Alec Powell runs a small firm that produces ornate wine racks for customers. These are high-quality products and Powell has gradually built up a reputation for high-quality output. Each wine rack sells for £50. A Spanish buyer, Ramadal, wants to import the wine racks for sale in her domestic market. She believes that market conditions would dictate a lower selling price and has offered to buy 500 wine racks from Powell at a price of £35 each. Powell is unsure whether or not to accept this order as it is for a price significantly lower than his normal selling price. His data below are based on the planned production level of 10,000 wine racks per year:
|
£ |
|
|
Direct materials |
12.00 |
|
Direct labour |
8.50 |
|
Variable overheads |
2.50 |
|
Fixed overheads |
6.00 |
|
Selling and distribution costs: Variable |
4.00 |
|
Selling and distribution costs: Fixed |
5.00 |
|
Total cost |
38.00 |
Initially, the order looks, on financial grounds, an unwise one to accept. Each wine rack has a unit cost of £38, which implies that Powell would lose £3 on each wine rack sold to Ramadal. However, the £38 cost includes those costs that are not part of the marginal cost of producing a wine rack. Hence, we should look at the marginal cost of producing each wine rack.
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