Question

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Morning Sky, Inc. (MSI), manufactures and sells computer games. The company has several product lines based on the age range of the target market. MSI sells both individual games as well as packaged sets. All games are in CD format, and some utilize accessories such as steering wheels, electronic tablets, and hand controls. To date, MSI has developed and manufactured all the CDs itself as well as the accessories and packaging for all of its products.

The gaming market has traditionally been targeted at teenagers and young adults; however, the increasing affordability of computers and the incorporation of computer activities into junior high and elementary school curriculums has led to a significant increase in sales to younger children. MSI has always included games for younger children but now wants to expand its business to capitalize on changes in the industry. The company currently has excess capacity and is investigating several possible ways to improve profitability.

MSI has been approached by a fourth-grade teacher from Portland about the possibility of creating a specially designed game that would be customized for her classroom and environment. The teacher would like an educational game to correspond to her classroom coverage of the history of the Pacific Northwest, and the state of Oregon in particular. MSI has not sold its products directly to teachers or school systems in the past, but its Marketing Department identified that possibility during a recent meeting.

The teacher has offered to buy 2,300 copies of the CD at a price of $6.00 each. MSI could easily modify one of its existing educational programs about U.S. history to accommodate the request. The modifications would cost approximately $320. A summary of the information related to production of MSI’s current history program follows:

Direct materials	$	1.22
Direct labor		0.30
Variable manufacturing overhead		2.13
Fixed manufacturing overhead		1.90
Total cost per unit	$	5.55
Sales price per unit	$	12.00

Required:
1. Compute the incremental profit (or loss) from accepting the special order.

2. Should MSI accept the special order?

3. Suppose that the special order had been to purchase 2,300 copies of the program for $2.50 each. Compute the incremental profit (or loss) from accepting the special order under this scenario.

4. Suppose that MSI is operating at full capacity. To accept the special order, it would have to reduce production of the history program. Compute the special order price at which MSI would be indifferent between accepting or rejecting the special order.

Answer 1

Answer 1:

Incremental profit (or loss) from accepting the special order = $ 5,085

Calculation:

Particulars	Amount
Revenue	$   13,800.00
Less: Variable cost (1.22+0.3+2.13)*2300	$     8,395.00
Less: Modification cost	$        320.00
Net benefit	$     5,085.00

Answer 2:

MSI should accept the special order.

Answer 3:

The incremental loss from accepting the special order = $ 2,965

Calculation:

Particulars	Amount
Revenue	$     5,750.00
Less: Variable cost (1.22+0.3+2.13)*2300	$     8,395.00
Less: Modification cost	$        320.00
Net benefit	$   (2,965.00)

Answer 4:

Special order price at which MSI would be indifferent between accepting or rejecting the special order = $ 12.14

Calculation:

Let the order price be x.

Profit from history program = Profit from special order

(12 - 1.22 - 0.3 - 2.13) * 2,300 = [(x - 1.22 - 0.3 - 2.13) * 2,300] (-) 320

$ 19,205 = [(x - 3.65) * 2,300] (-) 320

x = $ 12.14

In case of any doubt, please comment.