PowerDrive, Inc. produces a hard disk drive that sells for $175 per unit. The co

Question

PowerDrive, Inc. produces a hard disk drive that sells for $175 per unit. The cost of producing 25,000 drives in the prior year was: Direct material $625,000 Direct labor 375,000 Variable overhead 125,000 Fixed overhead 1,500,000 Total cost $2,625,000 At the start of the current year, the company received an order for 3,800 drives from a computer company in China. Management of PowerDrive has mixed feelings about the order. On the one hand they welcome the order because they currently have excess capacity. Also, this is the company’s first international order. On the other hand, the company in China is willing to pay only $135 per unit. What will be the effect on profit of accepting the order?

Explanation / Answer

Cost sheet before accepting the offer
Sales ($175 * 25000) = 4,375,000
Less
Direct material = $625,000
Direct Labour = $375,000
Variable Overhead = $125,000
Fixed overhead = $1,500,000
Total Costs = $2,625,000
Net Income = $1,750,000

Cost sheet after accepting the offer
Sales ($175 * 25000)+($135*3800) = $4,888,000
Less
Direct material(25*28,800) = $720,000
Direct Labour ($15*28,800)= $432,000
Variable Overhead ($5*28,800)= $144,000
Fixed overhead = $1,500,000
Total Costs = $2,796,000
Net Income = $2,092,000

If we accept the offer then profit will increase by $342,000

Direct material per unit = 625000/25000 = $25
Direct labor cost per unit = 375000/25000 = $15
Variable cost per unit = 125000/25000 =$5

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