36Chapter 10CHAPTER 10RELEVANT INFORMATION FOR DECISION MAKINGQUESTIONS1. Relevance means that a factor should be considered in making a decision. Arelevant cost is a cost that is applicable, pertinent, or logically related to making adecision. In business, managers use the concept of relevant costs in the allocationof resources.2. Time is correlated with relevance. For costs to be relevant, they must reside inthe future; historical costs are never relevant.Further, the more distant in the future a cost resides, the more likely it is to berelevant. For example, in the long run, certain fixed costs are likely to be relevant;however, in the short run, most fixed costs are not relevant.3. Opportunity costs are benefits that are sacrificed to pursue one decisionalternative over another. These costs are difficult to identify because they do notappear as costs in accounting records. For example, in allocating scarceresources, managers may decide to produce Product A rather than Product B. Anopportunity cost of this decision is the lost contribution margin on Product B. Thelost contribution margin does not appear in the accounting records as an expense.4. Sunkcostsarecoststhat havealreadybeenincurred(i.e., theyarehistorical costs). Sunk costs are never relevant to decisions because once a costhas been incurred, it cannot be unincurred.5. Outsourcing occurs when a firm chooses to acquire necessary servicefunctionsormaterialsfromasupplierratherthanproducethemin-house. Themovement favoring outsourcing is controversial because it often involves loss ofjobs to the organization electing to outsource. In the United States, the outsourcingcontroversy is even more tense because vendors selected in outsourcing decisionsoften are foreign companies. Thus, it can be argued that outsourcing leads to themovement of jobs from the United States to other countries.6. A scarce resource is any input that constrains production capacity. Inthe short run, any constraint can be binding and the tightest constraint changesover time. For example, in a labor strike, direct labor may be the most constrainedresource. If a machine breaks down, the conversion operation performed by thatmachine maybe the most bindingconstraint oncapacity, andif a supplierbecomes bankrupt, certain materials may become the most binding constraint.7. The object of managing the sales mix is to increase the contributionmargin (or total profit) realized on the sale of a portfolio of products. The majorfactors that can be manipulated to change product mix are product prices, focus of 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible ebsite, in hole or in part.3Chapter 10advertising and promotion, and the manner in which sales personnel arecompensated.8. A special order decision involves the analysis of a nonrecurring sale ofproducts. The typical circumstance involves the opportunity tosell productsoutside of the normal marketing area or toa one-time customer. The usualanalysis involves a consideration of incremental costs and incremental revenues aswell as the effect of the proposed sale on existing business. A business !ay re"usea special order because it could disrupt regular sales, not be su""iciently pro"itable,be in violation o" the Robinson#$at!an Act, or be illegal.9. Segment margin is sales less variable costs and avoidable fixed costs.Segment margin is used in decisions about whether to keep or eliminate a productline. The costs deducted in arriving at segment margin include only relevant costs(total direct variable expenses and avoidable fixed expenses). The costs presentedbelowthelevel ofsegment margintoderiveproduct lineoperatingresultsareirrelevant costs (sunk direct fixed costs) because such costs could not be avoidedor elimnated should the product line be discontinued. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible ebsite, in hole or in part.Chapter 10 E!ERCISES10. a. Oneoptionis toreworktheshirts as describedintheproblem; asecond option is to sell the shirts as scrap material; the third option is to donothing with the shirts, or simply discard the shirts.b. The only sunk cost is the original cost of the T-shirts, $11.75.c. Rework alternative: $5.50 per T-shirt.Sell as rags: no incremental costs.Do nothing: no incremental costs.d. Incremental profit of rework alternative: $10.25 $5.50 = $4.75 per T-shirtIncremental profit of selling as rags: $2.60 per T-shirtIncremental profit of doing nothing: $0.The relative advantage of reworking the T-shirts is $4.75 $2.60 = $2.1511. a. The only sunk cost is the purchase cost of the lettuce, $0.65 per head; or $0.65 3,000 = $1,950b. The unspoken alternative is to do nothing. Doing nothing might simply meanthrowing the heads of lettuce in a dumpster or giving the! to a "ood ban% orshelter.c. Do Sell to Sell toNothing Wholesaler RestaurantIncremental revenue $ 0 $ 750 $ 3,150Incremental costs002,500Incremental profit $ 0 $ 750 $650Based on a comparison of the incremental profits associated with eachalternative, the company should sell the lettuce to the wholesaler.12. Theminimumpriceisequal totheincremental cost of sellingtheobsolete units. The only cost that will be incurred to sell the units is the variableselling cost of $20 0.40 or $8. If the firm can sell the units for more than $8, thefirm is better off than it would be by simply destroying the unsold units.13. a. Therelevant