Question

PowerDrive, Inc. produces a hard disk drive that sells for $175 per unit. The cost of producing 25,000 drives in the prior year was:
Direct material		$625,000
Direct labor		375,000
Variable overhead		125,000
Fixed overhead		1,500,000
Total cost		$2,625,000

At the start of the current year, the company received an order for 4,000 drives from a computer company in China. Management of PowerDrive has mixed feelings about the order. On the one hand they welcome the order because they currently have excess capacity. Also, this is the company’s first international order. On the other hand, the company in China is willing to pay only $125 per unit.

What will be the effect on profit of accepting the order?

Answer 1

Total Variable Cost = Direct Material + Direct Labor + Variable Overhead

= $625,000 + $375,000 + $125,000 = $1,125,000

Variable cost per unit = Total Variable Cost / Total No. of Units = $1,125,000 / 25,000 = $45 per unit

As there is excess capacity , ignoring fixed costs.

Incremental Net Income = [(Incremental Price - VC) x Incremental Quantity] - Fixed Cost

= [($125 - $45) x 4,000] - $0 = $80 x 4,000 = $320,000

So, There will be net increase in profit by $320,000