Question

E7.4 (LO 2), AN Klean Fiber Company is the creator of Y-Go, a technology that weaves silver into its fabrics to kill bacteria and odor on clothing while managing heat. Y-Go has become very popular in undergarments for sports activities. Operating at capacity, the company can produce 1,000,000 Y-Go undergarments a year. The per unit and the total costs for an individual garment when the company operates at full capacity are as follows.

		Per Undergarment		Total
Direct materials		$2.00		$2,000,000
Direct labor		0.75		750,000
Variable manufacturing overhead		1.00		1,000,000
Fixed manufacturing overhead		1.50		1,500,000
Variable selling expenses		0.25		250,000
Totals		$5.50		$5,500,000

Use incremental analysis for special order.

The U.S. Army has approached Klean Fiber and expressed an interest in purchasing 250,000 Y-Go undergarments for soldiers in extremely warm climates. The Army would pay the unit cost for direct materials, direct labor, and variable manufacturing overhead costs. In addition, the Army has agreed to pay an additional $1 per undergarment to cover all other costs and provide a profit. Presently, Klean Fiber is operating at 70% capacity and does not have any other potential buyers for Y-Go. If Klean Fiber accepts the Army’s offer, it will not incur any variable selling expenses related to this order.

Instructions

Using incremental analysis, determine whether Klean Fiber should accept the Army’s offer.

Answer 1

	Reject order	Accept order	Net income increase(decrease)
Revenues	0	1187500	1187500
Variable costs:
Direct materials	0	500000	-500000
Direct labor	0	187500	-187500
Variable overhead	0	250000	-250000
Total variable costs	0	937500	-937500
Net income	0	250000	250000
Klean Fiber should accept the Army’s offer.

Formulas used:
Revenues	1187500	=250000*(2+0.75+1+1)
Variable costs:
Direct materials	500000	=250000*2
Direct labor	187500	=250000*0.75
Variable overhead	250000	=250000*1