factorsincludethedifferencebetweenthestartingsalariesforB.A.s and M.A.s, time until retirement,time to complete the M.A., and theout-of-pocket costs to obtain the M.A.b. The opportunity cost associated with earning the masters degree is two yearsincomethat couldhavebeenearnedwiththeB.A. degree($49,4002=$98,800).c. The out-of-pocket cost would include the cost of tuition, books, lab fees, andother direct educational costs ($94,000). It would not include room and boardorotherlivingexpensesthatwouldbeincurredirrespectiveofwhetherthe 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publiclyaccessible ebsite, in hole or in part.3"Chapter 10student works (with the B.A. degree) or attends school.d. The other factors to be considered would be the qualitative factors, e.g., therelativesatisfaction, prestige, andhappinessobtainedfromjobsthat canbesecured with each degree, and eachalternatives effecton retirementplans,free time, and travel opportunities.14. a. You would explain to Catanac that the purchase cost of $95 is not relevant toany decision she can now make regarding the DVD player. No matter whatactionshetakesnow, the$95isnotarecoverablecost. Indecidingwhichaction to take, Catanac should consider only those costs that can be avoided bytakingoneactionratherthananother. Anycost that isthesameacrossalldecisionalternatives canbeignored; suchacost is not relevant. Ignoringqualitative factors, Catanac should select the alternative that minimizes totalrelevant costs.b. Her logical choices are (1) repair the DVD player at an estimated cost of$75and(2)purchaseanewDVDplayer. Accordingly, thedecisionwouldlogically be made by comparing the purchase cost of a new player to the repaircost of the broken player. However, Catanac may want to consider differencesin features between the existing DVD player and replacement players as well.She may be willing to pay more than $75 for a new player if it has additionalfeatures. This would be a qualitative consideration.15. a. The sunk cost is the original cost of the old equipment, $350,000.b. Irrelevant futurecostsinclude$16,000of cashoperatingcostsandthe(nondifferential) salvage values in five years.c. The relevant costs include the cost of the new equipment, $396,000, thecurrent salvage value of the old equipment,$88,000 and $48,000 of annualcash operating savings.d. The opportunity costs associated with keeping the old equipment includethe potential $48,000 savings in cash operating costs, and the current $88,000salvage value of the old equipment.e. Theincremental cost topurchasethenewequipment is thedifferencebetween the purchase cost of the new machine and the current salvage value ofthe old machine, $396,000 $88,000 = $308,000.f. Somequalitativefactors tobeconsideredwouldincludehowthenewmachine would affect the quality of production relative to the old machine,effects onemployeemoraleif purchasingthenewmachinewouldrequirelayoffs, andwhether current employeeshavetheskillstooperatethenewmachine.16. Incremental savings ($32,000 10)$ 320,000Incremental cost of software ($840,000 $356,000) (484,000) 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible ebsite, in hole or in part.Chapter 10 Incremental loss$(164,000)Froma quantitative perspective, the newsoftware should not be purchasedbecause it will result in incremental losses of $164,000.17. a. Relevant cost to manufacture = $4.60Relevant cost to buy = $4.00Advantage of buying: 120,000 ($4.60 $4.00) = $72,000b. Relevant cost to buy $ 4.00 Avoidable variable costs(3.48)Minimum avoidable fixed costs $ 0.52 per unit18. The relevant costs to make the bumpers include only the variable costs:Direct material $53 (incl. purchased mounting hardwareat $15)Direct labor 17Overhead ($45 1/3) 15Total $85Incremental profit per bumper = $170 $85 = $85Increased profit from released facilities: ($85 4,800)$408,000Increased cost of production on first 300,000 units:($20 $15) 300,000(1,500,000)Net loss from purchasing mounting hardware $(1,092,000)19. a. Cost to make: $27,000 + ($2.70 25,000)$94,500 Cost to buy: 25,000 $3.60(90,000) Advantage of purchasing $4,500b. Cost to make: $27,000 + ($2.70 60,000)$ 189,000Cost to buy: 60,000 $3.60(216,000)Disadvantage of purchasing $(27,000)c. Point of indifference occurs at the volume level that equates the cost tomake with the cost to buy:$27,000 + $2.70 X = $3.60X X = 30,000 unitsa. MP3 Players PDAsContribution margin$14 $20Divide by labor time per unit 1 2CM per unit of labor time$14 $10Because the company can sell as many of either product as it can make, it shouldmake only MP3 players. The company should make 100,000 MP3 players.b. Thecompanyshouldconsider theneedtoprovideamarket assortment ofgoodsandthepossibilityofcustomerpreferencespermanentlychangingto 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publiclyaccessible ebsite, in hole or in part.