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Madison Inc. received an order for a piece of special machinery from Atlas Company. Just as
Madison completed the machine, Atlas Company declared bankruptcy, defaulted on the order,
and forfeited the 10 percent deposit paid on the selling price of $72,500.
Madison’s manufacturing manager identified the costs already incu
ed in the production of the
special machinery for Atlas Company as follows:
Direct material
$16,600
Direct labor 21,400
Manufacturing overhead applied:
Variable $10,700
Fixed 5,350 16,050
Fixed selling and administrative costs 5,405
Total $59,455
Another company, Outback Corporation, will buy the special machinery if it is reworked to
Outback’s specifications. Madison offered to sell the reworked machinery to Outback as a
special order for $68,400. Outback agreed to pay the price when it takes delivery in two months.
The additional identifiable costs to rework the machinery to Outback’s specifications are as
follows:
Direct material $ 6,200
Direct labor 4,200
Total $10,400
A second alternative available to Madison’s management is to convert the special machinery to
the standard model, which sells for $62,500. The additional identifiable costs for this conversion
are as follows:
Direct material $2,850
Direct labor 3,300
Total $6,150
A third alternative for Madison is to sell the machine as is for a price of $52,000. However, the
potential buyer of the unmodified machine does not want it for 60 days. This buyer has offered a
$7,000 down payment, with the remainder due upon delivery.
The following additional information is available regarding Madison’s operations.
• The sales commission rate on sales of standard models is 2 percent, while the rate on special
orders is 3 percent.
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• Normal credit terms for sales of standard models are 2/10, net/30. This means that a customer
eceives a 2 percent discount if payment is made within 10 days, and payment is due no later
than 30 days after billing. Most customers take the 2 percent discount. Credit terms for a
special order are negotiated with the customer.
• The allocation rates for manufacturing overhead and fixed selling and administrative costs
are as follows:
Manufacturing costs:
XXXXXXXXXXVariable 50% of direct-labor cost
XXXXXXXXXXFixed 25% of direct-labor cost
Fixed selling and administrative
costs
10% of the total of direct-material, direct-labor,
and manufacturing-overhead costs
• Normal time required for rework is one month.
Required:
1. Determine the dollar contribution the first alternative will add to Madison’ before-tax profit
(6 points).
2. Determine the dollar contribution the second alternative will add to Madison’ before-tax
profit (6 points).
3. Determine the dollar contribution the third alternative will add to Madison’ before-tax profit
(6 points).
4. If Outback makes Madison a counteroffer, what is the lowest price Madison should accept
for the reworked machinery from Outback? Determine the minimum acceptable price from
Outback (7 points).
Required: