Layton Ironworks manufactures a variety of industrial valves and pipe fittings sold primarily to customers in the United States. Currently, the company is operating at 70 percent of capacity and is earning a satisfactory return on investment.
Prince Industries Ltd. of Scotland has approached Layton's management with an offer to buy 120,000 pressure valves. Prince manufactures an almost identical pressure valve, but a fire in Prince's valve plant has closed its manufacturing operations. Prince needs the 120,000 valves over the next four months to meet commitments to its regular customers; the company is prepared to pay $19 each for the valves.
Layton's product cost for the pressure valve based on current attainable standards is
Direct material ........ $ 5
Direct labor .......... 6
Manufacturing overhead ..... 9
Total cost ........... $20
Manufacturing overhead is applied to production at the rate of $18 per standard direct labor hour. This overhead rate is made up of the following components:
Variable factory overhead ............ $ 6
Fixed factory overhead—direct .......... 8
Fixed factory overhead—allocated ........ 4
Applied manufacturing overhead rate ....... $18
Additional costs incurred in connection with sales of the pressure valve include 5 percent sales commissions and $1 freight expense per unit. However, the company does not pay sales commissions on special orders that come directly to management.
In determining selling prices, Layton adds a 40 percent markup to product cost, which provides a $28 suggested selling price for the pressure valve. The marketing department, however, has set the current selling price at $27 to maintain market share.
Production management believes that it can handle Prince Industries’ order without disrupting its scheduled production. The order would, however, require additional fixed factory overhead of $12,000 per month for supervision and clerical costs.
If management accepts the order, Layton will manufacture 30,000 pressure valves and ship them to Prince Industries each month for the next four months.
a. Determine how many additional direct labor hours would be required each month to fill the Prince Industries order.
b. Prepare an incremental analysis showing the impact of accepting the Prince
Industries order.
c. Calculate the minimum unit price that Layton Valves’ management could accept for the Prince Industries order without reducing net income.
d. Identify the factors, other than price, that Layton Valves should consider before accepting the Prince Industries order.