Reference no: EM131820848

Wainwright Electronics Ltd is a business with eight product lines. Income data for one of the products (XT-107) for June 2014 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 labour 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 5800000

Fixed costs 5000000

Operating income $800000

Puma Ltd, an instruments company, has a problem with its preferred supplier of XT-107. This supplier has had a three-week labour strike. Puma approaches Wainwright Electronics sales representative, Judy Monks, about providing 3000 units of XT-107 at a price of $75 per unit. Judy informs the XT-107 product manager, Sam O'Brien, that she would accept a flat commission of $8000 rather than the usual 15% of revenues if this special order were accepted. Wainwright has the capacity to produce 300 000 units of XT-107 each month, but demand has not exceeded 200 000 units in any month in the past year.

Required :

1 If the 3000-unit order from Puma is accepted, how much will operate income increase or decrease? (Assume the same cost structure as in June 2014.)

2 Sam O'Brien ponders whether to accept the 3000-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 Puma will expect favoured treatment again and again if we continue to do business with it.' Do you agree with Sam? Explain.