Grove Company makes special equipment used in cell towers. Each unit sells for $400. Grove uses just-in-time inventory procedures: they produce and sell 10,000 units per year. They have provided the following income statement data: An African cell phone company has offered a one-time deal to buy 200 units for a specially reduced price of $210 per unit. The marketing manager says the sale will not negatively impact the company's regular sales. The sales manager says that this sale will not require any variable selling & marketing costs. The production manager reports that it would require an additional $25,000 of fixed manufacturing costs to accommodate the specifications of the buyer. If Grove accepts the deal, how will this impact operating income?

Question

Grove Company makes special equipment used in cell towers. Each unit sells for $400. Grove uses just-in-time inventory procedures: they produce and sell 10,000 units per year. They have provided the following income statement data:  An African cell phone company has offered a one-time deal to buy 200 units for a specially reduced price of $210 per unit. The marketing manager says the sale will not negatively impact the company's regular sales. The sales manager says that this sale will not require any variable selling & marketing costs. The production manager reports that it would require an additional $25,000 of fixed manufacturing costs to accommodate the specifications of the buyer. If Grove accepts the deal, how will this impact operating income?

Quizplus · Accepted Answer

Grove Company normally sells 10,000 units at $400 per unit, which generates total revenue of $4,000,000 ($400 x 10,000). The total variable cost of producing 10,000 units is $2,200,000 ($220 x 10,000).

Without the special deal, the operating income is calculated as:

Operating Income = Total Revenue - Total Variable Costs - Fixed Costs
Operating Income = $4,000,000 - $2,200,000 - $780,000
Operating Income = $1,020,000

If we accept the special deal, Grove will sell an additional 200 units at a reduced price of $210 per unit, which generates total revenue of $42,000 ($210 x 200). However, Grove will need to incur an additional $25,000 in fixed manufacturing costs. The variable selling & marketing costs are not expected to increase.

The operating income after accepting the deal is calculated as:

Operating Income = Total Revenue - Total Variable Costs - Fixed Costs
Operating Income = ($4,000,000 + $42,000) - ($2,200,000 + $0) - ($780,000 + $25,000)
Operating Income = $1,037,000

Therefore, the impact on operating income is:

Operating Income with Special Deal - Operating Income without Special Deal
$1,037,000 - $1,020,000 = $17,000 decrease

Therefore, the correct answer is D) Down $3,000.

Grove Company Makes Special Equipment Used in Cell Towers