Morning Sky, Inc. (MSI), manufactures and sells computer games. The company has

Question

Morning Sky, Inc. (MSI), manufactures and sells computer games. The company has several product lines based on the age range of the target market. MSl sells both individual games as well as packaged sets. All games are in CD format, and some utilize accessories such as steering wheels, electronic tablets, and hand controls. To date, MSI has developed and manufactured all the CDs itself as well as the accessories and packaging for all of its products. The gaming market has traditionally been targeted at teenagers and young adults; however, the increasing affordability of computers and the incorporation of computer activities into junior high and elementary school curriculums has led to a significant increase in sales to younger children. MSI has always included games for younger children but now wants to expand its business to capitalize on changes in the industry. The company currently has excess capacity and is investigating several possible ways to improve profitability. 1. Required information MSI has been approached by a fourth-grade teacher from Portland about the possibility of creating a specially designed game that would be customized for her classroom and environment. The teacher would like an educational game to correspond to her classroom coverage of the history of the Pacific Northwest, and the state of Oregon in particular. MSI has not sold its products directly to teachers or school systems in the past, but its Marketing Department identified that possibility during a recent meeting The teacher has offered to buy 2,200 copies of the CD at a price of $5.00 each. MSI could easily modify one of its existing educational programs about U.S. history to accommodate the request. The modifications would cost approximately $450. A summary of the information related to production of MSI's current history program follows: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead S 1.12 0.32 2.07 1.80 S 5.31 $13.00 Total cost per unit Sales price per unit Required 1. Compute the incremental profit (or loss) from accepting the special order Profit (or Loss) by

Explanation / Answer

MSI has excess capacity so there is no opportunity cost. and Fixed Manufacturing Overhead has been Covered from normal production. Hence, cost for special order is -

Cost Statement (for 2200 copies)

Direct Materials (2200*$1.12) $2464

Direct Labour (2200*$0.32) $704

Variable Manufacturing Overhead (2200*$2.07) $4554

Modification Cost $450   

Total Incremental Cost    $8172

(1) Incremental Profit = Incremental Sales - Total Incremental Cost

= (2200*$5) - $8172

= $11000 - $8172

= $2828

(2) MSI should accept the special order due to increment in profit.

(3) Incremental Profit/(Loss)

  Sales (2200*$4.50) $9900

Less- Total Incremental Cost (shown above) $8172

Incremental Profit $1728   

(4)  For caculation of Indifference Price, Fixed Cost is irrelevant cost so we does not consider fixed cost.

Indifference Price per Copy of Program = Cost per unit for special order + Opportuniy Cost(see below)

= ($8172 / 2200 copies) + $9.49

= $3.71 + $9.49

= $13.20

Opportunity Cost = Selling Price - ( Diect Material Cost + Direct Labour Cost + Variable Manufacturing Cost )

= $13 - ( $1.12 + $0.32 + $2.07 )

= $13 - $3.51

= $9.49

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