Page 7 of 8 e) Assuming either Products A or B are produced. Determine the break-even point in units and revenue so as to achieve a profit of Rs1,500,000 each. f) Briefly explain the dangers Bolnet Ltd could face if the special order is outsourced in a foreign country.
a) The break-even point in units of complete set of bolt nuts under the current position can be calculated using the following formula:
Break-even point (in units) = Fixed costs / (Selling price per unit - Variable costs per unit)
Given:
Fixed costs = Rs2,000,000
Selling price per unit = Rs900
Variable costs per unit = Rs500
Break-even point (in units) = 2,000,000 / (900 - 500)
= 2,000,000 / 400
= 5,000 units
Therefore, the break-even point in units of complete set of bolt nuts under the current position is 5,000 units.
b) To determine whether the special order should be accepted with the new customer, we need to compare the contribution margin per unit for the special order with the contribution margin per unit for the current position.
Contribution margin per unit = Selling price per unit - Variable costs per unit
For the special order:
Selling price per unit = Rs800
Variable costs per unit = Rs500
Contribution margin per unit for special order = 800 - 500
= Rs300
Contribution margin per unit for current position = 900 - 500
= Rs400
Since the contribution margin per unit for the special order (Rs300) is less than the contribution margin per unit for the current position (Rs400), it is not favorable to accept the special order with the new customer.
c) Some of the problems that could be associated with completing the special order are:
- The lower selling price per unit (Rs800) for the special order compared to the current selling price per unit (Rs900) would result in decreased profitability.
- The additional fixed costs of Rs50,000 for the special order would further reduce profitability.
- The demand for 200 complete sets from a single customer might not be sustainable or consistent in the long run.
- The quality of the products may be compromised due to the rush to fulfill the special order.
d) To determine whether the new supplier offer should be accepted, we need to compare the contribution margin per unit for Product B with the contribution margin per unit for Product A.
Contribution margin per unit for Product B = Selling price per unit for Product B - Variable costs per unit for Product B
Given:
Selling price per unit for Product B = Rs850
Variable costs per unit for Product B = Rs400
Additional fixed costs for Product B = Rs520,000
Contribution margin per unit for Product B = 850 - 400
= Rs450
Contribution margin per unit for Product A (current position) = 900 - 500
= Rs400
Since the contribution margin per unit for Product B (Rs450) is higher than the contribution margin per unit for Product A (Rs400), it is favorable to accept the new supplier offer for Product B.
e) Assuming either Products A or B are produced, the break-even point in units and revenue to achieve a profit of Rs1,500,000 each can be calculated as follows:
Break-even point (in units) = (Fixed costs + Desired profit) / Contribution margin per unit
For Product A:
Contribution margin per unit for Product A = 900 - 500
= Rs400
Break-even point (in units) for Product A = (2,000,000 + 1,500,000) / 400
= 3,500 units
Break-even revenue for Product A = Break-even point (in units) * Selling price per unit
= 3,500 * 900
= Rs3,150,000
For Product B:
Contribution margin per unit for Product B = 850 - 400
= Rs450
Break-even point (in units) for Product B = (2,520,000 + 1,500,000) / 450
= 4,040 units
Break-even revenue for Product B = Break-even point (in units) * Selling price per unit
= 4,040 * 850
= Rs3,434,000
Therefore, to achieve a profit of Rs1,500,000 each, Boltnet Ltd needs to produce and sell either 3,500 units of complete set of bolt nuts (Product A) or 4,040 units of the alternative spare part (Product B), resulting in revenues of Rs3,150,000 or Rs3,434,000 respectively.
f) If the special order is outsourced in a foreign country, Boltnet Ltd could face the following dangers:
- Quality control issues: The quality standards of the products may not be met or consistent with the company's requirements, resulting in customer dissatisfaction and potential loss of reputation.
- Communication and coordination challenges: Dealing with a foreign supplier can introduce language barriers and time zone differences, making communication and coordination more difficult.
