It costs Dryer Company $26 per unit ($18 variable and $8 fixed) to produce its product, which normally sells for $38 per unit. A foreign wholesaler offers to purchase 5,000 units at $21 each. Dryer would incur special shipping costs of $2 per unit if the order were accepted. Dryer has sufficient unused capacity to produce the 5,000 units. If the special order is accepted, what will be the effect on net income?
A) $5,000 decrease
B) $5,000 increase
C) $15,000 increase
D) $90,000 increase

Question

Quizplus · Accepted Answer

To determine the effect on net income, we need to calculate the contribution margin per unit and the total contribution margin of the special order. The contribution margin per unit is the selling price of $21 minus the variable cost per unit of $18, which equals $3.
 
Contribution margin per unit = Selling price – Variable cost per unit
= $21 – $18 =$3

The total contribution margin of the special order is the contribution margin per unit of $3, multiplied by the number of units in the order, which is 5,000. Therefore, the total contribution margin of the special order is $15,000.

Total contribution margin = Contribution margin per unit x Number of units
= $3 x 5,000 = $15,000

To determine the effect on net income, we need to compare the total contribution margin of the special order ($15,000) to the net income without the special order. In this case, without the special order, the net income is:

Net income = (Sales revenue – Variable costs – Fixed costs)
= (0.6 x $38 x 5,000 – $18 x 5,000 – $8 x 5,000)
= ($114,000 – $90,000)
= $24,000

If the special order is accepted, the net income would be:

Net income = (Sales revenue – Variable costs – Fixed costs + Special order revenue – Special order costs)
= (0.6 x $38 x 5,000 – $18 x 5,000 – $8 x 5,000 + $21 x 5,000 – $2 x 5,000)
= ($114,000 – $90,000 + $105,000 – $10,000)
= $119,000

Thus, the effect on net income of accepting the special order is:

Effect on net income = Net income with special order – Net income without special order
= $119,000 – $24,000
= $95,000

Therefore, the special order will increase the net income by $95,000. The correct answer is B) $5,000 increase.

It Costs Dryer Company $26 Per Unit ($18 Variable and $8