PowerDrive, Inc. produces a hard disk drive that sells for $175 per unit. The co

Question

PowerDrive, Inc. produces a hard disk drive that sells for $175 per unit. The cost of producing 25,000 drives in the prior year was: Direct material $625,000 Direct labor 375,000 Variable overhead 125,000 Fixed overhead 1,500,000 Total cost $2,625,000 At the start of the current year, the company received an order for 3,800 drives from a computer company in China. Management of PowerDrive has mixed feelings about the order. On the one hand they welcome the order because they currently have excess capacity. Also, this is the company’s first international order. On the other hand, the company in China is willing to pay only $125 per unit. What will be the effect on profit of accepting the order?

Explanation / Answer

In this question the Fixed overheads of 1,500,000 $ are irrelevant for decision making as these are already been incurred. And they would remain same no matter how much units we produce.

These would have been relevant if the company did not have any additional capacity to produce but, now that the company has excess capacity we just have to see if we are getting Incremental contribution from the order.

Calulation of Per unit Cost:

So, the company should accept the offer as it would earn profits of 304000 $ (3800 units @ 80 $ (125-45) per unit)

Particulars Per Unit Cost Direct Material 25 $ (625000/25000) Direct Labour 15 $ (375000/25000) Variable Overhead 5 $ (125000/25000) Total Variable Cost 45 $

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