Farrow Co. expects to sell 200,000 units of its product in the next period with the following results: Sales (200,000 units) $3,000,000

Costs and expenses:
Direct materials 400,000
Direct labor 800,000
Overhead 200,000
Selling expenses 300,000
Administrative expenses 514,000
Total costs and expenses 2,214,000
Net income $786,000

The company has an opportunity to sell 20,000 additional units at $13 per unit. The additional sales would not affect its current expected sales. Direct materials and labor costs per unit would be the same for the additional units as they are for the regular units. However, the additional volume would create the following incremental costs:

1. total overhead would increase by 15%
2. administrative expenses would increase by $86,000.

Required:
Calculate the combined total net income if the company accepts the offer to sell additional units at the reduced price of $13 per unit.

Combined net income =$810,000

Explanation:

In order to carry out an incremental analysis, only relevant cash flows should be considered.

The relevant cash flows from accepting the special order are the variable costs and the sales revenue plus the incremental cost of overhead and administrative cost . Please, note that the fixed costs are not relevant for this decision. Simply because they would be incurred either way.

The relevant cash flows include:

Selling price per unit = $13

Variable cost per unit of additional sales

= (Direct material + Direct labour cost)/200,000 = 6

Analysis of incremental net income

                                                                                            $

Additional sales revenue ( 13×× 20,000)  =              260,000

Incremental variable cost (6 × 20,000)    =                 120000

Incremental overhead        (15%× 200,000)  =           (30000)

Incremental admin cost                                             (86,000)

Net income from additional sales                               24,000

Combined net income = original Net income + Additional  net income

= 786,000  +   24000  = $810,000

Combined net income =$810,000

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