Doubt ? Please help

Originally posted by : Krishna
	Question :   A customer has offered you Rs. 15.00 per unit for 5,000 units of your product. You normally sell your product for Rs. 25.00 per unit. Should you accept this offer?   You currently produce and sell 40,000 units with a maximum capacity of 50,000 units. Total manufacturing costs are Rs. 18.00 per unit, consisting of Rs. 12.50 variable and Rs. 5.50 fixed.   --------------------------------------------------------------------------------------------------------------------   Solution:   Change in Revenues Rs. 75,000 (5,000 x Rs. 15.00) Change in Expenses (62,500) (5,000 x Rs. 12.50) Net Change Rs. 12,500     Conclusion: You should accept the special offer since it results in Rs. 12,500 of additional income.   ------------------------------------------------------------------------------------------------------------------------   Doubt :   How is it possible?? While the same product can be sold at Rs. 25, then why should I select special offer by customers. Nevertheless, if we ignore fixed costs as a sunk cost we will be in loss too.

AT PRESENT PROFIT:

(40000*25)      1000000

(40000*12.5)   (500000)

(50000*5.5)     (275000)

                      .............................

PROFIT         225000

                 ...................................            

AT THIS STAGE , WE HAVE RECOVERED OUR ENTIRE FIXED COST............NOW IF WE PRODUCE AND SELL PRODUCT ADDITIONAL AND IT IS GENERATING POSITIVE REVENUE THEN IT IS ADVISABLE TO ACCEPT OFFER FOR THAT.............

CONTRIBUTION ITSELF WILL BECOME PROFIT AND OUR PROFIT WILL INCREASE BY RS. 12500/-......

SO ACCEPT THE OFFER FOR ANY PRICE ABOVE RS.12.50/- I.E. VARIABLE COST...IT CONTRIBUTES TO PROFIT...........

EVERY ONE IS RIGHT IN ANSWERING THE ABOVE QUESTION BUT ONE THING IS MISSING IN ABOVE ANSWERS

1. IN THE ABOVE QUESTION THERE IS MORE CAPACITY AVAILABLE i,e 50000 BUT ONLY 40000 CAPACITY IS UTILISING THAT MEANT THE VENDOR HAS NO CAPACIT CONSTRAINT, THEREFORE INSTEAD OF DOING NO PRODUCTION OF EXTRA 10000 CAPACITY IT IS BETTER FOR HIM TO PRODUCE 5000 UNIT AND EARNED 12500/-

2. IF IN THE QUESTION THERE THE TOTAL CAPACITY IS ALSO 40000 UNIT THEN THERE WILL BE CAPACITY CONTRAINT AND IN FIXING THE PRICE THERE NEED TO ADDITION OF OPPORTUNITY COST WHICH WILL BE Rs 25 -Rs 15 = Rs 10 AND CONSEQUENTY THE PRICE FOR THE 5OOO UNIT WILL BE 25 AND NOT 15 AND IN THAT CASE THE ABOVE PROPOSAL SHALL LIABLE TO BE REJECTED.

CORRECT ME IF I AM WRONG

due to spare capacity we charge only variable cost 

so the revenue is( 15-12.5)*5000=12500

so accept the offer.....

so no need to explain more 

this is the best solution...

WHAT IF THERE IS NO SPARE CAPACITY?

Thanks to all of you, my dear seniors

I have understood the concept but one more foolish question knock my mind that if I can sell the product in Rs. 25 normally and customer offers me for Rs. 15 then why would we bear loss as the same can be sold at Rs. 25 and we can generate more profits.

I know this is foolish one, just take it otherwise.

YOU SHOULD HVE  FIRST ASKED WHY THE VENDOR PRODUCING ONLY 40000 UNIT THOUGH HE HAS 50000UNIT CAPACITY?

THERE CAN BE MANY REASON FOR SUCH AND ONE REASON MAY BE THAT HE MIGHT NOT HVE REGULAR CUSTOMER FOR EXTRA 10000 UNIT,

THEREFORE INSTEAD OF SELLING NO EXTRA UNIT OUT OF 10000, HE SHLD BETTER SELL AT Rs. 15 AS HE HAS NO OTHER CUSTOMER FOR THIS EXTRA 5000 UNIT.

THINK HE HAS NO OTHER CUSTOMER FOR SUCH 5000 UNIT THEN U WILL UNDERSTAND, PUT UR SELF IN VENDOR SHOES

if there is no spare capacity then charged full amt  instead of variable cost .....

ur current production is 40000 units whereas ur mxm capacity is of 50000units which means u have 10000 units of ideal capacity....of which u will b using 5000 units of capacity to accept special offer frm a customer which will produce an extra profit of 12500..therefore it is acceptable>>

Thanks to all of you, my dear seniors

I have understood the concept but one more foolish question knock my mind that if I can sell the product in Rs. 25 normally and customer offers me for Rs. 15 then why would we bear loss as the same can be sold at Rs. 25 and we can generate more profits.

I know this is foolish one, just take it otherwise.

@ reply to above

Well as we have heard a saying -- kuch nahi se kuch tho bhala hai

in the same sense, 25/- nahi tho kya hua, 15/- which is more than 12.5/- will give u if not profit, but atleast recovery of fixed cost to an extend.

agar 25/- mai sale ho sakta tha, tho 50000 units waise hi sale karta tha, par nahi ho pata hoga, isliye woh 40000 units hi produce karke usse 25/- pe sale karta hai at a profit of 7/- p.u (25-18)

abhi on this spl order of 5000 units he is not at all getting profits of 7/- p.u. ( correctly as u said), but he is able to recover part of fixed cost , as he is incurring only 12.5/- p.u in making that unit and over and above 12.5/- i.e 2.5/- p.u will go towards recovery of fixed cost element .

It is generating additional contribution of Rs 15-12.50 ie Rs 2.5 , to reover the fixed cost , u are operating at 80 % capacity and u have 20 % idle capacity , Per unit fixed costs will be covered to some extent by additional contribution,

so we have to acccept the offer