Question

Pembina produces a hard disk drive that sells for $173 per unit. The cost of producing 25,000 drives in the prior year was:

Direct material		$	725,000
Direct labor			450,000
Variable overhead			225,000
Fixed overhead			1,500,000
Total cost		$	2,900,000

At the start of the current year, the company received an order for 3,260 drives from a computer company in China. Management of Pembina has mixed feelings about the order. On one hand, they welcome the order because they currently have excess capacity. Also, this is the company’s first international order. On the other hand, the company in China is willing to pay only $131 per unit.

What will be the effect on profit of accepting the order? (Enter decrease in profit using either a negative sign preceding the number e.g. -45 or parentheses e.g. (45).)

Profit will Increase or Decrease? By $_________

Answer 1

The financial advantage of accepting the special order

Total revenue from special order = $427,060 [3,260 units x $131]

Total Relevant cost of making the 3,260 units = Direct material + Direct labor + Variable overhead

= [($725,000/25,000) x 3,260] + [($450,000/25,000) x 3260] + [($225,000/25,000) x 3,260]

= $94,540 + $58,680 + $29,340

= $182,560

Therefore, the financial advantage of accepting the special order = Total revenue – Total relevant costs

= $427,060 - $182,560

= $244,500 (Increase of Profit)

Hence, the Profit will Increase by $244,500