Question

Consider accepting a special order to produce The ROAR company manufactures a single product that sells for $ 17.00 each unit. The cost of each unit produced at a monthly production level of 10,000 units is:

Direct materials $ 2.75

Direct labor $ 3.25

Indirect manufacturing variable cost $ .75

Fixed indirect manufacturing cost $ 4.50

Fixed administrative expenses $ 2.25

The total monthly production capacity is 12,000 units. A special order of 2,000 units was received at a purchase price of $ 14.00 per unit. Regular sales will not be affected by this order.

1. How much will the monthly profit increase or decrease if ROAR accepts the special order? Keep in mind that accepting the order will not affect the fixed costs. 2. Suppose the company has 600 units of an earlier model of this article that were left unsold last year. To dispose of the units, the company has to sell them at a reduced price through normal sales channels. Identify the unit cost that is relevant for the determination of the minimum price at which these units may be available. Explain why you think that is the relevant cost.

Answer 1

Since there is spare capacity, no additional fixed costs will be incurred on the special order

Increase in profits = Revenue – variable costs

= (14-2.75-3.25-0.75)*2000

= $14,500

Relevant cost to establish minimum price is $0

Since the product cost has already been incurred and it Is sunk now

No additional cost will be incurred on selling these units