Question

Q. Edmonds has a product that has the following budgeted amounts for January. Sales Price $200, Variable Manufacturing Cost $100, Commission (10% of sales) $20, Contribution Margin $80, Fixed costs $240,000, Maximum Capacity 5,000 units, Expected sales in January 4,500 units. They are approached about a special order for 500 units at $125. The sales commission would be a flat $500 and no other customer would be affected.

1) What is the expected income without the special order?

2) What is the effect of special order on the income?

3) Now suppose the order is for 600 units and is all or nothing.

What is the economic effect if they accept the new order?

Answer 1

1. Calculation of expected income without the special order:

Number of units to be sold = 4500

Contribution margin per unit = $80

Total Contribution = $360000

less: Fixed cost = $240000

Net Income = $ 120000

2. Effect of special order on net income:

Total Revenue = 125*500 = $62500

Less: Variable cost = 500*100 =$50000

Less: Sales Commission=$500

Net Income = $ 12000

The net Income would increase from the special order by $12000. No additional fixed costs would be incurred & no loss of contribution would arise from 4500 units since there is sufficient spare capacity for an order of 500 units.

3. Since the order is for 600 units & there is spare capacity for only 500 units, there would be loss of contribution from existing 100 units also.

Effect of special order on Net Income:

Total revenue = 600*125 = $75000

Less:variable costs = 600*100= $60000

Less: Sales Commission = $500

Less: Loss of contribution = 100*80 =$8000

Net Income = $6500

If the order for 600 units is accepted, then the net income will rise by $6500 .