Question

Delta Company produces a single product. The cost of producing and selling a single unit of this product at the company’s normal activity level of 99,600 units per year is:

Direct materials	$	2.00
Direct labor	$	3.00
Variable manufacturing overhead	$	1.00
Fixed manufacturing overhead	$	4.05
Variable selling and administrative expenses	$	1.20
Fixed selling and administrative expenses	$	2.00

The normal selling price is $21.00 per unit. The company’s capacity is 134,400 units per year. An order has been received from a mail-order house for 2,900 units at a special price of $18.00 per unit. This order would not affect regular sales or the company’s total fixed costs.

Required:

1. What is the financial advantage (disadvantage) of accepting the special order?

2. As a separate matter from the special order, assume the company’s inventory includes 1,000 units of this product that were produced last year and that are inferior to the current model. The units must be sold through regular channels at reduced prices. What unit cost is relevant for establishing a minimum selling price for these units?

Answer 1

1. What is the financial advantage (disadvantage) of accepting the special order?

Financial advantage = Annual profits will increase by $31,320

	Per Unit	2900 Units
Incremental sales	$18.00	$52,000
Incremental costs ;
Direct materials	$2.00	$5,800.00
Direct labor	$3.00	$8,700.00
Variable manufacturing overhead	$1.00	$2,900.00
Variable selling and administrative	$1.20	$3,480.00
Total incremental costs	$7.20	$20,880.00
Incremental profits	$10.80	$31,320.00

2. As a separate matter from the special order, assume the company’s inventory includes 1,000 units of this product that were produced last year and that are inferior to the current model. The units must be sold through regular channels at reduced prices. What unit cost is relevant for establishing a minimum selling price for these units?

The relevant cost per unit is $1.20 (Variable selling and administrative expenses).

All other variable costs are sunk costs. The fixed costs are not relevant because they will not change in total