Noreaster Company produces a product that has a regular selling price of $360 per unit. At a typical monthly production volume of 2,000 units, the product's average unit cost of goods sold amounts to $270. Included in this average is $120,000 of fixed manufacturing costs. All selling and administrative costs are fixed and amount to $30,000 per month.
Noreaster Company has just received a special order for 1,000 units at $240 per unit. The buyer will pay transportation, and the regular selling price will not be affected if Noreaster accepts the order.
Assuming Noreaster Company is operating at capacity and accepting the order would require an offsetting reduction in regular sales, the effect on profits of accepting the order would be a
A)$240,000 decrease.
B)$120,000 decrease.
C)$150,000 decrease.
D)$30,000 increase.

Question

Quizplus · Accepted Answer

The profit on the special order is calculated by comparing the revenue from the special order to the profit that would have been earned on the regular sales it displaces. The regular selling price is $360, and the cost of goods sold is $270, leaving a profit of $90 per unit on regular sales. For 1,000 units, this amounts to $90,000 in profit that would be lost by accepting the special order. The special order offers $240 per unit, resulting in $240,000 in revenue. The variable cost remains the same at $270 - $120,000 fixed = $150 per unit, so for 1,000 units, the cost is $150,000. The profit from the special order is $240,000 (revenue) - $150,000 (variable costs) = $90,000. Therefore, accepting the special order results in no additional profit from the order itself, but it displaces $90,000 of profit from regular sales. However, since the question assumes the company is operating at capacity and must reduce regular sales to accept the order, the correct calculation should consider the loss of profit from the displaced regular sales. Given this, there seems to be a misunderstanding in the explanation provided. The correct approach to determine the effect on profits should compare the total profit impact of accepting the special order against the profit from regular sales that would be displaced. The calculation provided does not accurately reflect the scenario described in the question, particularly under the assumption of operating at capacity and the need to reduce regular sales. The correct answer should consider the net effect on profit by comparing the profit lost from displaced regular sales to any profit gained or lost from the special order, taking into account the special order's lower selling price and the cost structure.

Noreaster Company Produces a Product That Has a Regular Selling