String Corporation can manufacture 490,000 tennis rackets a year at a variable cost of $15 per racket and at the fixed costs of $500,000.String budgeted that it can sell 400,000 at $25 each. An additional order of 100,000 was received, but at a discount of 35% from the regular price.
If String accepts the special order, income before taxes will:
A) Decrease by $100,000
B) Increase by $125,000
C) Increase by $25,000
D) Some other amount

Question

Quizplus · Accepted Answer

First, let’s calculate the contribution margin per racket for the regular orders:
Revenue per racket = $25
Variable cost per racket = $15
Contribution margin per racket = $10

Now, let’s calculate the contribution margin per racket for the special order:
Revenue per racket = $25 x 65% (because of the 35% discount) = $16.25
Variable cost per racket = $15
Contribution margin per racket = $1.25

Since the special order is at a lower price point, the contribution margin is lower as well. However, the special order will still bring in some additional contribution margin:

Contribution margin per racket x Number of rackets in the special order = $1.25 x 100,000 = $125,000

Since the fixed costs remain the same regardless of whether the special order is accepted or not, the increase in contribution margin will flow directly to the company's bottom line.

Therefore, the income before taxes will increase by $125,000 if String accepts the special order.

So the answer is C) Increase by $25,000.

String Corporation Can Manufacture 490,000 Tennis Rackets a Year at a Variable