Question

One of Phoenix Computer's products is WizardCard. The company currently produces and sells 30,000 WizardCards per month, although it has the plant capacity to produce 50,000 units per month. At the 30,000 units-per-month level of production, the average per-unit cost of manufacturing WizardCards is $45, consisting of $15 in variable costs and $30 in fixed costs. Phoenix sells WizardCards to retail stores for $90 each. Computer Marketing Corp. has offered to purchase 10,000 WizardCards per month at a reduced price at 70$. Phoenix can manufacture these additional units with no change in fixed manufacturing costs.

1. Does this make sense for Phoenix? Make an incremental analysis and give reasons for your decision
2. After signing the order Phoenix Computer recognizes, that the print of the logo of Computer Marketing Corp. causes additional $5 variable manufacturing costs per piece. In addition to that, they need to rent a special printing machine that costs 300.000$ for the whole production time. As the contract was already signed the agreed selling price of 70$ can not be changed per piece. How does this influences the operating income of Phoenix Computers?

Answer 1

Phoenix Computer has excess capacity to produce 20,000 units.
Hence, if it decides to produce the additional 10,000 units for Computer Marketing Corp, it will not be sacrificing any external sales.
The fixed costs of $30 per unit are sunk cost and irrelevant for such decision-making.
Since it has excess capacity available, the relevant price to be charged from Computer Marketing Corp would be the variable cost per unit i.e. $15 per unit.
a. Now, Computer Marketing Corp has offered a price of $70 per unit which is more than the relevant cost of $15. Hence, the offer would lead to an increase in operating income.
Increase in operating income due to the order = Revenue due to the order - Cost due to the order
=> Increase in operating income due to the order = ($70 per unit - $15 per unit) x 10,000 units = $550,000
b. Now, if additional variable cost of $5 per unit and additional fixed cost of $300,000 were to be incurred for the order, the impact on the operating income would be calculated as follows:
Particulars	Amount
Revenue due to the order ($70 per unit x 10,000 units)	$7,00,000
Less: Variable cost due to the order [($15 + $5 per unit) x 10,000 units]	$2,00,000
Less: Additional fixed cost to be incurred due to the order	$3,00,000
Increase in operating income due to the order	$2,00,000
Hence, the operating income would increase by $200,000 due to the order.