Fan Diego, Inc., manufactures a hand-held electric hair dryer. Sales have increased steadily during recent years and, because of a recently completed expansion program, annual capacity is now 250,000 units. Production and sales during the coming year are forecast at 150,000 units, and standard production costs have been estimated as:
Materials $3.00
Direct labor 2.00
Variable indirect labor 0.50
Fixed overhead 1.00
Allocated cost per unit $6.50
In addition to production costs, Fan Diego incurs fixed selling expenses of 50¢ per unit, and variable warranty repair expenses of 75¢ per unit. Fan Diego currently receives $8.25 per unit from its customers (primarily retail department stores) and expects this price to hold during the coming year.
After making the above projections, Fan Diego received an inquiry concerning the purchase of a large number of units by a discount department store. The inquiry contained two purchase offers:
Offer 1: The department store would purchase 100,000 units at $8 per unit. These units would bear the Fan Diego label, and the Fan Diego warranty would cover them.
Offer 2: The department store would purchase 150,000 units at $7 per unit.
These units would be sold under the buyer's private label and Fan Diego would not provide warranty service.
A. Evaluate the incremental net income from each offer.
B. What other factors should Fan Diego consider in deciding which offer to accept?
C. Which offer (if either) should Fan Diego accept? Why?