Tom Industries has a plant capacity of 70,000 units and current production is 55,000 units. At this production volume the variable cost per unit is $30, and the fixed cost per unit is $4.10 per unit. The normal selling price of Tom's product is $45 per unit. Tom Industries has been asked by Sadie, Inc., to fill a special order for 10,000 units of the product at a special sales price of$25 each. Sadie, Inc. will market the units in a foreign country under its own brand name; the special order is not expected to have any effect on Tom's regular sales.

1) What impact will accepting the special order have on Tom's operating income?

A. Accepting the special order will not impact Tom's operating income.

B. Accepting the special order will increase Tom's operating income.

C. Accepting the special order will decrease Tom's operating income.

2) By how much will operating income change if the special order is accepted?

If Tom Industries accepts the order, the result would be that C. Accepting the special order will decrease Tom's operating income will decrease it by $50,000.

Tom Industries has excess capacity of:

= 70,000 - 55,000

= 15,000 units

Tom Industries only has to produce 10,000 units for Sadie Inc which means that they have the capacity for it. They will therefore not incur any additional fixed costs.

Incremental income will be:

= (Special sales price - Variable cost per unit) x number of units

= (25 - 30) x 10,000

= 5 x 10,000

= -$50,000

In conclusion, Tom Industries would make a loss of $50,000 if they took this special order.

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