Wisconsin Metal Co. produces 12.5 gauge barbed wire that is retailed through far

Question

Wisconsin Metal Co. produces 12.5 gauge barbed wire that is retailed through farm supply companies. Presently, the company has the capacity to produce 100,000 tons of wire per year. It is operating at 80 percent of annual capacity and, at this level of operations, the cost per ton of wire is as follows:

Direct material $520
Direct labor 40
Variable overhead 50
Fixed overhead 190

total 800

The average sales price for the output produced by the firm is $900 per ton. The State of Texas has approached the firm to supply 200 tons of wire for the state's prisons for $620 per ton. No production modifications would be necessary to fulfill the order from the State of Texas.

a. What costs are relevant to the decision to accept this special order ?
b. What would be the dollar effect on pre-tax income if this order were accepted?

Explanation / Answer

The costs that are relevant are the variable costs – direct material, direct labor, and variable overhead. Fixed overhead is not relevant, since it will not change in total. The dollars effect would be: Revenue 124,000 (620*200) Less costs: Direct materials 104,000 (520*200) Direct labor 8,000 (40*200) Variable overhead 10,000 (50*200) Pre-tax net income 2,000 So this special order would increase net income by 2,000.

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