Question

Problem 3 Special order

Oliver is currently selling 9,800 units and their maximum capacity is 10,000. The normal selling price is $250, variable manufacturing costs are $125 and the normal sales commission is 10% of selling price. Fixed costs are $500,000. They are approached regarding a special order for 200 units at a price of $155. None of their current customers will be affected and the sales commission will be 10% of the sales price. What effect will this have on income?

Now suppose the company policy is that the sales commission on a special order is a flat $2,000 but a special machine must be rented at a cost of $3,000 per year and the offered price is $135. What effect would this have on income?

Finally, suppose the original facts but the current demand is 9,700 and the order is 400 or nothing. What is the effect on income?

Answer 1

Part 1
	With order	Without order
Units manufactured	10000	9800
Sales - (normal)	2450000	2450000
Spl at 155	31000
Total	2481000	2450000
Less : Variable manufacturing cost @125 / unit	1250000	1225000
Variable Selling cost	248100	245000
Contribution	982900	980000
Less : Fixed Cost	500000	500000
Operating Income	482900	480000
Increase in income	2900
Fixed cost is being covered by the normal sales of 9800. So, if Oliver takes up the order, it can make an operating profit of $2900
You can also calculate by per unit
Variable cost of manufacture	125
Variable selling costs 155@10%	15.5
Total variable cost	140.5
Contribution expected	14.5	(155-140.5)
Total increase in income	2900	(14.5*200)
Part 2
Variable cost of manufacture	125
Contribution expected	10	(135-125)
Total Contribution	2000
Less : Selling cost	2000
Additional Rent	3000
Operating Loss	-3000
Net effect on income is negative. Order will give a loss of 3000
Part 3
	With order	Without order
Units manufactured	10000	9800
Sales - (9600 @ 250, since maximum is 10000)	2400000	2450000
Spl 400 at 155	62000
Total	2462000	2450000
Less : Variable manufacturing cost @125 / unit	1250000	1225000
Variable Selling cost	246200	245000
Contribution	965800	980000
Less : Fixed Cost	500000	500000
Operating Income	465800	480000
Increase in income	-14200
Net effect on income is negative. Loss of 14200 if Oliver takes up the order. Hence it better not to take the order.