Question

Let's think through an example: Company A produces gadgets at $2 VC and incurs $200,000 FC...

Let's think through an example: Company A produces gadgets at $2 VC and incurs $200,000 FC per month. The gadget's normal sale price is $4 each and its break-even point is 100,000 units, correct? Now, assume that the company can produce up to 150,000 units (relevant range for this cost structure) and it typically sells 110,000 units per month. A customer has placed a bid for 30,000 gadgets; however, the customer is willing to pay only $3 each. Would Company A accept the order? What are your thoughts?


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Answer #1

Yes, the company should accept the order.

Company A should accept the order as it increases operating income by $30,000.

Increase in operating income = special order units (Special order price - Variable costs)

= 30,000(3-2)

=$30,000.

Fixed costs are irrelavent while evaluating special order decisions because they are incurred whether the company accepts the order or not. They are fixed in nature as the name suggests. Only variable costs are to considered.

(Please let me know if you have any queries. Best regards)

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