Class Quiz 2

Question 2 – Venky enterprises has received an export offer from a client in Rome for 1200 pieces of microwave ovens at a price of USD 300 / oven CIF Rome. Venky has a capacity of 6000 ovens per annum and he manufactures and sells 4800 ovens in the domestic market at a price of INR 15,000 / oven ex-factory Mumbai. The domestic variable costs of production is as under –

1) Raw Material cost = INR 3,000 / oven

2) Accessories and other components = INR 2000 / oven

3) Direct labor = INR 1000 / oven

4) Direct incentives to labor = INR 1000 / oven

5) Cost of transportation of raw material up to factory gates = INR 1000 / oven

6) Packaging and other overheads = INR 1000 / oven

The fixed cost for Mr. Venky is INR 20 lakhs per annum. In case Mr. Venky accepts the order, he will incur additional expenditure as under –

1) Additional packaging = INR 600 / oven

2) Cost of transportation of finished goods up to port = INR 300 / oven

3) Documentation and other doc charges = INR 70 / oven

The freight from Mumbai to Rome is $10 / oven

The insurance premium paid by Venky to cover the goods from Mumbai to Rome is 1% of insured value & the insured value is 110% of CIF price.

Venky has an agent in Rome who has helped him get this order. His commission of 5% is included in the Gross FOB price.

Venky earns valuable forex for the nation. He gets incentives from Government of India equivalent to 10% of the net export proceeds brought into the country.

Assume 1$ = INR 50

Advice Venky whether he should accept the export order. If Yes, calculate the export market contribution (EMC)

Clue – Find out of there is profit in domestic market. If yes, it means fixed costs are covered in domestic market. This means one should not try to cover the fixed cost from foreign market once again, one should only try to recover the variable cost from foreign market. Hence, total variable cost in foreign market = FOB (Cost)

Answer –

Domestic Market –

Total Sales in domestic market = 4,800 ovens = 4,800 * 15,000 INR = INR 7,20,00,000

Total Domestic Variable cost = INR (3,000+2,000+1,000+1,000+1,000+1,000) * 4800 = INR 4,32,00,000

Total Fixed Cost = INR 20,00,000

Profit in Domestic market = Sales – TVC - TFC = INR 2,68,00,000

Since, there is profit in domestic market after including fixed cost, hence, fixed cost is not to be recovered from foreign market again (FC of 20 lakhs is hence, not included in foreign market calculation)

International / Foreign Market -

Using equation to find Gross FOB (P)

CIF (P) = G FOB (P) + Insurance Premium + Freight

CIF (P) = $300 / oven * Number of ovens in international market = INR 300 * 50 * (6000-4800) = INR 1,80,00,000

Insurance Premium = 1% of insured value and insured value is 110% of CIF (P) = 1%*110%*1,80,00,000 = INR 1,98,000

Freight = $10 / oven *Number of ovens = 10*50*(6000-4800) = INR 6,00,000

Hence, Gross FOB (P) = INR 1,72,02,000

Now, G FOB (P) – Agent’s Commission = Net FOB (P)

Agents commission = 5% & is calculated as a % of G FOB (P)

Net FOB (P) = 95% of G FOB (P) = 95% * 1,72,02,000 = INR 1,63,41,900

Using equation to find out profit from foreign market,

Net FOB (P) + Incentives (from GOI) = FOB (C) + Profit

FOB (C) = (Total Domestic variable cost + Additional variable cost on acceptance of order) * Number of ovens = (9000 + 970) * 1200 = INR 1,19,64,000 (excluded fixed cost as per reason given above)

1,63,41,900 + 10% * 1,63,41,900 = 1,19,64,000 + Profit

Profit from foreign market = INR 60,12,090