Special-Order Decision with a Binding Constraint
Halcyon Components makes a single product with the following per-unit data at normal volume of 10,000 units: selling price $80; direct materials $22; direct labor $18; variable overhead $8; fixed overhead $12 (allocated, total $120,000); variable selling $5; fixed selling $3 (allocated). Normal capacity is 12,000 units; current production and sales are 10,000 units, so 2,000 units of idle capacity exist.
A one-time export customer offers to buy 2,000 units at $55 each. The order requires a special mold costing $14,000 (no other use) and would incur no variable selling costs (customer picks up). Alternatively, a domestic wholesaler offers to buy 2,500 units at $58, but that order would require displacing 500 units of regular sales and would still incur the $5 variable selling cost per unit.
1. Evaluate the export order. Should Halcyon accept it? Show relevant-cost reasoning.
Read the worked answer
Relevant (incremental) analysis - ignore allocated fixed costs, which do not change:
- Relevant variable cost per unit = DM $22 + DL $18 + VOH $8 = $48 (no variable selling on this order).
- Contribution per unit = $55 − $48 = $7.
- Total contribution = 2,000 × $7 = $14,000.
- Less special mold (avoidable, incremental) = $14,000.
- Net incremental benefit = $0.
So the export order is indifferent at the margin - it neither helps nor hurts profit. Because it uses idle capacity (2,000 ≤ 2,000 idle units) it does not displace regular sales. Judgment: accept only if there is strategic value (market entry, relationship) or if the mold cost can be reduced; otherwise it adds risk for zero profit. The $12 fixed overhead and $3 fixed selling are irrelevant - they are sunk/allocated and unchanged.
2. Now compare with the wholesaler order, which has a capacity constraint. Which order, if either, maximizes profit?
Read the worked answer
The wholesaler order needs 2,500 units but only 2,000 are idle - so 500 units displace regular sales.
Wholesaler order:
- Contribution per unit = $58 − ($48 + $5 variable selling) = $58 − $53 = $5/unit.
- Contribution on 2,500 units = 2,500 × $5 = $12,500.
- Lost contribution on 500 displaced regular units: regular contribution = $80 − ($48 + $5) = $27/unit × 500 = $13,500 lost.
- Net = $12,500 − $13,500 = −$1,000. Reject.
Comparison:
- Export order: net $0 (uses idle capacity, no displacement).
- Wholesaler order: net −$1,000 (displaces high-margin regular sales).
Neither adds profit, but the export order is the better of the two (break-even vs. a $1,000 loss). The key judgment is that when capacity is binding, the decision hinges on opportunity cost of displaced regular contribution ($27/unit), not on the special order's own contribution margin. The wholesaler's higher price ($58 vs $55) is misleading because of displacement and variable selling.