14. Montoya Enterprises produces a sword that sells for $200. Although the compa

Question

14. Montoya Enterprises produces a sword that sells for $200. Although the company's production capacity is 3,400 swords per year, only 2,500 swords are currently being produced and sold. Humperdinck Corporation has offered to purchase 500 swords as a one-time special purchase at a price of $160 per sword. If the special order is accepted, Montoya Enterprises will have to incur additional fixed costs of $1,500 due to additional set-ups.

At Montoya’s current level of production (2,500 swords), the Montoya Enterprises incurs the following costs:

Direct materials                                     $220,000

Direct labor                                           $100,000

Variable factory overhead                      $ 60,000

Fixed factory overhead                          $ 70,000

What will be the impact on Montoya’s Enterprises’ income if the special order is accepted?

Explanation / Answer

Answer:-Current operating income:-Sales-Variable costs -fixed costs

=(2500 swords*$200 per sword)-($200000+$100000+$60000+$70000)

=$500000-$430000 = $70000

Total production capacity=3400 swords per year

Current used capacity =2500 swords

Spare capacity =3400-2500 =900 swords

Offer from Humperdinck corporation to purchase =500 swords

Offer price =$160 per sword

Additional set cost (fixed cost) due to offer =$1500

Incremental income from special offer =(Offer price-Variable cost per unit)*500 swords-Additional fixed costs

=[$160 per sword –($220000+$100000+$60000)/2500 swords}*500 swords-$1500

=($160 per sword-$152 per sword) *500 swords-$1500

=$4000-$1500

=$2500

The income of Montoya’s Enterprises will increase by $2500

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