Question

14. Montoya Enterprises produces a sword that sells for $200. Although the company's production capacity is 3,400 swords per year, only 2,500 swords are currently being produced and sold. Humperdinck Corporation has offered to purchase 500 swords as a one-time special purchase at a price of $160 per sword. If the special order is accepted, Montoya Enterprises will have to incur additional fixed costs of $1,500 due to additional set-ups.

At Montoya’s current level of production (2,500 swords), the Montoya Enterprises incurs the following costs:

Direct materials                                     $220,000

Direct labor                                           $100,000

Variable factory overhead                      $ 60,000

Fixed factory overhead                          $ 70,000

What will be the impact on Montoya’s Enterprises’ income if the special order is accepted?

Answer 1

Calculate the incremental income: Incremental income is calculated by deducting the incremental costs from the incremental sales revenue. Incremental Amount($) 100000 Particulars Sales (A=500x$200) Less: Variable costs Direct material (B=500x$220,000/2,500) Direct labor (C=500x$100,000/2,500) Variable factory overhead (D=500x$60,000/2,500) Total variable costs (E=B+C+D) Contribution Margin (F=A-E) Fixed costs (G) Net income (F-G) 44000 20000 12000 76000 24000 1500 22500 As there is an incremental income of $22,500, the special order is accepted.