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Varone Company: calculate overall net operating income

Question

The Varone Company makes a single product called a Hom. The company has the capacity to produce 40,000 Homs per year. Per unit costs to produce and sell one Hom at that activity level are:

 

Direct materials

$24

Direct labor

$14

Variable manufacturing overhead

$9

Fixed manufacturing overhead

$11

Variable selling expense

$10

Fixed selling expense

$6

 

The regular selling price for one Hom is $80. A special order has been received at Varone from the Fairview Company to purchase 6,700 Homs next year at 20% off the regular selling price. If this special order were accepted, the variable selling expense would be reduced by 30%. However, Varone would have to purchase a specialized machine to engrave the Fairview name on each Hom in the special order. This machine would cost $11,200 and it would have no use after the special order was filled. The total fixed costs, both manufacturing and selling, are constant within the relevant range of 30,000 to 40,000 Homs per year. Assume direct labor is a variable cost.

 

If Varone can expect to sell 30,000 Homs next year through regular channels and the special order is accepted at 20% off the regular selling price, the effect on net operating income next year due to accepting this order would be:

 

a. $22,800 decrease

b. $51,200 increase

c. $55,800 increase

d. $67,000 increase

 

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