Gundy Company manufactures a product with the following costs per unit at the expected production of 30,000 units: The company has the capacity to produce 40,000 units.The product regularly sells for $40.A wholesaler has offered to pay $32 a unit for 2,000 units.
If the firm is at capacity and the special order is accepted, the effect on operating income would be
A) a $20,000 increase.
B) a $16,000 decrease.
C) a $4,000 increase.
D) $-0-.

Question

Gundy Company manufactures a product with the following costs per unit at the expected production of 30,000 units:  The company has the capacity to produce 40,000 units.The product regularly sells for $40.A wholesaler has offered to pay $32 a unit for 2,000 units.
If the firm is at capacity and the special order is accepted, the effect on operating income would be
A) a $20,000 increase. 
B) a $16,000 decrease. 
C) a $4,000 increase. 
D) $-0-.

Quizplus · Accepted Answer

To calculate the effect on operating income, we need to calculate the contribution margin per unit.

Contribution margin per unit = Selling price per unit - Variable cost per unit 
= $40 - $25 = $15

At the expected production of 30,000 units, the total contribution margin is:

Contribution margin = Contribution margin per unit x Expected production 
= $15 x 30,000 
= $450,000

If the company accepts the special order of 2,000 units, the additional contribution margin will be:

Additional contribution margin = Contribution margin per unit x Number of units in special order 
= $15 x 2,000 
= $30,000

However, the company is already at capacity and accepting the order of 2,000 units will reduce its regular sales by 2,000 units. This means that the company will lose $15 x 2,000 = $30,000 from regular sales.

Overall effect on operating income = Additional contribution margin - Opportunity cost of lost sales 
= $30,000 - $30,000 
= $0

Therefore, the correct answer is B, a $16,000 decrease.

Gundy Company Manufactures a Product with the Following Costs Per