Question

The Belik Company has the capacity to produce 5,000 units per year. Its predicted operations for the year are as follows:

Sales (4,000 units @ $20 each) $80,000

Manufacturing costs:

Variable $5 per unit

Fixed $10,000

Marketing and administrative costs:

Variable $1 per unit.

Fixed $8,000

The accounting department has prepared the following projected income statement for the coming year for your use in making decisions.

Sales $80,000

Variable costs:

Manufacturing ($5 x 4,000) $20,000

Marketing ($1 x 4,000) 4,000 24,000

Contribution margin $56,000

Fixed costs:

Manufacturing $10,000

Marketing 8,000 18,000

Operating profit $38,000

Required:

A.) Should the company accept a special order for 500 units at a selling price of $8? Assuming that there are no variable marketing and administrative costs for this order and that regular sales will not be affected, what is the impact of this decision on company profits?

B.) Suppose there was a one-time setup fee of $1,000 for the preceding order. Should the special order be accepted? Why?

C.) What other factors should be considered and how would they impact your decision to accept the special order?

Answer 1

Cost related to special order will be Variable manufacturing cost only. Since fixed costs remain same for level of output, it will not be considered for special order.

A)
Variable Manufacturing Cost = $5 per unit
Selling price per unit = $8
Since selling price is greater than costs concerned, company should accept the order.

Profits will increase by $1500 i.e. 500 x ($8 - $5)

B)
Profit after one time fee = $1500 - $1000 = $500,
Since there are still profits from special order, it should be accepted

C)
Other factors to be considered is
Capacity, Since fixed cost is for given capacity, if demand increases more than capacity, fixed costs will also increase
Qualitative factors
Opportunity cost