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29 August, 23:22

Pamela in Bamplona makes bull-repellent scent according to a traditional Spanish recipe, which normally sells at €9 (Euros) per unit. Normal production volume is 10,000 ounces per month. Average cost is €5 per ounce, of which €2 is direct material and €1 is variable conversion cost. This product is seasonal. After July, demand for this product drops to 6,000 ounces monthly. In November, Umberto offers to buy 1,500 ounces for €6,000. If Pamela accepts the order, she must design a special label for Umberto at a cost of €500. Each label will cost 25 cents to make and apply. Pamela should:

A. accept the order, at a gain of €625

B. reject the order, at a loss of €1,875

C. reject the order, at a loss of €2,375

D. accept the order, at a gain of €1,125

E. none of the above

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Answers (1)
  1. 30 August, 00:46
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    C. Pamela should reject the order, at a loss of € 2,375

    Explanation:

    The average cost of production is 5 euros per ounce. This implies that the production cost of 1500 ounces is: 1,500 * 5 = € 7,500. Apart from that, € 500 would have to be paid for the design of the labels and € 0.25 euros for making them and applying them (0.25 * 1,500 = 375 euros).

    If we consider all these amounts we have:

    Average cost of production: € 7,500

    Cost of designing labels: € 500

    Cost of making and applying labels: € 375

    TOTAL COSTS = € 8,325

    If Pamela decided to sell 1,500 ounces at € 6,000 she would lose: €8,325 - €6,000 = €2,325

    Then, she shoud reject the offer.
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