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: Picture The regular selling price for one Hom is $60. A special order has been received at Varone from the Fairview Company to purchase 8,000 Homs next year at 15% off the regular selling price. If this special order were accepted, the variable selling expense would be reduced by 25%. 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 $12,000 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 32,000 Homs next year through regular channels, at what special order price from Fairview should Varone be economically indifferent between either accepting or not accepting this special order? $39.60 $51.00 $42.50 $48.20

Explanation / Answer

The per unit cost table missing in the question is as below:

Direct materials

$20

Direct labor

$10

Variable manufacturing overhead

$5

Fixed manufacturing overhead

$7

Variable selling expense

$8

Fixed selling expense

$2

At the point of indifference, Verone should fix the special order price equal to the cost for making the special order Homs.

The fixed cost shall be incurred irrespective of the decision to accept or reject the special order. Hence fixed costs shall be ignored.

Variable selling cost shall be reduced by 25% if special order is accepted.

Revised variable selling overhead = $8 * 75% = $6

Variable cost = Direct material + Direct labor + Variable manufacturing overhead + Variable selling expense

Variable costs = $20 + $10 + $5 + $6 = $41

Additional cost for purchasing specialised machine = $12000

Per unit cost of specialised machine = $12,000/8000 = $1.50

Total cost for producing special order = $41 + $1.50 = $42.50

Hence, Answer is $42.50

Direct materials

$20

Direct labor

$10

Variable manufacturing overhead

$5

Fixed manufacturing overhead

$7

Variable selling expense

$8

Fixed selling expense

$2

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