Question

Structuring a Special-Order Problem Harrison Ford Company has been approached by a new customer with an offer to purchase 10,000 units of its model IJ5 at a price of $5 each. The new customer is geographically separated from the company's other customers, and existing sales would not be affected. Harrison normally produces 75,000 units of IJ5 per year but only plans to produce and sell 60,000 in the coming year. The normal sales price is $12 per unit. Unit cost information for the normal level of activity is as follows: Direct materials $1.75 Direct labor 2.50 Variable overhead 1.50 Fixed overhead 3.25 Total $9.00 Fixed overhead will not be affected by whether or not the special order is accepted.
Direct Materials $1.75
Direct Labor 2.50
Variable Overhead 1.50
Fixed Overhead 3.25
Total $9.00

Requried:
a. What are the relevant costs and benefits of the two alternatives (accept or reject the special order)?
b. By how much will operating income increase or decrease if the order is accepted?

Answer 1

Answer:

Effect on income= $7,500 increase

Explanation:

Giving the following information:

Special offer:

Units= 10,000

Price= $5

Production costs:

Direct Materials $1.75

Direct Labor 2.50

Variable Overhead 1.50

Because it is a special offer and there is unused capacity, we will not take into account the fixed costs.

Effect on income= number of units*unitary contribution margin

Effect on income= 10,000*(5 - 1.75 - 2.5 - 1.5)

Effect on income= $7,500 increase