Question

Potter has received a special order for 18,000 units of its product at a special price of $17. The product normally sells for $23 and has the following manufacturing costs: Per unit $ 5 Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Unit cost Potter is currently operating at full capacity and cannot fill the order without harming normal production and sales. If Potter accepts the order, what effect will the order have on the company's short-term profit?

Answer 1

Answers - $108,000 decrease.

Explanations-

The fixed costs are irrelevant for the purpose of decision making. Here also the fixed manufacturing overhead will not have any impact on the decision making process as it remains constant irrespective of the option selected.

Now Since potter is currently operating at full capacity and cannot feel the order without harming normal production, it means the loss of contribution on the existing production will be the opportunity cost for accepting the order.

Accordingly, loss of contribution = Sales - variable costs

= $ 23 - ($5+4+4)

= $ 23 - $13

= $ 10 per unit.

And the contribution generated from accepting the special order are -

Contribution = sales - variable cost

= $ 17 - ($ 5+4+4)

= $ 17 - $ 13

= $ 4.

Hence, it is clear that from accepting the special order we are getting a contribution of $ 4 per unit only, whereas we are losing contribution of $10 per unit.

The loss is more than the profit. Accordingly the net loss spotter accepts order = $ 10 - 4 = $ 6 per unit

Total net loss or decrease in profit due to accepting the special order are as $ 6 per unit * 18,000 unit

= $ 108,000 decrease.