Midwest Company manufactures portable radios. Shop smart, a large retail merchan

Question

Midwest Company manufactures portable radios. Shop smart, a large retail merchandiser, wants to buy 200,000 radios from Midwest for $12 each. The radio would carry Shop smart's name and would be sold in its stores.
Midwest normally sells 420,000 radios per year at $16 each; its production capacity is 540,000 units per year. Cost information for the radios is as follows:

Production costs:
Variable p.c. = $7
Fixed manufacturing overhead ($2,100,000 / 420,000 units) = $5

Selling & administrative costs:
Variable = $1
Fixed ($420,000 / 420,000 units) = $1

The $1 variable selling and administrative expenses would not be applicable to the radios ordered by Shop smart because that is a single large order. Shop smart has indicated that the company is not interested in signing a contract for less than 200,000 radios. Total fixed costs will not change regardless of whether the Shop smart order is accepted.

QUESTION: IDENTIFY ANY OPPORTUNITY COSTS THAT MIDWEST SHOULD CONSIDER WHEN MAKING THE DECISION.

Explanation / Answer

production capacity = 540,000radios actual production = 420,000 radios idle capacity = 120,000 radios while accepting the order for 200,000 radios, there are no opportunity costs upto 120,000 radios. However, for the balance 80,000 radios, Midwest will lose contribution it was already earning. Hence the opportunity cost is contribution lost on 80,000 radios. selling price =            $16 Less variable costs:       8 (7+1) contribution p.u           $8 total contribution lost on 80,000 radios = 80,000 * 8 = $640,000 Hence opportunity cost = $640,000 total contribution lost on 80,000 radios = 80,000 * 8 = $640,000 Hence opportunity cost = $640,000

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