Question

Delta Company produces a single product. The cost of producing and selling a single unit of this product at the company’s normal activity level of 85,200 units per year is:

Direct materials	$	2.40
Direct labor	$	3.00
Variable manufacturing overhead	$	0.60
Fixed manufacturing overhead	$	4.05
Variable selling and administrative expenses	$	1.30
Fixed selling and administrative expenses	$	2.00

The normal selling price is $24.00 per unit. The company’s capacity is 98,400 units per year. An order has been received from a mail-order house for 1,100 units at a special price of $21.00 per unit. This order would not affect regular sales or the company’s total fixed costs.

Required:

1. What is the financial advantage (disadvantage) of accepting the special order?

2. As a separate matter from the special order, assume the company’s inventory includes 1,000 units of this product that were produced last year and that are inferior to the current model. The units must be sold through regular channels at reduced prices. The company does not expect the selling of these inferior units to have any effect on the sales of its current model. What unit cost is relevant for establishing a minimum selling price for these units?

Answer 1

1.

1) Incremental Analysis
	Reject Order	Accept Order	Incremental effect
Units		1,100	1,100
Sales Price		$            21.00
Variable Cost ((2.4+3+0.6+1.3))		$              7.30
Sales (1100*$21)	$                     -	$     23,100.00	$     23,100.00
Variable Cost (1100*$7.30)	$                     -	$       8,030.00	$       8,030.00
Fixed Cost	$                     -	$                  -	$                  -
Profit	$                     -	$     15,070.00	$     15,070.00

Financial Advantage = $15070

2. As the 1000 units order is under capacity we would be able to sell it at least at the Variable cost as the fixed cost are unchanged and the ideal capacity will not make any difference hence a a seling price of more than 7.30 should be acceptable

Relevant cost per unit = $7.30