The Varone Company makes a single product called a Hom. The company has the capa

Question

The Varone Company makes a single product called a Hom. The company has the capacity to produce 40,000 Homs per year. Per unit costs to produce and sell one Hom at that activity level are:

The regular selling price for one Hom is $100. A special order has been received at Varone from the Fairview Company to purchase 7,900 Homs next year at 10% off the regular selling price. If this special order were accepted, the variable selling expense would be reduced by 20%. However, Varone would have to purchase a specialized machine to engrave the Fairview name on each Hom in the special order. This machine would cost $11,900 and it would have no use after the special order was filled. The total fixed costs, both manufacturing and selling, are constant within the relevant range of 30,000 to 40,000 Homs per year. Assume direct labor is a variable cost.

If Varone can expect to sell 31,000 Homs next year through regular channels and the special order is accepted at 10% off the regular selling price, the effect on net operating income next year due to accepting this order would be a

The Varone Company makes a single product called a Hom. The company has the capacity to produce 40,000 Homs per year. Per unit costs to produce and sell one Hom at that activity level are:

Explanation / Answer

D)$26,080 decrease

Selling price - Direct materials - Direct labor - Variable manufacturing overhead - Variable selling expense = Unit contribution margin on normal sales
$90 - 27 - 17 -12 - 10 = $24
Capacity 40,000
Special order 7,500
Capacity available for normal sales 32,500
Demand for normal sales 35,920
Displaced normal sales 3,420
3,420 x $24 = $82,080 lost contribution margin

Incremental revenue (7,500 x $72) $540,000
Less incremental costs:
Direct materials (7,500 x $27) $202,500
Direct labor (7,500 x $ 17) 127,500
Variable manufacturing overhead (7,500 x $ 12) 90,000
Variable selling expense (7,500 x $7**) 52,500
Special machine 11,500
Total increment cost $484,000
Incremental net operating income 56,000

$82,080 - 56,000 = 26,080 decrease in net operating income





* $90 x (1 - 20%) = $72
**$10 x (1 - 30%) = $7

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