Question

Delta Company produces a single product. The cost of producing and selling a single unit of this product at the company’s normal activity level of 90,000 units per year is:

Direct materials	$	2.20
Direct labor	$	3.00
Variable manufacturing overhead	$	.60
Fixed manufacturing overhead	$	3.85
Variable selling and administrative expenses	$	1.30
Fixed selling and administrative expenses	$	2.00

The normal selling price is $20 per unit. The company’s capacity is 117,600 units per year. An order has been received from a mail-order house for 2,300 units at a special price of $17.00 per unit. This order would not affect regular sales.

Required:

1.	If the order is accepted, by how much will annual profits be increased or decreased? (The order will not change the company’s total fixed costs.)

   

2.

Assume the company has 500 units of this product left over from last year that are inferior to the current model. The units must be sold through regular channels at reduced prices. What unit cost is relevant for establishing a minimum selling price for these units? (Round your answer to 2 decimal places.)

    

Answer 1

Requirement - 1

If the order is accepted, then the annual profits would increase by $22,770

	Per Unit	2,300 Units
Incremental sales	$17.00	$39,100
Incremental costs
Direct materials	$2.20	$5,060
Direct labor	$3.00	$6,900
Variable manufacturing overhead	$0.60	$1,380
Variable selling and administrative	$1.30	$2,990
Total incremental costs	$7.10	$16,330
Incremental profits	$9.90	$22,770

ANNUAL PROFITS WOULD INCREASE BY $22,770

Requirement - 2

The relevant cost per unit is $1.30, (Variable selling and administrative expenses). All other variable costs are sunk costs. The fixed costs are not relevant because they will not change in total.