#1Chapter 10PDAs not made by Sierra Sound Systems. This is acknowledging the possiblelong-term consequences of a short-term problem solution.21. a.Individual Estate CorporateRevenue $350$1,200$ 750Variable cost(50)(200) (150)Contribution margin $300 $1,000$ 600Contribution margin per hour of professional time:Individual: $300 2$150 Estate: $1,000 8 $125Corporate: $600 5 $120According to the CM generated per hour of professional time, White wouldprefer to satisfy demand for services in the following order: individualtaxation, estate taxation, and corporate taxation. Because all of Whites timecould be consumed in providing individual income tax services, all of her timeshould be dedicated to providing that service.b.Contribution margin: 2,000 $150$300,000Fixed costs (80,000)Pre-tax income $220,000c. White should carefully consider the relationship between the three services sheoffers. For example, much of the demand for individual and estate tax servicesmaybe generated by the services she providescorporateclients. It maybebecause of the quality of her corporate tax services that demand is generated toprovide individual income and estate tax services. Accordingly, there may belong-termnegative consequences toprovidingonlyindividual income taxservices.d. White could overcome the time constraint in one of two generic ways. First, shecould employ accountants in her firm to do work in all service lines. Second,she could engage in a joint venture or partnership with other firms to provide thefull array of services to clients. 22. a.GroomingTraining TotalRevenue $1,500,000 $1,400,000 $ 2,900,000Labor cost(600,000)(820,000) (1,420,000)Material cost(180,000)(140,000)(320,000)CM $ 720,000 $ 440,000 $ 1,160,000Fixed cost(250,000)(260,000)(510,000)Income before taxes $ 470,000 $ 180,000 $650,000b. Contribution margin $ 720,000 $ 440,000Divide by sales 1,500,000 1,400,000Contribution margin %48% 31% (rounded) 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible ebsite, in hole or in part.Chapter 10 If $1 spent on advertising could increase revenue by either service by $20, itshouldbespent ongroomingbecauseit hasahigher contributionmarginpercent.c. Grooming TrainingRevenue per hr. $ 50 $ 70Variable costs per hr.(26) (48)CM per hr. $ 24 $ 22Because $1 will yield $24 in CM if spent on grooming, but yield only $22 inCMifspentontraining, the$1shouldbespentadvertisingthecompanysgrooming services.23. a. Sales (120,000 $60) $7,200,000Variable costs [($25 + $12) 120,000](4,440,000)Contribution margin $2,760,000Fixed costs(1,240,000)Projected profit $1,520,000b. New sales [(120,000 1.20) ($60 0.90)] $7,776,000New variable costs [(120,000 1.20) $37](5,328,000)New contribution margin $2,448,000Old contribution margin(2,760,000)Change in profit$ (312,000)c.Change in CM ($2,760,000 0.20)$552,000Change in fixed costs (185,000)Change in profit $367,00024. a. Profit effect of option 1:Cell Phones Ear Buds Charger TotalIncrease in sales*$10,500,000 $ 800,000$ 400,000$11,700,000Increase in VC(8,960,000)(200,000)(140,000)(9,300,000)Contribution margin$1,540,000 $ 600,000 $ 260,000$2,400,000Increase in FC(1,000,000)Increase in profits $ 1,400,000* New sales volume would be as follows:Cell phones: 2,200,000 0.70 = 1,540,000Ear buds: 2,200,000 0.20 = 440,000Charger: 2,200,000 0.10 = 220,000Change in sales volume would be as follows:Cell phones: 1,540,000 1,400,000 = 140,000Ear buds: 440,000 400,000 = 40,000Charger: 220,000 200,000 = 20,000Profit effect of option 2:Cell PhonesEar Buds Charger TotalIncrease in sales*$115,500,000 $10,000,000$ 5,000,000 $ 130,500,000 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publiclyaccessible ebsite, in hole or in part.#3Chapter 10Increase in VC (112,000,000) (2,500,000) (1,750,000) (116,250,000)Contribution margin $3,500,000 $7,500,000$ 3,250,000 $ 14,250,000Increase in FC (0)Increase in profits $ 14,250,000*(1,750,000 $70) [1,400,000 ($75 $70)]The preferred alternative is to decrease the price of cell phones to $70. Thisalternative increases profits by $14,250,000 $1,400,000 =$12,850,000relative to the alternative of decreasing the price of cell phones.b. One alternative is to decrease the price of the ear buds and charger. Althoughthis alternative would minimally impact cell phone sales volume, salesvolumes for ear buds and chargers should increase. Another alternative wouldbe to focus promotional efforts on the ear buds and the charger in addition tothe cell phones.25. a.Only the variable production costs are relevant to this decision: $560 + $40 +$50 = $650.Incremental revenue: $670 200 $ 134,000Incremental costs: $650 200 (130,000)Incremental profit $ 4,000Profits would increase by $4,000 if this special order was accepted.26. a.The relevant costs include the lost contribution margin associated with the 20units of regular production that would be sacrificed to accept the special order,and the variable production costs for the three special stands:Normal sales price (20 $230)$ 4,600Variable costs (20 $100)(2,000)Lost contribution margin $ 2,600Production costs (3 $690) 2,070Total costs $ 4,670b. Additional sales $ 3,800Less total relevant costs (4,670)Incremental loss$(870)27. a. If the U.S. divisionhadbeeneliminated, Borderlands income statementwould have appeared as follows:Sales$3,600,000 Variable costs(2,088,000)Contribution margin$1,512,000Fixed costs:Direct $ 490,000Corporate2,790,000 (3,280,000)Operating income (loss) $(1,768,000) 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible ebsite, in hole or in part.Chapter 10 b. United States Mexico TotalSales $ 7,200,000 $ 3,600,000$10,800,000Variable costs (4,740,000)(2,088,000) (6,828,000)Direct fixed costs(800,000) (490,000) (1,290,000)Segment margin $ 1,660,000 $ 1,022,000 $2,682,000Corporate costs(2,790,000)Operating income (loss)$ (108,000)If theU.S. divisioniseliminated, corporateincomewoulddeclinebythe$1,660,000 of segment margin currently being generated by that division. Thecommon corporate costs of $2,790,000 would then need to be covered in totalby the Mexico division, which it cannot do. