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 84,000 units per year is:

Direct materials	$	1.80
Direct labor	$	3.00
Variable manufacturing overhead	$	0.50
Fixed manufacturing overhead	$	4.65
Variable selling and administrative expenses	$	2.00
Fixed selling and administrative expenses	$	2.00

The normal selling price is $22.00 per unit. The company’s capacity is 106,800 units per year. An order has been received from a mail-order house for 1,900 units at a special price of $19.00 per unit. This order would not affect regular sales or the company’s total fixed costs.

Required:

1. What is the financial advantage (disadvantage) of accepting the special order?

2. As a separate matter from the special order, assume the company’s inventory includes 1,000 units of this product that were produced last year and 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?

Answer 1

(1). Total financial advantage of accepting the special order = $22230

Explanation;

Fixed costs are not relevant for inremental decision making because fixed costs will not change due to this special order hence fixed costs will not be included in this process.

	Per unit	1900 Units
Sale	$19	$36100
Less: Variable cost ($1.8 + $3 + $0.50 + $2)	($7.30)	($13870)
Incremental profits	$11.70	$22230

(2).

$2.00 is the relevant cost for establishing a minimum selling price for these units.

Explanation;

The relevant cost is $2.00 variable selling and administrative expenses. All other variable and fixed costs are sunk costs because these have already incurred.