Question

Your Company produces an ink-jet printer. The cost of producing and selling a single unit at the company's normal activity level of 40,000 printers per month is as follows: [Note that the per-unit fixed costs are based on a denominator of 40,000 units]

Direct materials $53.60; Direct labor $5.30; Variable mfg OH $1.40; Fixed mfg OH $13.20; Variable selling & admin OH $1.60; and Fixed selling & admin OH $9.10.

The normal selling price of the printer is $91.60 per unit.

An order has been received from an overseas customer for 3,000 printers to be delivered this month at a special discounted price. The variable selling and administrative expense would be $1.00 less per unit on this order than on normal sales.
Direct labor is a variable cost in this company.

a. Suppose this order would have no effect on the company's normal sales because the company has sufficient excess capacity and would not change the total amount of the company's fixed costs. The discounted price to the overseas customer on the special order is $81.90 per unit. By how much would this special order increase (decrease) the company's net operating income for the month?

b. Suppose the company is already operating at full capacity when the special order is received from the overseas customer. That means to accept the special order would mean diverting away from the regular customers. What would be the opportunity cost of each unit that would be sold to the overseas customer?

c. Suppose there is not enough idle capacity to produce all of the printers for the overseas customer and accepting the special order would require cutting back on the sale of 2,000 units for the regular customers. What should be the minimum acceptable price per unit for the special order?

Answer 1

Solution a:

Computation of income from special order
Particulars	Amount
Revenue from special order (3000 * $81.90)	$245,700.00
Costs:
Direct materials	$160,800.00
Direct labor	$15,900.00
Variable manufacturing overhead	$4,200.00
Variable selling and admin overhead	$1,800.00
Net increase (decrease) in company operating income	$63,000.00

Solution b:

Computation of regular contribution margin per unit
Particulars	Per unit
Selling price	$91.60
Costs:
Direct materials	$53.60
Direct labor	$5.30
Variable manufacturing overhead	$1.40
Variable selling and admin overhead	$1.60
Contribution margin	$29.70

If company is operating at full capacity then it will loose regular sale if special order is accepted. Therefore opportunity cost of each unit that would be sol the overseas customer is loss of contribution margin from regular order i.e. ($29.70 * 3000) = $89,100

Solution c:

Loss of contribution margin on regular sale = 2000 * $29.70 = $59,400

Variable cost of special order = $53.60 + $5.30 + $1.40 + $0.60 = $60.90

Therefore minimum acceptable price is the price where company can recover its variable cost and loss of contribution margin on regular sale.

Therefore minimum required revenue on special order = 3000 * $60.90 + $59,400 = $242,100

Minimum acceptable price on special order = $242,100 / 3000 = $80.70 per unit