East Coast Digital ECD produces high quality audio and video equipment
East Coast Digital (ECD) produces high-quality audio and video equipment. One of the company’s most popular products is a high-definition personal video recorder (PVR) for use with digital television systems. Demand has increased rapidly for the PVR over the past three years, given the appeal to customers of being able to easily record programs while they watch live television, watch recorded programs while they record a different program, and save dozens of programs for future viewing on the unit’s large internal hard drive. A complex production process is utilized for the PVR involving both laser and imaging equipment. ECD has a monthly production capacity of 4,000 hours on its laser machine and 1,000 hours on its image machine. However, given the recent increase in demand for the PVR, both machines are currently operating at 90% of capacity every month, based on existing orders from customers. Direct labour costs are $15 and $20 per hour to operate, respectively, the laser and image machines. The revenue and costs on a per unit basis for the PVR are as follows:
On December 1, Dave Nance, vice-president of Sales and Marketing at ECD, received a special-order request from a prospective customer, Jay Limited, which has offered to buy 250 PVRs at $280 per unit if the product can be delivered by December 31. Jay Limited is a large retailer with outlets that specialize in audio and video equipment. This special order from Jay Limited is in addition to orders from existing customers that are utilizing 90% of the production capacity each month. Variable selling costs would not be incurred on this special order.
1. Is Davis’s general approach to calculating the opportunity cost in terms of the physical units involved correct? Explain.
2. Assuming productive capacity cannot be increased for either machine in December, how many PVRs would ECD have to forgo selling to existing customers to fill the special order from Jay Limited?
3. Calculate the opportunity cost of accepting the special order.
4. Calculate the net effect on profits of accepting the special order.
5. Now assume that ECD is operating at 75% of capacity in December. What is the minimum price ECD should be willing to accept on the special order?
6. What are some qualitative issues that should be considered when accepting special orders such as that proposed by Jay Limited?
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