Tasman Precision: Relevant Cost of a Capacity-Constrained Special Order
Tasman Precision Ltd manufactures engineered components in Christchurch. Its plant has practical capacity of 120,000 machine hours per year; budgeted use for the year ended 31 March 2026 is 108,000 hours. A New South Wales distributor has offered a one-off order for 9,000 units at $46 per unit. Each unit requires $31 of direct materials and variable conversion and 2.5 machine hours. The order would need $35,000 of setup and tooling and $12,000 of incremental freight. Tasman has no spare inventory and regular demand exceeds capacity; accepting the order would displace 7,500 machine hours of regular product that earns a contribution of $18 per machine hour. The distributor requires 60-day payment terms and a 2% penalty if delivery is late. The sales manager argues that any price above $31 variable cost is profitable and will help absorb fixed overhead. The production manager warns that the order will disrupt scheduled maintenance and overtime. The CFO asks for a relevant-cost analysis before the board meeting.
1. Calculate the relevant cost and minimum price for the special order. Recommend whether Tasman should accept it.
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The $31 variable cost is not the relevant cost when capacity is binding. Relevant costs are: variable cost 9,000 × $31 = $279,000; setup and tooling $35,000; incremental freight $12,000; and the opportunity cost of displaced regular work, 7,500 hours × $18 = $135,000. Total relevant cost = $461,000. Revenue = 9,000 × $46 = $414,000, so the order has a relevant loss of $47,000.
The minimum price is $461,000 ÷ 9,000 = $51.22 per unit before the late-delivery penalty. If the 2% penalty is probable, add $8,280, giving $469,280 ÷ 9,000 = $52.14. Fixed overhead is not relevant unless it is avoidable. On the numbers, reject the order unless there are separately identifiable strategic benefits, such as a credible route into a new market or learning that reduces future costs.
2. Identify the qualitative and behavioural issues the board should weigh before deciding.
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The sales manager’s ‘anything above variable cost’ argument is a fixed-cost fallacy: it ignores the contribution lost from regular customers. The production manager’s warning about maintenance and overtime is operationally relevant because disruption may raise defect rates, delay regular orders and damage supplier relationships. The board should also consider whether accepting a low price sets a precedent, whether the distributor could become a longer-term customer, and whether the 2% penalty is likely to be triggered. Behaviourally, the sales manager may be rewarded on revenue rather than contribution, which creates a misaligned incentive. A counteroffer above $51.22, or a smaller order that uses genuinely idle hours, would be more defensible than accepting a loss-making order. The decision and its assumptions should be minuted.