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publiclyaccessible ebsite, in hole or in part.#$Chapter 1028. a. Gross margin GL services $ 1,200,000Avoidable fixed and variable operating costs (1,470,000)Segment margin $ (270,000)Yes, thecompanyshouldstronglyconsider droppingthe GLservicelinebecause it generates a negative segment margin of $270,000.b. The pre-tax profit of the company would rise by $270,000 (the amount of thenegative segment margin of the GL service line) if the GL area was dropped. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible ebsite, in hole or in part.Chapter 10 PRO%LEMS29. a. The loss on the sale of the warehouse should not be relevant to the decision tosell the warehouse. The loss arises only because a sunk cost (net book value ofthe warehouse) is included in the loss calculation. However, because the losson the sale will affect the performance evaluation and compensation ofCosgrove, Cosgrove will likely consider the loss in her decision whether tokeep the warehouse.b. Inthelongrun,theremainingcostofthewarehouse, $12,200,000, willbecharged against income no matter what course of action Cosgrove takes. If thebuilding is retained, its cost will be written off through periodic depreciationcharges; if the building is sold, its book value will be deducted from the salesprice. Accordingly, one could advise Cosgrove that the best long-term courseof action is to go ahead and sell the warehouse and capture the incrementalbenefit of $7,000,000&assu!ing that the arehouse ill never appreciate sothat it ould not be held as an invest!ent.30. a. Cost of new machine$(1,600,000) Sales value of old machine 200,000Incremental cost of new machine $(1,400,000)Operating cost savings ($295,000 5) 1,475,000Net advantage of buying new machine $75,000b. The qualitative factors that should be considered include any qualitydifferences between the output generated by the two machines,whether thecompanys employees have the knowledge to operate the new machine, howacquisition of the machine would affect safety considerations, and the capacitylevels of the two machines.31. a. The relevant costs include the cost to purchase the new turbine,the currentmarket value of the old turbine, and the difference in annual operating costsbetween the old and new turbines.b. Incremental cost of new turbine: $6,000,000 $400,000$(5,600,000)Incremental cost savings of new turbine:[($210,000 $45,000) 4] 8 5,280,000Incremental profit from buying new turbine$ (320,000)c. The maximum amount that the company could pay: Total annual operating savings$5,280,000Cash value of old machine400,000Total $5,680,000d. Some of the factors to consider would include the reliability of thetechnologies, thedifferenceinlivesofthetechnologies, theenvironmentalimpacts of the technologies, and relative risks of using the two technologies.32. a. Ethical issues to consider: whether the competitor is exploiting the workers; 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publiclyaccessible ebsite, in hole or in part.#Chapter 10whether thecompetitor is displacingthedomesticworkforce; whether thecompetitor is violatingtherights of other companies tofair competition;effects onthevarious stakeholders includingcustomers (competitors andTates) of using the illegal workers and of not using the illegal workers. Inaddition, there exists the legal issue that hiring illegal aliens is unlawful. TateElectronics is considering knowingly and willfully becoming an accompliceby purchasing from this supplier.b. The short-run advantages are buying at a lower price to be more profitable,being able to sell at a lower price and therefore sell more computers, having acompetitiveadvantage, andpleasingthecustomerswhowill appreciatethelower prices. The potential disadvantages are longer run: damage to thebusiness community and to the socioeconomic balance; damage to thecompanys reputation; possiblefines and/or imprisonment if co-conspiracycould be proven; ill effects on workers who are exploited; and disadvantagesto domestic workers who are unable to obtain jobs.c. Tate should investigate further the hiring practices of the supplier or allow theproper authoritiestodoso. Ifsatisfiedthat thesupplier isfollowinglegalpractices, Tate should perform the necessary cost analysis for a make-or-buydecision. If the supplier is foundtobehiringillegal aliens, Tate shouldcontinue to make its own keyboards.33. a. Relevant costs include:Variable production costs: ($0.08 + $0.06 + $0.04) or $0.18 per unitAnnual salary of manager who can be replaced: $50,000Vendors offering price: $0.19 per unitb. Production costs saved ($0.18 4,000,000) $ 720,000Salary savings 50,000Purchase cost of part ($0.19 4,000,000)(760,000)Advantage of outsourcing the part $ 10,000c. Other considerations include the relative quality of the part acquired from thevendor and the part produced internally, the ability of the vendor to deliver ina timely manner, the existence of competitors of the vendor, the likelihood thatfuture volume levels will differ from present volume levels.34. a. Cost to make:Direct material $278.00Direct labor ($132 0.75)99.00Variable overhead ($86 0.75)64.50Fixed overhead:Rental value of production space ($228,000 50,000)4.56Depreciation