A manufacturer operating with excess capacity has been asked to fill a special order at $7.25 per unit. No other use of the currently idle capacity can be found. The manufacturer's usual variable costs per unit are $3.50 for direct materials, $1.50 for direct labour, $1.50 for variable overhead, and $0.50 for sales commission. No sales commission would be paid on this special order. The average overhead per unit is $0.25.
Under the general decision rule, the minimum price per unit for this special order is:
A) $7.25
B) $6.50
C) $7.00
D) $7.50

Question

Quizplus · Accepted Answer

The general decision rule is to accept a special order if the incremental revenue from the order exceeds the incremental cost of fulfilling it. Incremental revenue is the revenue from the special order minus any variable costs that are directly attributable to the order.

Incremental revenue = $7.25 per unit 
Variable costs directly attributable to the order: 
Direct materials = $3.50 per unit 
Direct labor = $1.50 per unit 
Variable overhead = $1.50 per unit 
Sales commission = $0.00 per unit

Total variable cost per unit = $3.50 + $1.50 + $1.50 + $0.00 = $6.50 per unit

Incremental profit = Incremental revenue - Total variable cost per unit - Average overhead per unit

Incremental profit = $7.25 - $6.50 - $0.25 = $0.50 per unit

Since the incremental profit per unit is positive, the manufacturer should accept the special order at $7.25 per unit. However, since the question is asking for the minimum price per unit that the manufacturer should accept, the answer is $6.50 per unit (which is the total variable cost per unit).

A Manufacturer Operating with Excess Capacity Has Been Asked to Fill