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 91,200 units per year is:

  Direct materials $ 2.00
  Direct labor $ 3.00
  Variable manufacturing overhead $ .70
  Fixed manufacturing overhead $ 4.05
  Variable selling and administrative expenses $ 1.20
  Fixed selling and administrative expenses $ 2.00

The normal selling price is $20 per unit. The company’s capacity is 109,200 units per year. An order has been received from a mail-order house for 1,500 units at a special price of $17.00 per unit. This order would not affect regular sales.

Required:

1.

If the order is accepted, by how much will annual profits be increased or decreased? (The order will not change the company’s total fixed costs.)

   

2.

Assume the company has 500 units of this product left over from last year 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? (Round your answer to 2 decimal places.)

    

  

Answer 1

Explanation
The financial advantage is computed as follows:
	Per Unit			1,500
				Units
Incremental sales	$	17		$	25,500
Incremental costs:
Direct materials		2			3,000
Direct labor		3			4,500
Variable manufacturing overhead		0.7			1,050
Variable selling and administrative		1.2			1,800
Total incremental costs	$	6.9			10,350
Financial advantage of accepting the special order		10.1			15,150
The fixed costs are not relevant to the decision because they will be incurred regardless of whether the special order is accepted or rejected.

1
financial advantage	15,150
2
The relevant cost is $1.20 (the variable selling and administrative expenses). All other variable costs are sunk because the units have already been produced. The fixed costs are not relevant because they will not change in total as a consequence of the price charged for the left-over units.