Question

PowerDrive, Inc. produces a hard disk drive that sells for $175 per unit. The cost of producing 25,000 drives in the prior year was:
Direct material	$625,000
Direct labor	375,000
Variable overhead	125,000
Fixed overhead	1,500,000
Total cost	$2,625,000

 

At the start of the current year, the company received an order for 3,200 drives from a computer company in China. Management of PowerDrive has mixed feelings about the order. On the one hand they welcome the order because they currently have excess capacity. Also, this is the company’s first international order. On the other hand, the company in China is willing to pay only $125 per unit.

What will be the effect on profit of accepting the order?

Round to two decimal places.

Answer 1

To accept or reject the order, first find out the variable cost per unit

 

Total variable costs for 25,000 drivers = Direct material + direct labor + variable overhead

                                                             = $625,000 +375,000 + 125,000

                                                              =$ 1,125,000

Variable cost per unit   = $1,125,000 /25,000

                                      = $45 per driver

Current profit on 25,000 drivers =  selling price per unit * number of units - Total costs

                                                     = $175 x 25,000 - $2,625,000 (already given)

                                                     = $1,750,000

 

 

Proposal from China company:

The company in China is willing to pay only $125 per unit.

This order will increase the variable cost of production but fixed cost will remain same as the company has excess capacity.

Therefore total cost of producing (25,000+3000=) 28,000 units = Total variable cost + total fixed cost

 

Total variable cost = variable cost per unit * number of units produced

                              = $45 * 28,000 = $1,260,000

Therefore total cost = $1,260,000 +$1,500,000 = $2,760,000

 

Total Revenue from selling 28,000 units = selling price per unit for 25,000 units * number of units + selling price per unit

                                                                                                                                             for 3,200 units * number of units

                 

                                                               = $175 *25,000 + $125 * 3200

                                                                = $4,775,000

Profit on 28,000 drivers  = Total revenue - total costs

                                        = $4,775,000 - 2,760,000

                                        = $2,015,000

 

 

Conclusion:

Therefore the effect on profit of accepting the order =  profit after accepting international order -  profit before accepting international order

                                                                            = $2,015,000 - $1,750,000

                                                                              = $265,000

The profit will increase by $265,000 on  accepting the order.

 

The profit will increase by $265,000 on  accepting the order.