Instructor’s Note: Ace Manufacturing
1. Ask students to suggest ways to cost this incremental business on a per unit basis. As
they come up with the two alternatives, write them under the columns labeled “+30,000.”
Groups of business people will usually propose first that the direct fixed and G&A costs
be allocated equally across the two products. In an MBA class, someone often begins
with the other extreme, arguing that the additional 30,000 units should be required to
cover only the incremental costs—implying a relevant unit cost of $7.50. If that happens,
take on the role of the product manager or sales manager who is charged with covering
the costs for the first 150,000 units of the regular product. Point out that there is no way
that the additional 30,000 units could be produced for only $7.50. Those units require
2. Show the students the importance of this decision. Show them that one alternative implies
that this will be highly profitable business, contributing $2.50 per incremental unit, while
the other implies that it would be unprofitable business, reducing profits by $1.50 per
incremental unit.
3. Now fill in the “Total Dollar Revenue” and add up the costs. Calculate the new level of
profits. The result: $300,000—or a gain of $75,000. On a per unit basis, it is certainly
4. Ask whether, based on this financial analysis alone, the company should definitely take
this business. This is a good opportunity to make the point that one must never evaluate
pricing decisions on an ad hoc basis, but by looking at their effect on the entire market.
Good answers that should be acknowledged here are as follows.
Sales people have a habit of treating all business as incremental, when often it is not. Many
possibly reduce sales from the traditional sources by 10,000 units (to 140,000 units). That loss of
10,000 higher margin units would make this a very unprofitable decision.
The lesson here: Make sure, when determining the profitability of incremental business, that you
know what the increment is (30,000 new units, or 30,000 minus 10,000 old units, or all 180,000
units).