0. The San Carlos Company is an electronics business with eight product lines. Income data
for one of the products (XT-107) for June 2020 are as follows:
Revenues, 200,000 units at average price of $100 each $20,000,000
Variable costs
Direct materials at $35 per unit $7,000,000
Direct manufacturing labor at $10 per unit 2,000,000
Variable manufacturing overhead at $6 per unit 1,200,000
Sales commissions at 15% of revenues 3,000,000
Other variable costs at $5 per unit 1,000,000
Total variable costs 14,200,000
Contribution margin 5,800,000
Fixed costs 5,000,000
Operating income $800,000
Abrams, Inc., an instruments company, has a problem with its preferred supplier of
XT-107. The 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 XT107 each month, but demand has not exceeded 200,000 units in any month in the past
year.
a) 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 2020).
b) McMahon ponders whether to accept the 3,000-unit special order. He is afraid of the
precedent that might be set by cutting 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