Question

Sherene Nili manages a company that produces wedding gowns. She produces both a custom product that is made to order and a standard product that is sold in bridal salons. Her accountant prepared the following forecasted income statement for March, which is a busy month:

	Custom Dresses			Standard Dresses			Total
Number of dresses		10			20			30
Sales revenue	$	51,500		$	31,500		$	83,000
Materials	$	10,300		$	8,300		$	18,600
Labor		20,300			9,300			29,600
Machine depreciation		630			330			960
Rent		4,500			3,100			7,600
Heat and light		1,000			600			1,600
Other production costs								3,100
Marketing and administration								8,000
Total costs							$	69,460
Operating profit							$	13,540

Ms. Nili already has orders for the 10 custom dresses reflected in the March forecasted income statement. The depreciation charges are for machines used in the respective product lines. Machines depreciate at the rate of $1 per hour based on hours used, so these are variable costs. In March, cutting and sewing machines are expected to operate for 960 hours, of which 630 hours will be used to make custom dresses. The rent is for the building space, which has been leased for several years at $7,600 per month. The rent, heat, and light are allocated to the product lines based on the amount of floor space occupied.

A valued customer, who is a wedding consultant, has asked Ms. Nili for a special favor. This customer has a client who wants to get married in early April. Ms. Nili's company is working at capacity and would have to give up some other business to make this dress. She can't renege on custom orders already agreed to, but she can reduce the number of standard dresses produced in March to 10. Ms. Nili would lose permanently the opportunity to make up the lost production of standard dresses because she has no unused capacity for the foreseeable future. The customer is willing to pay $25,500 for the special order. Materials and labor for the order will cost $6,300 and $10,300, respectively. The special order would require 152 hours of machine time. Ms. Nili's company would save 165 hours of machine time from the standard dress business given up. Rent, heat and light, and other production costs would not be affected by the special order.

Required:

a-1. Calculate the differential operating profit (loss). (Select option "increase" or "decrease", keeping Without special order as the base. Select "none" if there is no effect.)

a-2. From an operating profit (loss) perspective for March, should Ms. Nili accept the order?

	Yes
	No

b. What is the minimum price Ms. Nili should accept to take the special order?

Answer 1

a-1)

Computation of Differential Opertaing profit
Sales revenue	25,500
Less: Costs
Materials	6,300
Labor	10,300
Machine depreciation	152
Profit from the Special Order		8,748
Opportunity costs of the 10 standard dresses
Sales revenue	15750
Less: Costs
Materials	4150
Labor	4650
Machine depreciation	165
Less: Opportunity costs of the 10 standard dresses	-6785
Incremental Operating Profit (Increase)		1,963

a-2) From the perspective of operational income, she should accept the special order as it results in incremental profits

b) Minimum price to charge for the special order is the opportunity costs of the standard dresses, which is $6785