on new machine ($10,000,000 5) 50,000 40.00Total unit cost $486.06Cost to buy: $480.00 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible ebsite, in hole or in part.Chapter 10 b. If60,000subassemblieswererequiredannually, thecost tomakewouldchange because of the lower fixed costs on a per-unit basis. The depreciationwould be ($10,000,000 5) 60,000 = $33.33, and the rental valueopportunitycostwould declineto: $228,00060,000 = $3.80.Thiswouldchangetheoverall cost tomake to $278.00+$99.00 + $64.50+ $33.33+$3.80 = $478.63. At this volume level, the advantage is slightly in favor ofmaking.c. If75,000subassemblieswererequiredannually, thecost tomakewouldagain change due to the lower fixed costs on a per-unit basis. The depreciationwould be ($10,000,000 5) 75,000 = $26.67, and the rental value opportunitycost would decline to $228,000 75,000 = $3.04. This would change the overallcost to make to $278.00 + $99.00 + $64.50 + $26.67 + $3.04 = $471.21. At thisvolume level, the advantage is significantly in favor of making.d. Qualitative considerations: Quality control systems in place by potential supplier Reliability of the supplier Risk of future price increases by supplier Lead time to receive orders Number of competing suppliers Labor relations in suppliers plants35. The first step is to compute the contribution margin for each product.Product P Product Q Product R Product SSales price per unit $ 10.00 $ 15.00 $7.00 $ 11.00Variable cost of goods sold2.503.00 6.50 6.00Variable operating expenses1.171.251.001.20Contribution margin per unit $ 6.33 $ 10.75 $ (0.50)$ 3.80Units sold 1,000 1,200 1,800 2,000Total contribution margin $ 6,330 $ 12,900 $(900) $ 7,600a. Dropping Product P would result in a lost contribution margin o" '(,330 witha consequent loss of the same amount of operating income.b. Because Product Rcurrently has negative contribution margin of $900,operating income will increase by $900 if Product R is dropped.c. If dropping Product R results in a loss of sales of 200 units of Product Q, thecompanys operating income will decrease by $1,250:Impact of dropping Product R $900Impact of loss sales of Product Q: 200 $10.75 (2,150)Impact on income $(1,250)d. The companys income will increase by $1,650:Before AfterSelling price $ 7.00 $ 8.00Variable cost per unit7.507.50 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publiclyaccessible ebsite, in hole or in part.#"Chapter 10Contribution margin per unit $(0.50) $ 0.50Units sold 1,800 1,500Total contribution margin $ (900) $750Increase in contribution margin: $1,650 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible ebsite, in hole or in part.Chapter 10 Incremental approach:Increase in contribution margin ($1.00 1,500 units) $1,500Increase by avoiding sales of 300 unitsat negative CM (300 0.50)150Increase in total contribution margin $1,650e. Poole is mistaken. The decision lacks goal congruence. Although the increasein total sales will have a beneficial effect on the commissions of the sales staff,the company as a whole will suffer, as total contribution margin will decreaseby$2,266.Sincethefixedcostswillbeunaffectedintotal, thecompanysoperating income will decline.Product S Product TSelling price per unit $ 11.00 $ 14.00Variable costs per unit7.2011.46Contribution margin per unit $ 3.80 $ 2.54Units sold2,000 2,100Total contribution margin $ 7,600 $ 5,334f. Traditional accounting does not always take into account the relevant costs ofdecisions. Sincefixedcosts areoftenallocated, thetotal will not changeregardless of changes involume. This sometimes gives product lines theappearance of losing money. However, if a product that provides a positivecontributionmarginisdroppedwithnochangeintotal fixedcosts, overallcompany income will decline. Replacing Product S is only wise if thereplacement product provides a higher overall contribution margin than ProductS. (AICPA adapted)36. a.The out-of-pocket costs per unit will increase by $9,600:Manufacture PurchaseDirect material $2,000 $0Direct labor 16,000 0Variable manufacturing overhead($24,000 1/3)8,000 0Component purchase price 30,000Material handling cost (20% of DM)400 6,000Out-of-pocket cost per unit $26,400 $36,000b. Total monthly costs would increase $46,000.Monthly out-of-pocket costs to manufacture: ManufacturePurchase(Requirement a) $26,400 $36,000Number of units 10 10Total monthly out-of-pocket costs $264,000 $360,000Rental income0(50,000)Total $264,000 $310,000Fixed manufacturing cost is irrelevant because it does not change regardless of 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publiclyaccessible ebsite, in hole or in part.