The order utilizes the capacity and contributes a positive net cash flow of $2,500, even though the overhead charge renders it unprofitable in the accounting sense. In determining whether or not Sport Cardz should take the order, they must consider cash flow rather than accounting profit. If they did not take the order, the overhead charge would be applied elsewhere anyway, so it is not included in the decision-making process.
The order will therefore generate $20,000 in revenues and costs of $17,500. This leaves a positive cash flow of $2,500 that will be applied to the fixed overhead. The choice of allocation method, from which the actual charge is derived, is irrelevant to the decision of whether or not to take the order.
3. Fixed Systems should continue to make the switch....
If they purchased the switch from the other company, their cost would be the switch cost plus the overhead cost. This is because the overhead will exist whether they make or buy the switch. Given that the space cannot be used for any other purpose, Fixed Systems must consider the overhead cost regardless of whether they are making or buying the switch. This means that the cost of making the switch, aside from the overhead is $12.50. The cost of buying the switch is $14. Therefore, Fixed Systems should continue making the switch, because they can make it for $1.50 less than they can buy it. If they were able to use that physical space for another purpose, the overhead cost could be applied to that other purpose, which would make purchasing the switch more attractive. But under the given circumstances…
