Question

Alpine Luggage has a capacity to produce 410,000 suitcases per year. The company is currently producing and selling 330,000 units per year at a selling price of $399 per case. The cost of producing and selling one case follows:

Variable manufacturing costs $ 164
Fixed manufacturing costs 40
Variable selling and administrative costs 78
Fixed selling and administrative costs 21
Total costs $ 303

The company has received a special order for 40,000 suitcases at a price of $250 per case. It will not have to pay any sales commission on the special order, so the variable selling and administrative costs would be only $52 per suitcase. The special order would have no effect on total fixed costs. The company has rejected the offer based on the following computations:

Selling price per case $ 250
Variable manufacturing costs 164
Fixed manufacturing costs 40
Variable selling and administrative costs 52
Fixed selling and administrative costs 21
Net profit (loss) per case $ (27 )
Required:

a. What is the impact on profit for the year if Alpine accepts the special order?

b. Do you agree with the decision to reject the special order?
Yes
No

Answer 1

a) If Alpine accepts special order, then its profit will increase $1,360,000

b) I don't agree with the decision to reject the special order because the profit will increase without any extra cost.

Step-by-step explanation:

As current operation (reject special order), the company can make profit = revenue - fixed cost - variable cost, in which fixed cost is applied to full capacity (410,000 units), while revenue and variable cost apply for current producing and selling only ($330,000 units).

Profit = $399*330,000 - ($164+$78)*330,000 - ($40+$21)*410,000

= $26,800,000

If the company accept the special order, the new profit = current profit + (sales - variable cost) x number unit of special order

= $26,880,000 + ($250 - $164 - $52)*40,000

= $28,160,000

So the increase = profit before special order - profit with special order = $28,160,000 - $26,800,000 = $1,360,000