Special Order and Normal Loss at a Mandalay Juice Bottler
Mandalay Juice Co. bottles 70,000 litres of good output per month for local sale at MMK 4,000 per litre. Plant capacity is 100,000 good litres per month. Variable input cost is MMK 2,200 per litre of input; normal loss in filling is 5% of input and has no scrap value. Monthly fixed costs are MMK 60,000,000 and are unchanged within the relevant range. An exporter offers a one-off order for 20,000 good litres at MMK 2,800 per litre. The order needs a special label costing MMK 150 per good litre and an incremental fixed setup cost of MMK 8,000,000. It would use otherwise idle capacity and would not affect local sales or regular fixed costs. The sales manager argues that any price above MMK 2,200 variable cost is profitable because fixed costs are already covered by local sales. The finance director asks for a relevant-cost analysis and a minimum acceptable price, ignoring qualitative factors.
1. Prepare a relevant-cost analysis for the 20,000-litre export order at MMK 2,800 per good litre and recommend whether to accept it.
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Normal loss means input must exceed good output. Required input = 20,000 / 0.95 = 21,052.63 litres. Relevant costs:
- Variable input: 21,052.63 x MMK 2,200 = MMK 46,315,789.
- Special labels: 20,000 x MMK 150 = MMK 3,000,000.
- Incremental fixed setup: MMK 8,000,000. Total relevant cost = MMK 57,315,789. Relevant revenue = 20,000 x MMK 2,800 = MMK 56,000,000. Financial result = MMK 56,000,000 - MMK 57,315,789 = loss of MMK 1,315,789. Recommendation: reject on purely financial grounds. Existing fixed costs are committed for this decision and idle capacity has no alternative contribution, so they are not added. The order fails to cover its avoidable costs.
2. Calculate the minimum acceptable price per good litre and explain the error in the sales manager's reasoning.
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Minimum price = total relevant cost / 20,000 good litres = MMK 57,315,789 / 20,000 = MMK 2,865.79, so about MMK 2,866 per litre. Equivalently: variable cost per good litre = MMK 2,200 / 0.95 = MMK 2,315.79; plus label MMK 150; plus setup MMK 8,000,000 / 20,000 = MMK 400; total MMK 2,865.79. The sales manager compares MMK 2,800 with MMK 2,200 and ignores the 5% yield loss (about MMK 2.315m of extra input), the special label (MMK 3m) and the incremental setup (MMK 8m). At MMK 2,800 the order makes a negative contribution after avoidable costs. Qualitative factors could include export-market entry, quality risk, labour availability and future capacity constraints, but they do not fix the arithmetic.