Special Order with an Alternative Use of Idle Capacity
Meridian Polymers makes industrial bins at a normal capacity of 80,000 units a year; it currently produces and sells 62,000 units. The domestic price is ₹1,450 per unit. Variable costs are materials ₹540, direct labour ₹210 and variable overhead ₹160. Fixed overhead of ₹2.40 crore a year is absorbed at ₹300 per unit on normal capacity. An exporter offers ₹1,080 per unit for 9,000 units, FOB. The order needs tooling that costs ₹6.50 lakh and has no scrap value afterwards. Because of the delivery schedule, direct labour on the export units would carry a 20% overtime premium. No domestic sales would be lost. Separately, a domestic distributor has offered ₹1,250 per unit for 7,000 units, using the same idle capacity and no tooling. Both offers are one-time and mutually exclusive. The sales director argues the export order must be rejected because its price is below the full cost of ₹1,210 per unit.
1. Quantify the relevant cost and contribution of each offer. Which offer, if either, should Meridian accept, and what is the minimum export price that would make the exporter's offer equally attractive?
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Relevant cost of export:
- Revenue: 9,000 × ₹1,080 = ₹97,20,000
- Variable cost: 9,000 × ₹910 = ₹81,90,000
- Overtime premium: 20% × ₹210 × 9,000 = ₹3,78,000
- Tooling: ₹6,50,000
- Incremental cost: ₹92,18,000
- Net contribution: ₹5,02,000
Domestic offer:
- Contribution: 7,000 × (₹1,250 − ₹910) = ₹23,80,000
- No tooling or overtime.
Accept the domestic offer. The export order earns only ₹5.02 lakh over its incremental costs, while it uses the same idle capacity that could earn ₹23.80 lakh. The allocated fixed overhead of ₹300 per unit is not relevant because total fixed overhead does not change.
Minimum export price: set export contribution equal to the domestic opportunity cost: 9,000 × (P − ₹952) − ₹6,50,000 = ₹23,80,000 P = ₹952 + (₹30,30,000 ÷ 9,000) = ₹1,288.67. So the exporter would need to pay about ₹1,289 per unit. If the domestic offer did not exist, the break-even export price would be ₹1,024.22, not ₹1,210.
2. The sales director says any price below ₹1,210 destroys value. Critically evaluate that statement and state two qualitative factors that could change the ranking.
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The ₹1,210 full cost is a reporting cost, not a decision cost. It includes ₹300 of absorbed fixed overhead that is unaffected by the order. A price below ₹1,210 can still add contribution if capacity is idle and no better use exists. Here, however, the export order is not value-maximising because it forgoes the ₹23.80 lakh domestic contribution; the correct comparison is incremental contribution plus opportunity cost, not full cost.
Qualitative factors: (i) strategic export-market entry and future repeat orders may have value beyond this one order; (ii) tooling and overtime raise quality/delivery risk, and the domestic distributor may be a long-term relationship. Foreign-exchange and payment risk also matter. These could justify accepting a lower export price only if the strategic benefits are quantified and the domestic alternative is genuinely unavailable.