$1Chapter 10the decision. (CMA adapted)37. a. Since machine hours are the scarce resource, Callahan should maximize thetotal profits by maximizing production of the product with the highestcontribution margin per machine hour.Contribution margin per unit: Blender Electric MixerSelling price $20 $38Direct material6 11Direct labor4 9Variable overhead*6 12Contribution margin per unit $ 4 $ 6Machine hours per unit 1 2Contribution margin per machine hour $ 4 $ 3* Fixed overhead cost per unit averages $10 per machine hour.Overhead cost per unit $16 $32Fixed overhead $10 1; $10 210 20Variable overhead cost per unit $6 $12Because the blender is the most profitable product per unit of the constrainingfactor, Callahan should maximize production of blenders based on marketdemand.The optimumstrategy wouldbe to produce 20,000blenders and15,000electric mixers andpurchase anyadditional electric mixers fromoutsidesuppliers as needed.Total available machine hours 50,000Annual market demand of blenders 20,000Machine hours per unit 1Total machine hours used by blenders 20,000Machine hours available for electric mixers 30,000Machine hours per unit 2Maximum production of electric mixers 15,000b. If Callahan is able to reduce the direct material cost per unit of the electricmixer to $6, the electric mixer will become the most profitable product perunit of theconstrainingresourceof machine hours. Thecompanyshouldmaximizeproductionofelectricmixers. Sincethemachinehoursavailableexceed the required machine hours to maximize production of electric mixers,thecompanyshouldproduce25,000electricmixersandpurchaseall otherunits as needed from outside suppliers.Blender Electric MixerContribution margin per unit $4 $12Machine hours per unit 1 2 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible ebsite, in hole or in part.Chapter 10 Contribution margin per machine hour $4 $6Total available machine hours 50,000Annual market demand of electric mixers 28,000Machine hours per unit 2Total machine hours required by electric mixers 56,000Machine hours available for electric mixers 50,000Machine hours required per unit 2Annual production of electric mixers 25,000c. During the flu epidemic, the company has a scarce resource of direct labor.While this shortage of direct labor exists, thecompanyshouldmaximizeproduction of the item with the highest contribution margin per direct laborhour. Based on a direct labor rate of $18 per hour, a blender has a contributionmargin per direct labor hour of $18, while a mixer has a contribution marginperdirect laborhourof$12. Thecompanyshouldmaximizeproductionofblenders during the month and purchase all other units as needed from outsidesuppliers.Blender Electric MixerDirect labor cost per hour $ 18 $ 18Direct labor cost per unit $4 $9Units produced per hour 4.52Contribution margin per unit [from (a)]$4 $6Contribution margin per direct labor hour $ 18 $ 12 (CMA adapted)38. a. The minimum acceptable price is $50 per unit. The company has excess capacity.It must cover its incremental costs, which are $20 direct materials + $15 directlabor + $12 variable overhead + $3 shipping and handling.b. The minimum acceptable price is $3 per unit. Because the units are defectiveand cannot be sold through regular channels, all historical costs are irrelevant.The company should consider only the out-of-pocket costs of selling the units,which would be the $3 per unit shipping and handling costs.c. The total contribution margin will be $1,080,000. All variable costs per unitremain the same except for direct materials, which increase by 10 percent. Thechange in fixed costs does not affect the unit contribution margin.Selling price $160Variable costs per unit:Direct material ($20 1.1) $22 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publiclyaccessible ebsite, in hole or in part.$3Chapter 10Direct labor 15Variable overhead 12Shipping and handling 3Contribution margin per unit $108Number of units sold 10,000Total contribution margin $1,080,000d. Given no excess capacity, the price must cover the incremental costs plus theopportunity cost of $100,000 for the displaced contribution margin.Incremental costs:Direct material $20Direct labor15Variable overhead12Shipping and handling3Opportunity cost: $100,000* 1,000100 Minimum price $150*Opportunity cost = Lost CM = $100 1,000 = $100,000 (CMA adapted)39. a. Microsoft likelyrecognizedthefollowingcosts indecidingtoextendthewarrant of its Xbox 360. Costs to handle customer returns Cost to repair defective units Lost customer goodwill because of the defect in the product Lost future sales of Xbox units Lost sales for Xbox software because of lost sales of Xbox units Lost revenues of future generations of video gamesb. Microsofts stock price was virtually unaffected by the announcement. Therearetwoprimaryreasons for this mildeffect. First, the$1billioncost isrelatively small compared to Microsofts total market capitalization. Second,investors recognize that by extending the warranty on the Xbox 360, the costsidentified in (a) are avoided.c. In addition to the Xbox 360 hardware, Microsoft sells software or games forthe Xbox 360. Any factor that affects Xbox 360 sales likely also impacts salesofsoftware. Byconvincingthepublicthat it wouldcoverthecostsinthisparticular defect intheXbox360hardware, Microsoft undoubtedlycausedfuture sales of Xbox 360 software to be higher than they otherwise would be.d. Microsoft likely had an ethical obligation to extend the Xbox 360 warrantywith respect to this specific defect. Because the rate of this defect was muchhigherthaneither Microsoft orthetypical customerexpected, therewasagreater obligation to extend the warranty than with normal failure rates. