Reference no: EM132614626

Question - Consider the following details of the income statement of the McGregor Pen Company (MPC) for the year ended December 31, 20X0:

Sales $15900000

Less COGS $9450000

Gross margin or gross profit $6450000

Less selling and administrative expenses $4350000

Operating income $2100000

MPC's fixed manufacturing costs were $3.6 million, and its fixed selling and administrative costs were $3.3 million. Sales commissions of 3% of sales are included in selling and administrative expenses.

The division had produced and sold 3 million pens. Near the end of the year, Pizza Hut offered to buy 140,000 pens on a special order. To fill the order, a special Pizza Hut logo would have to be added to each pen. Pizza Hut intended to use the pens for special promotions in an eastern city during early 20X1.

Even though MPC had some idle plant capacity, the president rejected the Pizza Hut offer of $610,400 for the 140,000 pens. He said,

The Pizza Hut offer is too low. We'd avoid paying sales commissions, but we'd have to incur an extra cost of $0.35 per pen to add the logo. If MPC sells below its regular selling prices, it will begin a chain reaction of competitors' price cutting and of customers wanting special deals. I believe in pricing at no lower than 8% above our full costs of $13,800,000/3,000,000 units = $4.60 per unit plus the extra $0.35 per pen less the savings in commissions.

Required -

1. Using the contribution-margin technique, compare the MPC financial performance when accepting and rejecting the offer.

2. By what percentage would operating income increase or decrease if the order had been accepted? Do you agree with the president's decision? Why?