Question

Rocket Life manufactures small toy rockets. At their normal level of activity of 50,000 units, the cost of producing a single rocket is: Direct Materials $4.00 Direct Labor $2.00 Variable Manufacturing Overhead $1.00 Fixed Manufacturing Overhead $3.00 Variable Selling & Admin Expenses $2.00 Fixed Selling & Admin Expenses $3.00 The company sells each rocket for $20 per unit. The company has capacity to produce 60,000 rockets per year, even though they produce only 50,000.

A special order has been received for 5,000 rockets at a special price of $10 per unit. If the order is accepted, by how much will the annual profits be increased or decreased? Please note that the order will not affect the company's fixed costs in any way.

Answer 1

Note : In case of special order , fixed manufacturing overhead & selling & admin expenses (Variable & Fixed) are not considered as relevant cost.

Incremenal cost per unit for special order = Direct Materials + Direct Labor + Variable Manufacturing Overhead

= $4 + $2 + $1 = $7

Incremenal profit per unit of special order = special price - Incremenal cost per unit = $10 - $7 = $3

Annual profits be increased if the order is accepted = 5,000 rockets * $3 = $15,000 .

Note : Whenever mentioned Variable Selling & Admin Expenses are also considered in special order pricing. However as nothing is mentioned in this question , we had ignored variable selling & admin expense.