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible ebsite, in hole or in part.Chapter 10 40. a.Plan 1:New commission on belts = 0.12($40 $25) = $1.80New commission on key fobs = 0.12($10 $6) = $0.48New CM on belts: ($40 $1.80 $25 $4) 95,000 = $874,000New CM on key fobs: ($10 $0.48 $6 $0.50) 115,000 = $347,300Income from belts: ($874,000 $580,000) $294,000Income from key fobs: ($347,300 $180,000) 167,300Total Plan 1 income $461,300Plan 2:New FC for belts: $580,000 + $75,000 = $655,000New sales for belts: 119,000 unitsCM: ($9 119,000) = $1,071,000New sales for key fobs: 91,000 unitsCM: (91,000 $3) = $273,000Income from belts: ($1,071,000 $655,000) $416,000Income from key fobs: ($273,000 $180,000) 93,000Total Plan 2 income $509,000Plan 3New sales for belts: 94,000 unitsCM: ($14 94,000) = $1,316,000New sales for key fobs: 90,000 unitsCM: $6 90,000 = $540,000Income from belts: ($1,316,000 $580,000) $ 736,000Income from key fobs: ($540,000 $180,000)360,000Total Plan 3 income $1,096,000b. Plan 3 should be adopted because it maximizes total income relative to theexisting price and cost structures and Plans 1 and 2.41. a.Maximize the contribution per unit of the scarce resource (direct labor hours): RacingTouring BasicSales per unit $ 3,600 $ 2,720 $ 960VC per unit(3,180) (2,230) (744)CM per unit $420 $490 $ 216Hours per bike503510CM per hour $ 8.40 $14 $21.60Sincebasicbicyclesyieldthegreatest contributionmarginperdirect laborhour, the company should devote all of its capacity to their production in theabsence of market or other restrictions. Profit can be determined as follows: 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publiclyaccessible ebsite, in hole or in part.$$Chapter 10Production of basic bicycles = 34,000 10 = 3,400Contribution margin 3,400 $216 $ 734,400Fixed costs (500,000)Pre-tax income $ 234,400b. In (a), it was determined that basic bicycles are the most profitable product,so the company will devote 50 percent of its time to that product. Racing bikesyield the lowest contribution margin per hour, so 20 percent of the time shouldbe devoted to them. This would leave 30 percent of the time to manufacturetouring bikes.Production levels:Basic (34,000 0.50) 10 1,700Touring (34,000 0.30) 35 291 (rounded)Racing (34,000 0.20) 50 136Contribution margin:Basic (1,700 $216) $ 367,200Touring (291 $490)142,590Racing (136 $420)57,120Total $ 566,910Less: Fixed costs (500,000)Pre-tax income $ 66,910c. Yes. The demand in this market is likely fragmented, with particularconsumers preferring a bicycle suited for a particular purpose. However, thereislikelyenoughdemandforthebasicbiketoabsorbtheentireproductioncapacity of the company.d. The companys tax rate is irrelevant because it does not change across thechoices under consideration in this decision.42. a. The manufacturing overhead rate is $18 per standard direct labor hour and thestandardproduct cost includes $9of manufacturingoverheadper pressurevalve. Accordingly, thestandarddirect laborhourperfinishedvalveis0.5hour($9$18). Therefore, 30,000unitspermonthwouldrequire15,000direct labor hours.b. Per Unit 120,000 UnitsIncremental revenue $19.00 $2,280,000Incremental costs:Variable costs:Direct material$5.00 $ 600,000Direct labor 6.00720,000Variable overhead 3.00360,000 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible ebsite, in hole or in part.Chapter 10 Freight expense 1.00120,000Total variable costs $15.00 $1,800,000Fixed overhead:Supervisory and clerical costs(4 months $12,000)48,000Total incremental costs $1,848,000Incremental profit before tax $ 432,000Sales commission and fixed factory overhead (direct and allocated) areirrelevant to the incremental analysis.c. The minimum unit price that Layton Valves could accept without reducingnet income must cover variable costs plus the additional fixed costs.Variable unit cost $14.00Additional fixed cost ($48,000 120,000) 0.40Minimum unit price $14.40d. LaytonValvesshouldconsiderthefollowingfactorsbeforeacceptingthePrince Industries order. The effect of the special order on Layton Valves sales at regular prices. Thepossibilityof futuresales toPrinceIndustries andtheeffects ofparticipating in the international market. The companys relevant range of activity and whether or not the specialorder will cause volume to exceed this range. The impact on local, state, and federal taxes. The effect of scheduled maintenance of equipment. (CMA adapted)43. a. Ice CreamSteaks TotalSales $ 4,000,000$2,000,000 $ 6,000,000Variable costsMerchandise sold(2,600,000) (1,500,000)(4,100,000)Commissions (200,000)(150,000) (350,000)Delivery costs (600,000)(105,000) (705,000)CM $600,000$ 245,000 $845,000Avoidable fixed costsAllocated corporate 0(30,000) (30,000)Managers salary (80,000)(75,000) (155,000)Segment margin $520,000 $ 140,000 $660,000Unavoidable direct fixed costsDelivery costs0(15,000) (15,000)Depreciation (200,000) (100,000) (300,000)Product line results $320,000$25,000 $345,000Common costs (100,000)(70,000) (170,000)Net income (loss) $220,000 $ (45,000) $175,000b. Based on segment margin, the Steaks division generates $140,000 of income 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publiclyaccessible ebsite, in hole or in part.