MC Qu. 56 Minor Electric has received a special one-t... Minor Electric has rece

Question

MC Qu. 56 Minor Electric has received a special one-t... Minor Electric has received a special one-time order for 1,500 light fixtures (units) at $5 per unit. Minor currently produces and sells 7,500 units at $6.00 each. This level represents 75% of its capacity. Production costs for these units are $4.50 per unit, which includes $3.00 variable cost and S150 fixed cost. To produce the special ordet, a new machine needs to be purchased at a cost of $1,000 with a zero salvage value. Management expects no other changes in costs as a result of the additional production. Should the company accept the special order? Multiple Choice No, because additional production would exceed capacity No, because incremental costs exceed incremental revenue yes, because incremental revenue exceeds incremental costs Yes, because incremental costs exceed incremental revenues No. because the incremental revenue is too low MacBook Air

Explanation / Answer

Current production at 75% level = 7,500

So, total production capacity = Current production / Capacity percentage

= 7,500 / 75%

= 10,000

So, Spare capacity available

= Total capacity – Utilized capacity

= 10,000 – 7,500

= 2,500

So, the special order of 1,500 units is within the spare capacity and so option A is not correct

Relevant costs for production will be variable costs + Relevant fixed cost per unit

Fixed cost per unit allocated to product of $1.50 per unit is not relevant as it is a sunk cost already incurred and since the production is within capacity so, fixed cost will not increase any further and is not relevant

So, Relevant fixed cost is cost per unit of new machine which will be used for special order

So, Fixed cost relevant per unit

= Cost / Number of units

= $1,000 / 1,500

= $0.67 per unit

So, relevant costs per unit

= Variable costs + Fixed costs

= $3 + $0.67

= $3.67

So, Net Income per unit will be Selling price – Relevant costs

= $5 - $3.67

= $1.33 per unit

Total incremental revenue

= Net income per unit x Number of units

= $1.33 x 1,500

= $1,995

So, Incremental revenue exceeds incremental costs and so option B is not correct and option C is correct

When incremental costs exceeds incremental revenues, the decision will lead to a loss and so option D is not correct

Incremental revenue is not too low and so option E is not correct

So, as per above discussion, option C is the correct option

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