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:

Direct materials $21
Direct labor $11
Variable manufacturing overhead $6
Fixed manufacturing overhead $8
Variable selling expense $10
Fixed selling expense $3

The regular selling price for one Hom is $65. A special order has been received at Varone from the Fairview Company to purchase 8,100 Homs next year at 20% off the regular selling price. If this special order were accepted, the variable selling expense would be reduced by 30%. 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 $12,100 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 30,000 Homs next year through regular channels and the special order is accepted at 20% off the regular selling price, the effect on net operating income next year due to accepting this order would be a:

$21,900 decrease
$81,000 increase
$52,100 increase
$44,600 increase

Explanation / Answer

So we have no change in Existing Fixed costs as we have idle capacity of 10000 Homs. COst pu of Hom for SPl order is : Direct materials $21 Direct labor $11 Variable manufacturing overhead $6 Variable selling expense (1-30%)*$10=$7 ------------------------------------------------ Total Var cost pu for Spl order = $45 Sale price pu for Spl order = (1-20%)*$65 = $52 SO COnt pu of spl order = 52-45 = $7 pu So Total Cont = 8100*$7 = $56,700 Less Addl Fixed cost of new machine = $12,100 ------------------------------------------------------------ SO Net Income from Spl order = $44,600 SO Net Income will increase by $44,600 by accepting this order

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