Question

A state government office wants a special order of furniture. Fjord is not currently operating at full capacity, but accepting the special order would require a reduction in production for regular customers. The state order is 10 percent less than Fjord normally charges. Fjord should produce furniture for the state and reduce other production if

(A) the gross margin on the reduced amount of routine production is less than the gross margin on the state order

(B) the profit margin on the reduced amount of routine production is less than the profit margin on the state order

(C) the total revenue for the reduced amount of routine production is less than the total revenue on the state order

(D) net income for the month would remain unchanged by accepting the state order

Please answer the question and explain why it is the correct answer. Thanks

Answer 1

For Example, let’s say Fjord has the capacity to produce 40,000 furniture in a period while it has the regular order of only 30,000 furniture.

Now, Fjord received a special order for another 15,000 furniture which is at 10% less price as compared to regular order.

Only Option Fjord has is to forego the 5,000 furniture of regular order if they wish to accept the special order since the full capacity is only 40,000 furniture (not 45,000 furniture)

Question is In which situation Fjord should accept the order.

Let’s analyze every situation given in question:

1. The gross margin on the reduced amount of routine production is less than the gross margin on the state order - There is no point of looking on gross margin since it doesn’t consider the fixed cost. There may be an extra fixed cost incurrence on Special Order, Hence the decision cannot be taken solely based on gross margin which is nothing but Contribution.

(B) The profit margin on the reduced amount of routine production is less than the profit margin on the state order – In this case, Fjord will make additional profit if State orders are accepted. Hence Fjord should choose this option.

(C) The total revenue for the reduced amount of routine production is less than the total revenue on the state order – In our example, this holds perfectly true. Revenue for foregone furniture (5,000 units of regular order) will be less than the total revenue of the state order even after 10% discount. But revenue doesn’t define the profit. Hence this situation cannot be called off as a mandatorily profitable situation for Fjord.

(D) Net income for the month would remain unchanged by accepting the state order – If the Net Income is unchanged then Fjord should not accept the special offer since it will have to forego the order of regular customer with no added advantage in income. Regular Customer is always first (before special order). Since there is no change in income, there is no point of dissatisfying the regular customer.