Question

Pamela in Bamplona makes bull-repellent scent according to a traditional Spanish recipe, which normally sells at €9 (Euros) per unit. Normal production volume is 10,000 ounces per month. Average cost is €5 per ounce, of which €2 is direct material and €1 is variable conversion cost. This product is seasonal. After July, demand for this product drops to 6,000 ounces monthly. In November, Umberto offers to buy 1,500 ounces for €6,000. If Pamela accepts the order, she must design a special label for Umberto at a cost of €500. Each label will cost 25 cents to make and apply. Pamela should:
A. accept the order, at a gain of €625
B. reject the order, at a loss of €1,875
C. reject the order, at a loss of €2,375
D. accept the order, at a gain of €1,125
E. none of the above

Answer 1

Answer:

C. Pamela should reject the order, at a loss of € 2,375

Explanation:

The average cost of production is 5 euros per ounce. This implies that the production cost of 1500 ounces is: 1,500 * 5 = € 7,500. Apart from that, € 500  would have to be paid for the design of the labels and € 0.25 euros for making them and applying them (0.25 * 1,500 = 375 euros).

If we consider all these amounts we have:

Average cost of production: € 7,500

Cost of designing labels: € 500

Cost of making and applying labels: € 375

TOTAL COSTS = € 8,325

If Pamela decided to sell 1,500 ounces at € 6,000 she would lose: €8,325 -€6,000 = €2,325

Then, she shoud reject the offer.