Meco Company produces a product that has a regular selling price of £360 per unit. At a typical monthly production volume of 2,000 units, the product's average unit cost of goods sold amounts to £270. Included in this average is £120,000 of fixed manufacturing costs. All selling and administrative costs are fixed and amount to £30,000 per month. Meco Company has just received a special order for 1,000 units at £240 per unit. The buyer will pay transportation, and the regular selling price will not be affected if Meco accepts the order.
Assuming Meco Company has excess capacity, the effect on profits of
Accepting the order would be
A) a £60,000 increase.
B) a £60,000 decrease.
C) a £30,000 increase.
D) a £30,000 decrease.
E) no change in profits.

Question

Quizplus · Accepted Answer

The incremental revenue from the special order is £240 per unit, which results in a total revenue of £240,000 for the 1,000 units.

The incremental cost of goods sold includes only variable costs since fixed costs are already being absorbed by the regular production volume. The variable cost per unit is £270 - £120,000/2,000 = £210. Thus, the incremental cost of goods sold for the special order is £210 per unit, which results in a total cost of goods sold of £210,000 for the 1,000 units.

Therefore, the incremental profit from the special order is £240,000 - £210,000 = £30,000. Since all selling and administrative costs are fixed, there is no incremental cost associated with these expenses.

Thus, accepting the special order would result in a £30,000 increase in profits for Meco Company.

Meco Company Produces a Product That Has a Regular Selling