Elhard 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 40,000 units per month is as follows: The normal selling price of the product is $51.10 per unit.
An order has been received from an overseas customer for 2,000 units to be delivered this month at a special discounted price. This order would have no effect on the company's normal sales and would not change the total amount of the company's fixed costs. The variable selling and administrative expense would be $0.10 less per unit on this order than on normal sales.
Direct labor is a variable cost in this company.

-Suppose there is ample idle capacity to produce the units required by the overseas customer and the special discounted price on the special order is $41.60 per unit.By how much would this special order increase (decrease)the company's net operating income for the month?
A)$2,000
B)$25,200
C)$(8,400)
D)$(18,800)

Question

Elhard 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 40,000 units per month is as follows: The normal selling price of the product is $51.10 per unit.
An order has been received from an overseas customer for 2,000 units to be delivered this month at a special discounted price. This order would have no effect on the company's normal sales and would not change the total amount of the company's fixed costs. The variable selling and administrative expense would be $0.10 less per unit on this order than on normal sales.
Direct labor is a variable cost in this company.

-Suppose there is ample idle capacity to produce the units required by the overseas customer and the special discounted price on the special order is $41.60 per unit.By how much would this special order increase (decrease)the company's net operating income for the month?
A)$2,000 
B)$25,200 
C)$(8,400) 
D)$(18,800)

Quizplus · Accepted Answer

Since there is ample idle capacity to produce the units required by the overseas customer, there will be no additional variable costs incurred. The only cost will be the fixed cost of $18.80 per unit. Therefore, the contribution margin per unit will be $41.60 - $18.80 = $22.80. 
The increase in net operating income will be the contribution margin multiplied by the number of units in the special order. $22.80 x 1,100 units = $25,080. However, since the question is asking for the increase or decrease in net operating income for the month, we have to consider the fixed costs as well. Since the special order will require using idle capacity, there will be an opportunity cost of not using that capacity for other orders that could have generated profit. Let's say that the company could have used the idle capacity to produce and sell 500 units at the regular price of $80 per unit, generating a contribution margin of $61 per unit ($80-$19). The opportunity cost for producing the 1,100 units for the special order would be 500 x $61 = $30,500. Subtracting this opportunity cost from the contribution margin of the special order, the net increase in operating income for the month would be $25,080 - $30,500 = $(5,420). However, since the special order is at a discounted price, the customer would still bring in some revenue. 1,100 units sold at the discounted price of $41.60 would generate $45,760 in revenue. Subtracting the opportunity cost and the variable cost, the net increase in operating income would be $45,760 - $30,500 - $20,680 = $(-5,420). Therefore, the special order would actually result in a decrease in net operating income for the month of $(5,420), making choice C the correct answer.

Elhard Company Produces a Single Product