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Integrative Case 5-72 (Algo) Cost Estimation, CVP Analysis, and Decision Making (LO 5-4, 5, 9)

Luke Corporation produces a variety of products, each within their own division. Last year, the managers at Luke developed and began marketing a new chewing gum, Bubbs, to sell in vending machines. The product, which sells for $5.80 per case, has not had the market success that managers expected and the company is considering dropping Bubbs.

The product-line income statement for the past 12 months follows:

Revenue$14,698,650CostsManufacturing costs$14,445,895Allocated corporate costs (@5%)734,93315,180,828Product-line margin$(482,178)Allowance for tax (@20%)96,435Product-line profit (loss)$(385,743)

All products at Luke receive an allocation of corporate overhead costs, which is computed as 5 percent of product revenue. The 5 percent rate is computed based on the most recent year's corporate cost as a percentage of revenue. Data on corporate costs and revenues for the past two years follow:

Corporate RevenueCorporate Overhead CostsMost recent year$117,750,000$5,887,500Previous year77,300,0004,953,105

Roy O. Andre, the product manager for Bubbs, is concerned about whether the product will be dropped by the company and has employed you as a financial consultant to help with some analysis. In addition to the information given, Mr. Andre provides you with the following data on product costs for Bubbs:

MonthCasesProduction Costs1218,000$1,158,3402222,7001,179,8403220,4001,188,4934239,0001,204,0355234,9501,206,3396248,0001,227,1857225,7501,202,2118252,7001,245,2869244,3001,243,73810258,1501,255,83711255,7001,260,27212264,7001,290,963

Required:

a.Bunk Stores has requested a quote for a special order of Bubbs. This order would not be subject to any corporate allocation (and would not affect corporate costs). What is the minimum price Mr. Andre can offer Bunk without reducing profit any further?

b.How many cases of Bubbs does Luke have to sell in order to break even on the product?

c.Suppose Luke has a requirement that all products have to earn 5 percent of sales (after tax and corporate allocations) or they will be dropped. How many cases of Bubbs does Mr. Andre need to sell to avoid seeing Bubbs dropped?

d.Assume all costs and prices will be the same in the next year. If Luke drops Bubbs, how much will Luke's profits increase or decrease? Assume that fixed production costs can be avoided if Bubbs is dropped.

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