Relevant-cost approach to short-run pricing decisions. The San Carles Company is an electronics business with eight product lines. Income data for one of the products (XT-107) for June 2009 are:

Abrams, Inc., an instruments company, has a problem with its preferred supplier of XT-107 components. This supplier has had a three-week labor strike. Abrams approaches the San Carlos sales representative, Sarah Holtz, about providing 3,000 units of XT-107 at a price of $75 per unit Holtz informs the XT-107 product manager, Jim McMahon, that she would accept a flat commission of $8,000 rather than the usual 15% of revenues if this special order were accepted. San Carlos has the capacity to produce 300,000 units of XT-107 each month, but demand has not exceeded 200,000 units in any month in the past year

1. If the 3,000-unit order from Abrams is accepted, how much will operating income increase or decrease? (Assume the same cost structure as in June 2009.)

2. McMahon ponders whether to accept the 3,000-unit special order. He is afraid of the precedent that might be set by cuffing the price. He says, “The price is below our full cost of $96 per unit. I think we should quote a full price, or Abrams will expect favored treatment again and again if we continue to do business with it” Do you agree with McMahon? Explain.

Revenues, 200,000 units at average price of $100 each Variable costs Direct materials at $35 per unit Direct manufacturing labor at $10 per unit Variable manufacturing overhead at $6 per unit Sales commissions at 15% of revenues Other variable costs at $5 per unit Total variable costs Contribution margin Fixed costs Operating income $20,000,000 S7,000,000 1,200,000 3,000,000 1,000,000 14,200,000 5,800,000 5,000,000