Question

Question Farrow Co. expects to sell 150,000 units of its product in the next period with the following results.

Sales (150,000 units) $2,250,000

Costs and expenses

Direct materials . 300,000

Direct labor 600,000

Overhead . 150,000

Selling expenses . 225,000

Administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 385,500

Total costs and expenses 1,660,500

Net income . $ 589,500

The company has an opportunity to sell 15,000 additional units at $12 per unit. The additional sales would not affect its current expected sales. Direct materials and labor costs per unit would be the same for the additional units as they are for the regular units. However, the additional volume would create the following incremental costs: (1) total overhead would increase by 15% and (2) administrative expenses would increase by $64,500. Prepare an analysis to determine whether the company should accept or reject the offer to sell additional units at the reduced price of $12 per unit.

 

Answer 1

Step 1: Definition of incremental net income

 

The incremental income is the company’s income after choosing various courses of action.

 

Step 2: Calculation of incremental net income

 

	Normal Value	Additional Value	Combined Total
Sales	$2,250,000	$180,000	$2,430,000
Cost and Expenses:
Direct Material	$300,000	$30,000	$330,000
Direct Labour	$600,000	$60,000	$660,000
Overhead	$150,000	$22,500	$172,500
Selling Expenses	$225,000		$225,000
Administrative Expenses	$385,500	$64,500	$450,000
Total Cost and Expenses	$1,660,500	$177,000	$1,837,500
Incremental Income from new business	$589,500	$3,000	$592,500

 

Hence, the incremental net income of the new business is $592,500.

Answer

 

The company should accept the offer because this offer increases the company’s net income by $3,000.