Question

Bob makes widgets. Variable costs per unit are $2. Fixed cost per unit (at an output level of 100) are $1 per unit. The normal sales price per unit is $5. A customer approaches Bob offering to buy 40 widgets for $4 each. Assume Bob has excess capacity.

1) What is the effect on operating income if he accepts the order? Additional revenue – additional cost = effect on oper. income. Fixed costs won’t change so additional costs = VC

2) Assume that, to fill the special order, Bob must buy and completely use up (no future use) a special material for $50. What is the effect on operating income if he accepts the order? Consider the special material to be part of the additional cost specific to this order.

3) Assume the need for the special material as in #2. Also, assume there is no excess capacity. What price would Bob need to charge for the special order so that operating income will be the same whether or not he accepts the special order?

Answer 1

Que. 1) Calculation of Effect on Operating Income if Bob accepts the Order

As Bob is having excess capacity there will be no effect on Fixed Cost. The Effect will be as Follows

Particulars	Amount ($)
Additional Revenue ( $ 4 * 40)	160
Less: Additional Variable Cost ($ 2 * 40)	80
Additional Operating Income	80

So in First case Operating Income will increase by $ 80

Que. 2)

Calculation of operating Income

Particulars	Amount ($)
Additional Revenue ( $ 4 * 40)	160
Less: Additional Variable Cost ($ 2 * 40)	80
Cost of Special Material	50
Additional Operating Income ( 160-80-50 )	30

So in Second case Operating Income will increase by $ 30

Que. 3 Calculation of Price to be charged

Given that he has no excess capacity

Current Operating Income Per Unit = Sales - Variable Cost - Fixed Cost

= ( $ 5 - $ 2 - $ 1)

= $ 2

Calculation Table

If Bob Accepts the Order, price Charged will be

Particulars	Amount ($)
Varible Cost per Unit	2
Fixed Cost Per Unit	1
Special Material cost per Unit ( $50 / 40 Units )	1.25
Expected Operating Income Per Unit	2
Total Price to be Charged ( 2+1+1.25+2)	6.25

So Bob must Charge $ 6.25 per unit for the Special Order so as to maintain his operating Income.