Delta Company produces a single product. The cost of producing and selling a single unit of this product at the company’s normal activity level of 98,400 units per year is:

Delta Company produces a single product. The cost of producing and selling a single unit of this product at the company’s normal activity level of 98,400 units per year is:

Direct materials	$	1.50
Direct labor	$	2.00
Variable manufacturing overhead	$	0.90
Fixed manufacturing overhead	$	4.05
Variable selling and administrative expenses	$	1.40
Fixed selling and administrative expenses	$	1.00

The normal selling price is $18.00 per unit. The company’s capacity is 112,800 units per year. An order has been received from a mail-order house for 1,200 units at a special price of $15.00 per unit. This order would not affect regular sales or the company’s total fixed costs.

Required:

1. What is the financial advantage (disadvantage) of accepting the special order?

2. As a separate matter from the special order, assume the company’s inventory includes 1,000 units of this product that were produced last year and that are inferior to the current model. The units must be sold through regular channels at reduced prices. The company does not expect the selling of these inferior units to have any effect on the sales of its current model. What unit cost is relevant for establishing a minimum selling price for these units?

Explanation

1.

The financial advantage is computed as follows:

	Per Unit			1,200 Units
Incremental sales	$	15.00		$	18,000
Incremental costs:
Direct materials		1.50			1,800
Direct labor		2.00			2,400
Variable manufacturing overhead		.90			1,080
Variable selling and administrative		1.40			1,680
Total incremental costs	$	5.80			6,960
Financial advantage of accepting the special order		9.20			11,040

The fixed costs are not relevant to the decision because they will be incurred regardless of whether the special order is accepted or rejected.

2.

The relevant cost is $1.40 (the variable selling and administrative expenses). All other variable costs are sunk because the units have already been produced. The fixed costs are not relevant because they will not change in total as a consequence of the price charged for the left-over units.

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