Lattimer Company had the following results of operations for the past year:

Sales (15,000 units at $12.25) $ 183,750
Variable manufacturing costs $ 101,250
Fixed manufacturing costs 24,750
Selling and administrative expenses (all fixed) 39,750 (165,750 )
Operating income $ 18,000

A foreign company whose sales will not affect Lattimer's market offers to buy 5,500 units at $8.00 per unit. In addition to existing costs, selling these units would add a $0.30 selling cost for export fees. Lattimer’s annual production capacity is 25,000 units.

If Lattimer accepts this additional business, the special order will yield a:

A. $3,850 loss. B. $6,875 profit. C. $2,200 loss. D. $5,225 profit. E. $9,350 loss.

D. $5,225 profit

Explanation:

To determine the effect of accepting the offer on income, we must first examine if the company has excess capacity available for such order. Since the company has a capacity of  25,000 units and currently operates at 15,000 units, there is an excess capacity of 10,000 units. This means that the company has enough excess capacity to take on the order.

This also means that the fixed element of cost remains unchanged. In other words, to make a gain from the order, the sales must be more than the additional variable cost.

The gain/(loss) per unit from the special order is the difference between the selling price per unit and the total variable cost.

Variable manufacturing costs per unit

= $101,250/15,000

= $6.75

The gain/(loss) per unit from the special order

= $8 - $6.75 - $0.30

= $0.95

Total gain from the order

= 5500 * $0.95

= $5,225