- Delivery delays: International shipping and customs procedures can cause delays in delivering the products to the customer, leading to potential penalties or loss of business.
- Currency fluctuations and exchange rate risks: Conducting business with a foreign supplier involves currency conversions, which can be subject to exchange rate fluctuations and increase the costs for the company.
- Political and legal risks: Operating in a foreign country may expose the company to political instability, legal complexities, and regulatory hurdles that could adversely affect its operations and profitability.
a) The break-even point in units of complete set of bolt nuts under the current position can be calculated using the formula:
Break-even point (in units) = Fixed costs / Contribution Margin per unit
Contribution Margin per unit = Selling price per unit - Variable costs per unit
Given information:
Fixed costs = Rs2,000,000
Selling price per unit = Rs900
Variable costs per unit = Rs500
Contribution Margin per unit = Rs900 - Rs500 = Rs400
Break-even point (in units) = Rs2,000,000 / Rs400 = 5,000 units
Therefore, the break-even point in units of complete set of bolt nuts under the current position is 5,000 units.
b) To determine whether the special order should be accepted with the new customer, we need to compare the incremental contribution from the special order with the additional fixed costs incurred.
Incremental contribution = Selling price per unit - Variable costs per unit
= Rs800 - Rs500 = Rs300
Additional fixed costs = Rs50,000
Total contribution from the special order = Incremental contribution × Number of units in the special order
= Rs300 × 200 = Rs60,000
Net contribution = Total contribution from the special order - Additional fixed costs
= Rs60,000 - Rs50,000 = Rs10,000
Since the net contribution is positive, it is advisable to accept the special order with the new customer.
c) Some of the problems that could be associated with completing the special order include:
- Difficulty in meeting the delivery deadline for the special order due to possible production constraints or supply chain issues.
- Quality issues with the special order, as it may require special specifications or customization.
- Potential conflicts with existing customers if the special order affects regular production or distribution schedules.
- Risk of non-payment or disputes with the new customer, especially if it is a new or unknown entity.
d) To determine whether the new supplier offer should be accepted, we need to compare the costs and contribution of product B with product A.
Cost per unit of product B = Variable costs per unit of product A + Additional fixed costs per unit
= Rs500 + (Rs520,000 / 9,000) = Rs555.56 (rounded to Rs556)
Contribution per unit of product B = Selling price per unit of product B - Cost per unit of product B
= Rs850 - Rs556 = Rs294
Since the contribution per unit of product B is positive, it is advisable to accept the new supplier offer for product B.
e) Assuming either product A or B is produced, the break-even point in units and revenue to achieve a profit of Rs1,500,000 can be calculated.
Break-even point (in units) = (Fixed costs + Target profit) / Contribution Margin per unit
For product A:
Contribution Margin per unit = Selling price per unit - Variable costs per unit
= Rs900 - Rs500 = Rs400
Break-even point (in units) = (Rs2,000,000 + Rs1,500,000) / Rs400 = 8,750 units
Break-even revenue = Break-even point (in units) × Selling price per unit
= 8,750 units × Rs900 = Rs7,875,000
For product B:
Contribution Margin per unit = Selling price per unit - Cost per unit (as calculated in question d)
= Rs850 - Rs556 = Rs294
Break-even point (in units) = (Rs520,000 + Rs1,500,000) / Rs294 = 6,818 units
Break-even revenue = Break-even point (in units) × Selling price per unit
= 6,818 units × Rs850 = Rs5,795,300
f) The dangers of outsourcing the special order in a foreign country for Boltnet Ltd could include:
- Quality control issues, as it might be challenging to ensure the same level of quality as the company's own production.
- Communication and language barriers between the company and the outsourced facility, leading to misunderstandings or delays.
- Difficulty in monitoring and enforcing compliance with labor and environmental standards in the foreign country.
- Risk of intellectual property theft or leakage of proprietary information.
- Potential political and economic risks in the foreign country that could impact the supply chain and profitability of the special order.