Question

PowerDrive, Inc. produces a hard disk drive that sells for $175 per unit. The cost of producing 25,000 drives in the prior year was:

Direct material $625,000

Direct labor 375,000

Variable overhead 125,000

Fixed overhead 1,500,000

Total cost $2,625,000

At the start of the current year, the company received an order for 3,800 drives from a computer company in China. Management of PowerDrive has mixed feelings about the order. On the one hand they welcome the order because they currently have excess capacity. Also, this is the company’s first international order. On the other hand, the company in China is willing to pay only $135 per unit.

What will be the effect on profit of accepting the order?

Answer 1

First of all we shall calculate the company's per unit cost of producing drives as follows:

Direct material = $ 625,000 / 25,000

= $ 25 per drive

Direct labor = $ 375,000 / 25,000

= $ 15 per drive

Variable overhead = $ 125,000 / 25,000

= $ 5 per unit

We shall not consider the per unit cost of fixed overhead since this is the cost that will be incurred irrespective of the fact that whether we will accept or not accept the order from China.

So per unit cost incurred by Power Drive inc in producing a drive excluding fixed overhead is

= $ 25 + $ 15 + $ 5

= $ 45 per drive

Selling price of drive to the computer company in China is $ 135 per unit

Profit from selling one unit to the company in China is selling price less cost incurred

= $ 135 - $ 45

= $ 90 per drive

So the profit on 3,800 drivers shall be

= $ 90 x 3800

= $ 342,000

So the effect on profitability of the company is that the company shall be earning profit of $ 342,000 by accepting the order

Feel free to ask in case of any query relating to this question.