PRICING DECISIONS AND COST MANAGEMENT
Relevant-cost approach to short-run pricing decisions.
Analysis of special order:
Sales, 3,000 units
Direct materials, 3,000 units
Direct manufacturing labor, 3,000 units
Variable manufacturing overhead, 3,000 units
Other variable costs, 3,000 units
Total variable costs
Note that the variable costs, except for commissions, are affected by production volume,
not sales dollars.
If the special order is accepted, operating income would be $1,000,000 + $49,000 =
Whether McMahon’s decision to quote full price is correct depends on many factors. He is
incorrect if the capacity would otherwise be idle and if his objective is to increase operating
income in the short run. If the offer is rejected, San Carlos, in effect, is willing to invest $49,000
in immediate gains forgone (an opportunity cost) to preserve the long-run selling-price structure.
McMahon is correct if he thinks future competition or future price concessions to customers will
hurt San Carlos’s operating income by more than $49,000.
There is also the possibility that Abrams could become a long-term customer. In this case,
is a price that covers only short-run variable costs adequate? Would Holtz be willing to accept a
$8,000 sales commission (as distinguished from her regular $33,750 = 15%
every Abrams order of this size if Abrams becomes a long-term customer?
Short-run pricing, capacity constraints.
1. Per kilogram of hard cheese:
Milk (10 liters
$1.50 per liter)
Direct manufacturing labor
Variable manufacturing overhead
Fixed manufacturing cost allocated
Total manufacturing cost
If Vermont Hills can get all the Holstein milk it needs, and has sufficient production capacity,
then, the minimum price per kilo it should charge for the hard cheese is the variable cost per kilo
= $15+5+3 = $23 per kilo.