Delta Company produces a single product. The cost of producing and selling a sin

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 92,400 units per year is: Direct materials $ 2.50 Direct labor $ 3.00 Variable manufacturing overhead $ .90 Fixed manufacturing overhead $ 3.75 Variable selling and administrative expenses $ 1.30 Fixed selling and administrative expenses $ 2.00 The normal selling price is $23 per unit. The company’s capacity is 128,400 units per year. An order has been received from a mail-order house for 3,000 units at a special price of $20.00 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.)

Explanation / Answer

Solution:

Under this type of questions, where company has idle capacity, the decision should be made on the basis of only Variable Cost which will be incurred for making additional special order units.

Fixed Costs are treated as Sunk Cost in this type of question and hence not considered in decision making.

1)

Calculation of increase or decrease in annual profit, If the order is accepted

Special Price = $20 per unit

Total Variable Cost per unit = Direct Materials + Direct Labor + Variable Manufacturing Overhead + Variable selling and administrative expenses = $2.50 + 3.00 + 0.90 + 1.30 = $7.70

Increase in Contribution Margin from Special Order = ($20 - $7.70)*3,000 Units = $36,900

If the order is accepted, profit will be increase by $36,900

2) In this situation the minimum selling price for the inferior 500 Units left over from last year is Total Variable Cost for manufacturing these units.

Minimum Selling Price per Unit = $7.70 per unit

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