Question

(Algo) Analyzing Special-Order Decision [LO 7-2, 7-3]

Mohave Corp. makes several varieties of beach umbrellas and accessories. It has been approached by a company called Lost Mine Industries about producing a special order for a custom umbrella called the Ultimate Shade (US). The special-order umbrellas with the Lost Mine Company logo would be distributed to participants at an upcoming convention sponsored by Lost Mine. Lost Mine has offered to buy 2,900 of the US umbrellas at a price of $27 each. Mohave currently has the excess capacity necessary to accept the offer. The following information is related to the production of the US umbrella:
Direct materials $ 12.00
Direct labor 6.00
Variable manufacturing overhead 8.00
Fixed manufacturing overhead 2.50
Total cost $ 28.50
Regular sales price $ 35.00
Required:
1. Compute the incremental profit (or loss) from accepting the special order.
2. Should Mohave accept the special order?

Answer 1

Because there is unused capacity, and the effect on income is positive, the offer should be accepted.

Step-by-step explanation:

Giving the following information:

Lost Mine has offered to buy 2,900 of the US umbrellas for $27 each.

Production costs:

Direct materials $ 12.00

Direct labor 6.00

Variable manufacturing overhead 8.00

Because it is a special offer and there is unused capacity, we will not take into account the fixed costs.

Unitary production cost= $26

Net effect on income= 2,900*(27 - 26)

Net effect on income= $2,900 increase

Because there is unused capacity, and the effect on income is positive, the offer should be accepted.