Question

Samson Designers producers a lady's handbag that normally sets for $120. The company produces 800 units annually but has the capacity to produce 1, 100 units. An order from a customer has been received for 200 handbags at $85 each that would not disrupt current operations. Current costs for the handbags are as follows.
Direct materials $23.00
Direct labor 45.00
Variable overhead 7.00
Fixed overhead 12.00
Total 87.00

In addition the customer would like to add a monogram to each bag which would require an additional $4 per bag in additional labor costs. Samson would also have to purchase a piece of equipment to create the monogram which would costs $800. This equipment would not have any other users. Which statement is true with regard to this situation?

A. Incremental revenues will exceed incremental costs by $400
B. Incremental revenues will exceed incremental costs by $1, 200
C. Incremental costs will exceed incremental revenues by $1, 200
D. Incremental costs will exceed incremental revenues by $2,000

Answer 1

Answer: A. Incremental revenues will exceed incremental costs by $400

Explanation:

First let us start by calculting the incremental revenue from the special order,

Incremental revenue from special order = Incremental Revenue per unit x no. of units

=200*$85

= $17,000

Then we need to calculate the incremental cost of the special order which would include all the costs,

Incremental cost on special order = Direct materials + Direct labor + Variable overhead + Additional labor cost for monogram + Purchase of equipment for monogram

= (200*$23) + (200*$45) + (200*$7) + (200*$4) + $800

= $16,600

Finally we will then subtract the Incremental cost from revenue,

=17,000 - 16,600

=$400

Incremental Costs increased by $400 so Option A is correct.