Question: Consider the following details of the income statement of the

Consider the following details of the income statement of the McGregor Pen Company (MPC) for the year ended December 31, 20X0:
Sales ................ $15,900,000
Less cost of goods sold ........ 9,450,000
Gross margin or gross profit ..... $ 6,450,000
Less selling and administrative expenses . 4,350,000
Operating income .......... $ 2,100,000

MPC’s fixed manufacturing costs were $3.6 million and its fixed selling and administrative costs were $3.3 million. Sales commissions of 3% of sales are included in selling and administrative expenses.
The division had produced and sold 3 million pens. Near the end of the year, Pizza Hut offered to buy 140,000 pens on a special order. To fill the order, a special Pizza Hut logo would have to be added to each pen. Pizza Hut intended to use the pens for special promotions in an eastern city during early 20X1.

Even though MPC had some idle plant capacity, the president rejected the Pizza Hut offer of $610,400 for the 140,000 pens. He said,
The Pizza Hut offer is too low. We’d avoid paying sales commissions, but we’d have to incur an extra cost of $.35 per pen to add the logo. If MPC sells below its regular selling prices, it will begin a chain reaction of competitors’ price cutting and of customers wanting special deals. I believe in pricing at no lower than 8% above our full costs of $13,800,000, 3,000,000 units = $4.60 per unit plus the extra $.35 per pen less the savings in commissions.
1. Using the contribution-margin technique, prepare an analysis similar to that in Exhibit 5-6 on page 187. Use four columns: without the special order, the effect of the special order (one column total and one column per unit), and totals with the special order.
2. By what percentage would operating income increase or decrease if the order had been accepted? Do you agree with the president’s decision? Why?

  • CreatedNovember 19, 2014
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