Pea Ridge Corporation Manufactures Faucets

Essay

Pea Ridge Corporation manufactures faucets. Several weeks ago, the company received a special-order inquiry from Galena, Inc. Galena desires to market a faucet similar to Pea Ridge's model no. 55 and has offered to purchase 3,000 units. The following data are available:
· Cost data for Pea Ridge's model no. 55 faucet: direct materials, $45; direct labor, $30 (2 hours at $15 per hour); and manufacturing overhead, $70 (2 hours at $35 per hour).
· The normal selling price of model no. 55 is $180; however, Galena has offered Pea Ridge only $115 because of the large quantity it is willing to purchase.
· Galena requires a design modification that will allow a $4 reduction in direct-material cost.
· Pea Ridge's production supervisor notes that the company will incur $8,700 in additional set-up costs and will have to purchase a $3,300 special device to manufacture these units. The device will be discarded once the special order is completed.
· Total manufacturing overhead costs are applied to production at the rate of $35 per labor hour. This figure is based, in part, on budgeted yearly fixed overhead of $624,000 and planned production activity of 24,000 labor hours.
· Pea Ridge will allocate $5,000 of existing fixed administrative costs to the order as "part of the cost of doing business."
Required:
A. One of Pea Ridge's staff accountants wants to reject the special order because "financially, it's a loser." Do you agree with this conclusion if Pea Ridge currently has excess capacity? Show calculations to support your answer.
B. If Pea Ridge currently has no excess capacity, should the order be rejected from a financial perspective? Briefly explain.
C. Assume that Pea Ridge currently has no excess capacity. Would outsourcing be an option that Pea Ridge could consider if management truly wanted to do business with Galena? Briefly discuss, citing several key considerations for Pea Ridge in your answer.