Question

At the end of the year, a company offered to buy 4,580 units of a product from X Company for $11.00 each instead of the company's regular price of $19.00 each. The following income statement is for the 60,000 units of the product that X Company has already made and sold to its regular customers:

Sales		$1,140,000
Cost of goods sold		491,400
Gross margin		$648,600
Selling and administrative costs		150,000
Profit		$498,600

For the year, fixed cost of goods sold were $128,400, and fixed selling and administrative costs were $62,400. The special order product has some unique features that will require additional material costs of $0.77 per unit and the rental of special equipment for $3,000.

4. Profit on the special order would be

A: $6,555

B: $7,407

C: $8,370

D: $9,458

E: $10,687

F: $12,076

Tries 0/99

5. The marketing manager thinks that if X Company accepts the special order, regular customers will be lost unless the selling price for them is reduced by $0.14. The effect of reducing the selling price will be to decrease firm profits by

A: $6,720

B: $8,400

C: $10,500

D: $13,125

E: $16,406

F: $20,508

Answer 1

Solution

Profit for special order –

Incremental revenue = $50,380                                       ($11 x 4,580 units)

Incremental costs –

Variable cost of goods sold $27,709                                (491,400 – 128,400)/60,000 x 4,580

Variable selling and admin $6,687                                   (150,000 – 62,400)/60,000 x 4,580

Additional material cost $3,526

Rental cost $3,000

Total incremental cost = 40,922

Incremental profit = $9,458

Hence, profit on special order would be $9,458         

Part 2 –

The effect of reducing the selling price would be –

Revised selling price = $19 - $0.14 = $18.86

Variable costs –

Cost of goods sold per unit = (491,400 – 128,400)/60,000 = $6.05

Selling and admin per unit = (150,000 – 62,400)/60,000 = $1.46

Variable cost per unit (computed above.) = $7.51

Contribution margin per unit = $11.35

Contribution margin total = $11.35 x 60,000 = $681,000

Fixed costs:

Cost of goods sold = $128,400

S&A cost = 62,400

Total fixed costs = 190,800

Profit = 681,000 – 190,800 = $490,200

Original profit = 498,600

Reduction in profits = 498,600 – 490,200 = $8,400

Hence, firm’s profits decrease by $8,400