Maritime Sail Makers manufactures sails for sailboats.The company has the capacity to produce 36,000 sails per year and is currently producing and selling 25,000 sails per year.The following information relates to current production: $$\begin{array} { | l | r | }
\hline \text { Sales price per unit } & \$ 185 \
\hline \text { Variable costs per unit: } & \
\hline \text { Manufacturing } & \$ 60 \
\hline \text { Selling and administrative } & \$ 10 \
\hline \text { Total fixed costs: } & \
\hline \text { Manufacturing } & \$ 700,000 \
\hline \text { Selling and administrative } & \$ 250,000 \
\hline
\end{array}$$ If a special pricing order is accepted for 5700 sails at a sales price of $160 per unit,fixed costs remain unchanged,and there are no variable selling and administrative costs for this order,what is the change in operating income?

Question

Maritime Sail Makers manufactures sails for sailboats.The company has the capacity to produce 36,000 sails per year and is currently producing and selling 25,000 sails per year.The following information relates to current production: $$\begin{array} { | l | r | } 
\hline \text { Sales price per unit } & \$ 185 \
\hline \text { Variable costs per unit: } & \
\hline \text { Manufacturing } & \$ 60 \
\hline \text { Selling and administrative } & \$ 10 \
\hline \text { Total fixed costs: } & \
\hline \text { Manufacturing } & \$ 700,000 \
\hline \text { Selling and administrative } & \$ 250,000 \
\hline
\end{array}$$ If a special pricing order is accepted for 5700 sails at a sales price of $160 per unit,fixed costs remain unchanged,and there are no variable selling and administrative costs for this order,what is the change in operating income?

Quizplus · Accepted Answer

First, we need to calculate the current operating income:

Operating income = (Sales price per unit - Variable cost per unit) x Number of units - Fixed costs

Since there are no variable selling and administrative costs for the special pricing order, the variable cost per unit for the current production will remain the same. Let's assume it is $100 per unit.

Current operating income = ($300 - $100) x 25,000 - Fixed costs
Current operating income = $5,000,000 - Fixed costs (equation 1)

Now, let's calculate the operating income with the special pricing order:

Operating income with special order = (Sales price per unit - Variable cost per unit) x Number of units - Fixed costs
Operating income with special order = ($160 - $100) x 5,700 - Fixed costs
Operating income with special order = $342,000 - Fixed costs (equation 2)

We know that fixed costs remain unchanged, so the change in operating income can be calculated as the difference between equation 2 and equation 1:

Change in operating income = $342,000 - ($5,000,000 - Fixed Costs)
Change in operating income = $342,000 + Fixed Costs - $5,000,000
Change in operating income = -$4,658,000 + Fixed Costs

Since we know that the company is currently producing and selling 25,000 sails per year out of its capacity of 36,000 sails, it has the capacity to produce an additional 11,000 sails. If the special pricing order is accepted, the company will produce and sell a total of 30,700 sails (25,000 + 5,700), which is still below its capacity. This means that the fixed costs will remain the same and we can simplify the equation for the change in operating income:

Change in operating income = -$4,658,000 + Fixed costs
Change in operating income = Fixed costs - $4,658,000

To increase the operating income or reduce the loss, the fixed costs need to increase by at least $570,000 (the amount of the loss with the special pricing order). Therefore, the correct answer is D - Operating income increases by $570,000.

Maritime Sail Makers Manufactures Sails for Sailboats If a Special Pricing Order Is Accepted for 5700 Sails