Question

Digital Devices, Inc. has received a special order to manufacture 10,000 CD ROM drives for an Italian computer manufacturer. Digital determines that the order will not affect its current domestic sales of CD ROM drives and because of the special nature of the order no sales commission would be paid. However, to process the order for export, an additional handling cost of $10 per unit is estimated. The order indicates that the price of the drives cannot exceed $200.

The company has the capacity to produce 100,000 units annually but is currently operating at 75% of available capacity. Unit selling price and costs, based on estimated actual capacity being utilized, are as follows:

Selling price	$	260
Expenses:
Direct materials	$	80
Direct labor		40
Variable manufacturing overhead		50
Fixed manufacturing overhead		30
Sales commission		26
Fixed administrative expenses		8
Total	$	234

(a.) Prepare a relevant cost analysis showing the effect on profit if the company accepts the special order.
(b.) How would your analysis change if Digital Devices, Inc., was producing and selling 100,000 units annually?

Answer 1

Since there is spare capacity, no additional fixed cost will be incurred on the order
a.Relevant cost analysis is as follows:
Sales Revenue	2,000,000
Expenses:
Direct Material	800,000
Direct Labor	400,000
Variable Manufacturing Overhead	500,000
Handling Cost	100,000
Total cost	1,800,000
Effect on Profit	200,000
If it is operating at full capacity, acceptance of special order will lead to a fall in regular sales
Profit from Special Order	200,000
Less: Contribution Margin from Regular Sales	640,000
Effect on Profit	(440,000)