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Davis Company normally produces 150,000 units of Product AB per year. Due to an economic downturn, the company has some idle capacity. Product AB sells for $15 per unit.

The firm's production, marketing, and administration costs at its normal capacity are:

Direct material 1.00

Direct labor 2.00

Variable overhead 1.50

Fixed overhead 3.00

($450,000/150,000 units)

Variable marketing costs 1.05

Fixed marketing and administrative costs 1.40

($210,000/150,000 units)

Total $9.95

a. Compute the firm's operating income before income taxes if the firm produced and sold 110,000 units.

b. For the current year, the firm expects to sell the same number of units as it sold in the prior year. However, in a trade newspaper, the firm noticed an invitation to bid on selling Product AB to a state government. There are no marketing costs associated with the order if Davis is awarded the contract. The company wishes to bid for 40,000 units at its full manufacturing cost plus $ 0.25 per unit.

How much should it bid? If Davis is successful at getting the contract, what would be its effect on operating income?

c. Assume that the company is awarded the contract on January 2, and in addition it also receives an order from a foreign vendor for 40,000 units at the regular price of $15 per unit. The foreign shipment will require the firm to incur its normal marketing costs. The government contract contains a 10-day escape clause (i.e., the firm can reject the contract within 10 days without any penalty). If the firm accepts the government contract, overtime pay at 1 1/2 times the straight time rate will be paid on the 40,000 units. In addition, fixed overhead will increase

by $60,000 and variable overhead will behave in its normal pattern. The company has the capacity to produce both orders. Decide the following:

1. Should the firm accept the foreign offer? Show the effect on operating income of

accepting the order

2. Assuming the foreign order is accepted, should the firm accept the government order?

Show the effect on operating income of accepting the government order.

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