Newtown Sunglasses sell for about $154 per pair. Suppose that the company incurs the following average costs per pair:
Direct materials .................................. $ 39
Direct labor ......................................... 15
Variable manufacturing overhead ................ 6
Variable selling expenses ......................... 3
Fixed manufacturing overhead ................. 20*
Total cost ....................................... $ 83
* $2,050,000 Total fixed manufacturing overhead / 102,500 Pairs of sunglasses Newtown has enough idle capacity to accept a one-time-only special order from Water Shades for 17,000 pairs of sunglasses at $80 per pair. Newtown will not incur any variable selling expenses for the order.
Requirements
1. How would accepting the order affect Newtown's operating income? In addition to the special order's effect on profits, what other (longer-term qualitative) factors should Newtown's managers consider in deciding whether to accept the order?
2. Newtown's marketing manager, Peter Kyler, argues against accepting the special order because the offer price of $80 is less than Newtown's $83 cost to make the sunglasses. Kyler asks you, as one of Newtown's staff accountants, to explain whether his analysis is correct. What would you say?