Question

A Skill builder Exercise Instructions

Following is an Income Statement for Jordon Ltd.

Per Unit

Sales Revenue $20

Variable Cost:

Manufacturing $10

Selling & Administrative $2

Fixed Cost:

Manufacturing $3

Selling & Administrative $4

Operating Profit $1

The company has the capacity to produce 10,000 units and is currently operating at 90% of capacity. The company has been approached by T.J. Ltd. and is asked to supply 1,200 units at a price of $15.00. Should the company accept this offer? If the offer is accepted no selling & administrative costs would be incurred on those units but variable manufacturing costs will increase by $2 only on the 1,200 units.

1. Should the company accept this order?

2. What is the minimum price that the company would accept on this special order that would not cause profits to decrease?

Answer 1

Solution 1:

Regular contribution margin per unit = $20 - $10 - $2 = = $8 per unit

If company accept special order of 1200 units then it will loose regular sale of 200 units as it is having spare capacity for 1000 units only.

Contribution margin per unit from special order = $15 - $12 = $3 per unit

Incremental profit on accepting the special order = Contribution margin from special order - Loss of contribution margin on regular sale

= (1200*$3) - (200*$8) = $2,000

As there is incremental profit, therefore special order should be accepted.

Solution B:

Minimum price for special order = variable cost per unit + (Loss of contribution margin on regular sale) / Nos of units in special order

= $12 + ($1,600/1200) = $13.33 per unit