Question

Minor Electric has received a special one-time order for 1,500 light fixtures (units) at $5 per unit. Minor currently produces and sells 7,500 units at $6.00 each. This level represents 75% of its capacity. Production costs for these units are $4.50 per unit, which includes $3.00 variable cost and $1.50 fixed cost. To produce the special order, a new machine needs to be purchased at a cost of $1,000 with a zero salvage value. Management expects no other changes in costs as a result of the additional production. Should the company accept the special order?

Answer 1

The company should accept the special order because it will get an additional profit of $4,000 ($12,500 - $7,500 - $1,000) for the special order. This additional profit amount can be acquired by separating the effect from the special order on each cost and sales of the company's business. The sales should increase by $12,500 ($5 x 2500 unit) amount if the job is taken and the variable cost should increase by $7,500 ($3 x 2500 unit). Lastly, the fixed cost should increase by $1,000 (the new machine).

Answer 2

The company should accept the special order. This is the correct answer.

 

 

EXPLANATION

 

To determine whether to accept the offer or not, we first need to evaluate the profit the new offer brings. And the general rule is, profit = revenue – cost

 

If the new order is accepted, the revenue will increase by $5 x 2500 = $12,000.  

On the other hand, the cost of the current production and the new offer will be the same, $4.5, which consists of $1.5 fixed cost and $3 variable cost. Thus, the fixed cost will increase by $1000 to purchase the machine and the variable cost will increase by $3 x 2500 = $7000.

As a result, the overall profit will increase by $4000 from $12000 -$1000 - $7000.  

 

This is true if we assume that the company uses the whole 25% capacity (2500 units) left even if the new order is only for 1500 units. Therefore, the company should accept the new and special order.

 

LEARN MORE

If you’re interested in learning more about this topic, we recommend you to also take a look at the following questions:

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KEYWORD: special order, fixed cost, production

Subject: Business

Class: 10-12

Subchapter: Cost