The production capacity of Miller Company’s facilities is 3,000 units of product
ID: 2468441 • Letter: T
Question
The production capacity of Miller Company’s facilities is 3,000 units of product per year. A summary of operating results for the year ended December 31, 2005 is as follows: Sales (1,800 units @ $1,000) $1,800,000 Variable costs 990,000 Contribution margin 810,000 Fixed costs 400,000 Operating income 410,000 Another retailer has offered to buy 1,500 units at $900 per unit during 2005. Assume that all of Miller’s Costs would be at the same levels and rates in 2005 and 2006. If Miller accepted this offer and rejected some business from regular customers so as not exceed capacity, what would be the increase (decrease) in the operating income for 2006?
Explanation / Answer
Unused available capacity = 3,000 – 1,800 = 1,200 units
Required capacity for new offer = 1,500 units
Regular Unit sales rejected to accept the offer = 1,500 units – 1,200 units = 300 units
Variable cost per unit = $990,000/1,800 units = $550 per unit
Contribution margin per unit from new offer = $900 - $550 = $350
Contribution margin from new offer = $350 * 1,500 units = $525,000
Contribution margin per unit as per existing facility = $1,000 - $550 = $450 per unit
Contribution margin lost = $450 * 300 units = $135,000
Net increase in operating income = Contribution margin from new offer – Contribution margin lost = $525,000 - $135,000 = $390,000
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