Question

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 1,400 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 $360. A summary of the information related to production of MSI’s current history program follows:

Direct materials	$	1.08
Direct labor		0.37
Variable manufacturing overhead		2.09
Fixed manufacturing overhead		1.80
Total cost per unit	$	5.34
Sales price per unit	$	12.00

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. (Round your answer to 2 decimal places.) ?What is the special order price?

Answer 1

Since MSI is fully engaged with its regular orders, if the company accepts the special order it will have to forego the contribution earned on regular orders. Since fixed cost will remain same, it will be irrelevant cost for our calculation.

Total Cost for special order will be Opportunity Cost (Contribution foregone on regular orders) + any extra cost incurred.

We can calculate the total cost per unit as below:

	Per unit	1400 units
Revenue lost	12	16800
Less: Direct Material	1.08	1512
Less: Direct Labor	0.37	518
Less: Variable Overhead	2.09	2926
Contribution lost (a)	8.46	11844
Additional Modification Cost (b)		360
Total Cost for Special Order (a+b)		12204
No. of CDs to be delivered		1400
Minimum price to be charged		8.72

At Price of $8.72 per CD, company will be indifferent to accept or reject the order since it can make the same amount of contribution by selling the CDs outside.

$6 is less price for modified unit since company will earn a contribution of $8.46 selling outside.