Question

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 1,000 copies of the CD at a price of $5 each. MSI could easily modify one of its existing educational programs about U.S. history to accommodate the request. The modifications would cost approximately $500. A summary of the information related to production of MSI’s current history program follows:
Direct materials $ 1.50
Direct labor 0.60
Variable manufacturing overhead 2.25
Fixed manufacturing overhead 2.00
Total cost per unit $ 6.35
Sales price per unit $ 12.00
Required:
1. Compute the incremental profit (or loss) from accepting the special order.
2. Should MSI accept the special order?
Yes
No
3. Suppose that the special order had been to purchase 1,000 copies of the program for $4.50 each. Compute the incremental profit (or loss) from accepting the special order under this scenario.
4. Suppose that MSI is operating at full capacity. To accept the special order, it would have to reduce production of the history program. Compute the special order price at which MSI would be indifferent between accepting or rejecting the special order. (Round your answer to 2 decimal places.)

Answer 1

1. The incremental profit from accepting the special order is $150.

2. Yes, MSI should accept the special order. This is because it will increase profit by $150.

3. The incremental loss from accepting the special order is $350.

4. The special order price at which MSI would be indifferent between accepting or rejecting the special order is $12.50 per unit.

Step-by-step explanation:

Note that only variable costs are relevant to making decision on a special order. That is, fixed cost is not relevant. Therefore, we have:

Total variable cost per unit = Direct materials + Direct labor + Variable manufacturing overhead = $1.50 + $0.60 + $2.25 = $4.35.

We then proceed as follows:

1. Compute the incremental profit (or loss) from accepting the special order.

Incremental profit (or loss) = ((Special order price per unit - Total variable cost per unit) * Units of special order) - Modification cost = (($5 - $4.35) * 1,000) - $500 = $150

Therefore, the incremental profit from accepting the special order is $150.

2. Should MSI accept the special order?

Yes, MSI should accept the special order. This is because it will increase profit by $150.

3. Suppose that the special order had been to purchase 1,000 copies of the program for $4.50 each. Compute the incremental profit (or loss) from accepting the special order under this scenario.

Incremental profit (or loss) = ((Special order price per unit - Total variable cost per unit) * Units of special order) - Modification cost = (($4.50 - $4.35) * 1,000) - $500 = ($350), or –$350

Therefore, the incremental loss from accepting the special order is $350.

4. Suppose that MSI is operating at full capacity. To accept the special order, it would have to reduce production of the history program. Compute the special order price at which MSI would be indifferent between accepting or rejecting the special order. (Round your answer to 2 decimal places.)

This can be calculated as follows:

Modification cost per unit = Modification cost / Units of special order = $500 / 1,000 = $0.50

Special order price = Regular price + Modification cost per unit = $12 + $0.50 = $12.50 per unit

Therefore, the special order price at which MSI would be indifferent between accepting or rejecting the special order is $12.50 per unit.