The Vanishing Margin at Rahim Textiles
Rahim Textiles produces a single fabric grade. Last month it sold 12,000 metres at Tk 250 per metre. The cost sheet shows: direct material Tk 900,000, direct labour Tk 480,000, variable overhead Tk 360,000, and fixed overhead Tk 600,000 (absorbed at Tk 50 per metre based on a normal capacity of 12,000 metres). The sales director has secured an export order for 3,000 additional metres at Tk 175 per metre, but the plant is already at normal capacity, so fulfilling it would require overtime that raises direct labour by 40% on the extra units only and adds Tk 45,000 of incremental fixed supervision cost. The finance manager warns that accepting below 'full cost' of Tk 195 per metre would 'destroy the margin'.
1. Should the company accept the export order? Support your decision with a relevant-cost analysis.
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Relevant cost build-up for 3,000 extra metres:
- Direct material: 900,000 / 12,000 × 3,000 = Tk 225,000
- Direct labour (with 40% overtime): 480,000/12,000 × 3,000 × 1.40 = Tk 168,000
- Variable overhead: 360,000/12,000 × 3,000 = Tk 90,000
- Incremental fixed supervision: Tk 45,000
- Total relevant cost = Tk 528,000, i.e. Tk 176 per metre.
Incremental revenue = 3,000 × 175 = Tk 525,000.
Incremental loss = Tk 3,000. The order should be rejected on purely financial grounds - it is marginally below the relevant cost line.
Note the finance manager's Tk 195 'full cost' is the wrong benchmark: existing fixed overhead is sunk/committed and does not change with this order. The correct test is relevant cost of Tk 176. Since price (175) < relevant cost (176), reject - unless a strategic reason (market entry, customer relationship) justifies a Tk 3,000 sacrifice.
2. At what minimum price per metre would the order become worthwhile, and what qualitative factors should the board weigh before overriding the number?
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Break-even price = Tk 528,000 / 3,000 = Tk 176 per metre. Any price above this adds contribution.
At the offered Tk 175 the loss is only Tk 1/metre - trivially small - so qualitative factors dominate:
- Capacity strain: overtime fatigues the workforce and may hurt quality on the core 12,000-metre business.
- Price precedent: if existing domestic customers learn of a Tk 175 export price, they may demand matching terms, eroding the Tk 250 base.
- Market entry value: the export buyer may open a recurring channel worth more than this single order.
- Contract risk: overtime wage rates and supervision cost are estimates; a small overrun flips the loss wider.
A defensible board position: counter-offer at Tk 180–185 to build in a margin of safety, and ring-fence the price so it is not visible to domestic buyers.