Structuring a Special-Order Problem Harrison Ford Company has been approached by a new customer with an offer to purchase 10,000 units of its model IJ5 at a price of $5 each. The new customer is geographically separated from the company's other customers, and existing sales would not be affected. Harrison normally produces 75,000 units of IJ5 per year but only plans to produce and sell 60,000 in the coming year. The normal sales price is $12 per unit. Unit cost information for the normal level of activity is as follows: Direct materials $1.75 Direct labor 2.50 Variable overhead 1.50 Fixed overhead 3.25 Total $9.00 Fixed overhead will not be affected by whether or not the special order is accepted. Required: 1. Should the company accept or reject the special order

(1) rejected (2) $7500

Explanation:

Here is the complete question

Harrison Ford Company has been approached by a new customer with an offer to purchase 10,000 units of its model IJ4 at a price of $5 each. The new customer is geographically separated from the company's other customers, and existing sales would not be affected. Harrison normally produces 75,000 units of IJ4 per year but only plans to produce and sell 60,000 in the coming year. The normal sales price is $12 per unit. Unit cost information for the normal level of activity is as follows: Fixed overhead will not be affected by whether or not the special order is accepted.

Direct Materials                     $1.75

Direct Labor                           2.50

Variable Overhead                1.50

Fixed Overhead                     3.25

           Total                           $9.00

1. What are the relevant costs and benefits of the two alternatives (accept or reject the special order)?

2. By how much will operating income increase or decrease if the order is accepted? by $??

Answer

(1)

Relevant Benefits = 10000 x 5 = $50000

Production Costs = Total Unit x (Direct Material + Direct Labor + Variable Overhead) = 10000 x (1.75 + 2.50 + 1.50) = $57500

given that the production cost are higher than the benefit, I think the special order should be rejected

(2)

Net Operating Income if the Order is Accepted = Relevant Benefits - Relevant Costs = 50000 - 57500 = -$7500

Operating Income will decrease by $7500

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