Potlatch Company manufactures sonars for fishing boats. Model 100 sells for $200. Potlatch produces and sells 5,000 of them per year. Cost data are as follows:
The sales manager says he has an opportunity to pitch a special sale to a new Canadian fishing company that is outfitting new boats. He proposes a sale of 30 units at a special price of $140 per unit. He says it will not cannibalize the company's regular sales and is a one-time transaction. It will require the normal amount of variable costs, both marketing and manufacturing, but will not impact fixed costs in any way. The president of the company has some reservations, but finally agrees to make the deal if and only if it adds a minimum of $1,000 to operating income. Based on the president's criteria, Potlatch will decline the offer.

Question

Potlatch Company manufactures sonars for fishing boats. Model 100 sells for $200. Potlatch produces and sells 5,000 of them per year. Cost data are as follows:
  The sales manager says he has an opportunity to pitch a special sale to a new Canadian fishing company that is outfitting new boats. He proposes a sale of 30 units at a special price of $140 per unit. He says it will not cannibalize the company's regular sales and is a one-time transaction. It will require the normal amount of variable costs, both marketing and manufacturing, but will not impact fixed costs in any way. The president of the company has some reservations, but finally agrees to make the deal if and only if it adds a minimum of $1,000 to operating income. Based on the president's criteria, Potlatch will decline the offer.

Quizplus · Accepted Answer

The contribution margin per unit for Model 100 is $80 ($200 - $120). Thus, the total contribution margin for 5,000 units is $400,000 ($80 x 5,000).

If Potlatch were to sell 30 units at the special price of $140 per unit, the contribution margin per unit would be reduced to $20 ($140 - $120). The total contribution margin for these 30 units would be $600 ($20 x 30).

This additional contribution margin of $600 would not be enough to meet the president's requirement of a minimum of $1,000 increase in operating income. Therefore, Potlatch will decline the offer.

Potlatch Company Manufactures Sonars for Fishing Boats