Fifth edition Alnoor Bhimani Charles T. Horngren Srikant M. Datar Madhav V. Rajan Farah Ahamed


Special order, relevant costs, capital budgeting



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13.13 Special order, relevant costs, capital budgeting.
(30 min)
1
Relevant cash inflow from accepting the special order
Relevant cash flows
Per car
(1)
Total
(2) = (1)
× 100,000
Incremental revenues (cash inflows) Incremental costs (cash outflows) Neon paint Boxes Direct manufacturing labour Total incremental costs Net incremental benefit
€50 6
3 8
17
€33
€5,000,000 600,000 300,000 800,000 1,700,000
€3,300,000 Notes
a
The costs of plastic cars are irrelevant because these cars have already been purchased and so entail no incremental cash flow.
b
VAT depreciation is irrelevant because it is a past cost.
c
Allocated plant manager's salary is irrelevant because it will not change whether or not the special order is accepted.


Bhimani, Horngren, Datar and Rajan, Management and Cost Accounting, 5
th
Edition, Instructor’s Manual
© Pearson Education Limited 2012
d
Variable marketing costs are not deducted because they will not be incurred on the special order.
e
Fixed marketing costs are irrelevant because they will not change whether or not the special order is accepted. If it must offer the same €50 price to its other customers, Euro-Jouets will lose cash flow of €9
×
130,000 = €1,170,000 per year for 4 years from its existing customers. Note that whatever incremental costs Euro-Jouets incurs on sales to its existing customers is irrelevant. These costs would continue to be incurred whether Euro-Jouets prices the cars at €50 or €59. You can verify that Euro-Jouets generates positive contribution margin at a price of €50 and so should continue to sell to its existing customers. From Appendix B, Table 4, the present value of a stream of €1,170,000 payments for 4 years discounted at 16% is €1,170,000
×
2.798 = €3,273,660. The net relevant benefit of accepting the special order is €3,300,000 − €3,273,660 =
€26,340. Therefore, Euro-Jouets should accept the special order.
2
Let the Euro discount from the current €59 price offered to existing customers be €X. Then €X (130,000) (2.798) = 3,300,000
X
=
3,300, 000
(130, 000)(2.798)
= €9.0724 At a price of €49.9276 (€59 − €9.0724) per car to its existing customers, Euro-Jouets would just be indifferent between accepting and rejecting Mille-Fontaines’ special order.

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