Question

Rabbit Foot Motors has been approached by a new customer with an offer to purchase 5,000 units of its hands-free, Wi-Fi-enabled automotive model—the SMAK—at a price of $18,000 per automobile. Rabbit Foot’s other sales would not be affected by this new customer offer. Rabbit Foot normally produces 100,000 units of its SMAK model per year but only plans to produce and sell 90,000 in the coming year. The normal sales price is $35,000 per SMAK. Unit cost information for the normal level of activity is as follows:

Direct materials	$10,000
Direct labor	2,000
Variable overhead	4,000
Fixed overhead	8,000
Total	$24,000

Fixed overhead will not be affected by whether or not the special order is accepted.

Required:

1. What are the relevant costs and benefits of the two alternatives (accept or reject the special order)?

2. By how much will operating income increase or decrease if the order is accepted?

by $

Answer 1

Part 1

Accept the order

- Sales price of $18000 per unit -Benefit

- Direct materials $10000 per in unit -Cost

-Direct labor $2000 per unit - Cost

- Variable overhead $4000 per unit -Cost

Reject the order: when there are no relevant costs or benefits, order should be rejected.

Part 2

	Accept	reject	differential benefits to accept
Sales price	18000		18000
Direct materials	(10000)		(10000)
Direct labor	(2000)		(2000)
Variable overhead	(4000)		(4000)
Increase in operating income	2000		2000

Per unit increase in operating income = $2000

Total operating income increases by = $2000*5,000= $10,000,000