Potter has received a special order for 10,000 units of its product at a special price of $24. The product normally sells for $32 and has the following manufacturing costs: Potter is currently operating at full capacity and cannot fill the order without harming normal production and sales. If Potter accepts the order, what effect will the order have on the company's short-term profit?
A) $64,000 decrease
B) $64,000 increase
C) $80,000 decrease
D) $16,000 increase

Question

Potter has received a special order for 10,000 units of its product at a special price of $24. The product normally sells for $32 and has the following manufacturing costs:  Potter is currently operating at full capacity and cannot fill the order without harming normal production and sales. If Potter accepts the order, what effect will the order have on the company's short-term profit?
A) $64,000 decrease 
B) $64,000 increase 
C) $80,000 decrease 
D) $16,000 increase

Quizplus · Accepted Answer

The cost to manufacture one unit of the product is $18, which is obtained by adding the variable cost per unit ($6) to the fixed cost per unit ($12). Therefore, the normal profit per unit is $14 ($32 sales price - $18 manufacturing cost).

If the special order is accepted, the revenue from the 10,000 units sold at a price of $24 will be $240,000 ($24 price per unit x 10,000 units sold), while the manufacturing cost of 10,000 units is $180,000 ($18 cost per unit x 10,000 units manufactured). This will result in a contribution margin of $60,000 ($240,000 revenue - $180,000 manufacturing cost).

However, accepting the special order will require Potter to operate at full capacity and forego the normal production and sales of 10,000 units. The normal profit lost from not producing 10,000 units is $140,000 ($14 normal profit per unit x 10,000 units foregone). Therefore, the short-term profit effect of accepting the special order is a decrease of $80,000 ($140,000 normal profit foregone - $60,000 contribution margin from special order).

Potter Has Received a Special Order for 10,000 Units of Its