Petro Motors Inc. (PMI) produces small gasoline-powered motors for use in lawn mowers. The company has been growing steadily over the past five years and is operating at full capacity. PMI recently completed the addition of new plant and equipment at a cost of $6,200,000, thereby increasing its manufacturing capacity to 104,000 motors annually. The addition to plant and equipment will be depreciated on a straight-line basis over 10 years. Sales of motors were 75,000 units prior to the completion of the additional capacity. Cost records indicated that manufacturing costs had totaled $80 per motor, of which $62 per motor was considered to be variable manufacturing costs. PMI has used the volume of activity at full capacity as the basis for applying fixed manufacturing overhead. The normal selling price is $105 per motor, and PMI pays a 11% commission on the sale of its motors. LawnPro.com offered to purchase 26,000 motors at a price of $80 per unit to test the viability of distributing lawn mower replacement motors through its website. PMI would be expected to produce the motors, store them in its warehouse, and ship individual motors to LawnPro.com customers. As orders are placed directly through the LawnPro.com website, they would be forwarded instantly to PMI. No commissions will be paid on this special sales order, and freight charges will be paid by the customer purchasing a motor.

Required information

g. Assume that sales of motors in PMIs regular market are expected to increase by 20% in the coming 12 months. Should the offer from LawnPro.com be accepted?

No

Yes

Indifferent

Calculation of operating income without the special order:

Sales (90,000 $105)				$	9,450,000
Less variable costs:
Manufacturing costs (90,000 $62)	$	5,580,000
Commission (90,000 $11.6)		1,039,500			6,619,500
Contribution margin				$	2,830,500
Less fixed costs					1,970,000
Operating income				$	860,500

Calculation of operating income with the special order:

Sales (78,000 $105)	$
(26,000 $80)				$
Less variable costs:
Manufacturing costs (104,000 $62)	$	6,448,000
Commission (78,000 $11.6)
Contribution margin
Less fixed costs					1,970,000
Operating income				$

Difference between the two?

This result provides another opportunity to stress how important it is to consider the key qualitative factors associated with the special pricing decision.