$Chapter 10above its avoidable expenses. Additional computations are necessary todetermine whether the steaks product line should be kept:Steaks segment margin $140,000Opportunity cost, rent(8,500)Net advantage to keeping steaks line $131,500c. Totheextent thetwoproduct linescross-fertilizeeachotherssales, thecompany should be concerned. Some customers who prefer to purchase bothice cream and steaks from the same vendor may seek another vendor that has abroader product offering.d. Layoffs couldadverselyaffect moraleandtrust betweenemployees andmanagers. If cordial relations existed between managers and workers prior tothe layoffs, that culture could be destroyed by the layoffs. The consequencemight be a loss of key employees, a drop in profits, and a decline in customerservice.44. a. Idaho factory expansion:Sales $8,400,000Fixed costs:Factory $1,344,000Administration 484,000 $1,828,000Variable costs $2,688,000Alloc. home office costs700,000 3,388,000 (5,216,000)Est. net profit from operations $3,184,000Montana factoryestimated:Net profit from operations2,160,000Home office expense allocated to Dako to Dakota factory (400,000)Estimated net profit from operations $4,944,000Estimated net profit from operations: Montana factory $2,160,000Idaho factory 1,640,000Estimated royalties to be received (30,000 $16) 480,000$4,280,000Less home office expense allocated toDakota factory (400,000)Estimated profit from operations $3,880,000Estimated net profit from operations:Montana factory $2,160,000Idaho factory 1,640,000$3,800,000 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible ebsite, in hole or in part.Chapter 10 Less home office expense allocated toDakota factory (400,000)Estimated profit from operations $3,400,000(AICPA adapted)45. a. Sales $1,100,000Variable costs(825,000)Contribution margin $ 275,000Units sold: ($1,100,000 $10) 100 = 11,000,000 unitsContribution margin per unit: $275,000 11,000,000 = $0.025Required unit sales: ($350,000 + $50,000) $0.025 = 16,000,000 unitsb. Plan A (000s Omitted)Kentucky Pennsylvania TotalSales $1,700 $2,000 $3,700Variable costs:Direct material $ 425 $ 500 $ 925Direct labor510500 1,010Factory overhead340350690Total $1,275 $1,350 $2,625Contribution margin $ 425 $ 650 $1,075Direct fixed costs:Overhead $ 350 $ 450 $ 800Promotion costs17050220Total $ 520 $ 500 $1,020Segment margin $ (95) $ 150 $ 55Allocated fixed costs 7184155Operating income (loss) $ (166) $ 66 $(100)Plan BSales $ 3,100,000Variable costs:Direct material $775,000Direct labor 775,000Variable overhead 542,500 (2,092,500)Contribution margin$ 1,007,500Fixed costs:Factory overhead $475,000Promotion costs 100,000Allocated costs 155,000(730,000)Operating income $277,500Plan CSales $ 2,000,000Royalties137,500Variable costs: 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publiclyaccessible ebsite, in hole or in part.$"Chapter 10Direct material $500,000Direct labor 500,000Variable overhead 350,000 (1,350,000)Contribution margin $787,500Fixed costs:Factory overhead $475,000Promotion costs 100,000Allocated costs 155,000(730,000)Operating income $57,500(AICPA adapted)46. a.ForMay, it appearsthat Store2ismoreprofitable. AlthoughStore2hadlower sales than Store 1, it is clear that Store 1 incurred more expense. Forexample, Store 1 spent two-thirds of the entire district advertising budget; thiswas 10 times more than Store 2 spent. Store 1 also incurred more expense forrent andwouldhavebeenallocatedmoredistrict level costsbecauseofitshigher sales.b. Store1isgeneratingthemost revenue. Thisisgiveninthefirst bulletedstatement.c. TheincentiveforStore1istogenerateasmuchrevenueaspossible. Thebonus scheme for that store does not take into account any expenses.Consequently, the manager of the store canbenefit fromthe advertisingwithout bearing any advertising costs.d. Store 1 would have more incentive. Since Store 2 is evaluated on net income,any expenditure for maintenance will reduce the net income that mightotherwisehavebeenrecorded. Store1wouldwant tospendanadequateamount for maintenance so that no machine malfunction or downtime occursthat might interfere with sales.e. Both bonus schemes have some problems. The bonus scheme based on salesvolume is not likely to increase profits in the short- or the long-term becausenoincentiveisgiventothemanagertobeconsciousofthecoststhat areincurred to generate revenues.The bonus based on net income is morepromising. The only detrimental aspect of this performance measure is that it isshort-term oriented. It encourages managers to take actions that may generateshort-term profits at the expense of long-term profits. For example, a managermay forgo maintenance activities to reduce costs in the short term. However, thelong-term implications of this act may be higher costs resulting from brokenmachinery. (CMA adapted)47.a. Clean-N-Briteshouldpricetheregular compoundat $22per caseandtheheavy-duty compound at $30 per case. The contribution margin is the highestat these prices as shown below. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible ebsite, in hole or in part.Chapter 10 Regular CompoundSelling price per case $18 $20 $21 $22 $23Variable cost per case 16 16 16 16 16Contribution margin/case $2 $4 $5 $6 $7Volume in cases(000s omitted) 120 100 90 80 50Total contribution margin(000s omitted) $240 $400 $450 $480 $350Heavy-Duty CompoundSelling price per case $25 $27 $30 $32 $35Variable cost per case 21 21 21 21 21Contribution margin/case $4 $6 $9 $11 $14Volume in cases(000s omitted) 175 140 100 55 35Total contribution margin(000s omitted) $700 $840 $900 $605 $490b. (1)Clean-N-Briteshouldcontinuetooperateduringthefinal sixmonthsof2014becauseanyshutdownwouldbetemporary. Thecompanyclearlyintends to remain in the business and expects a profitable operation in 2014.This is a short-run decision analysis problem. Therefore, the fixed costs areirrelevant to the decision because they cannot be avoided in the short run.The products do have a positive variable contribution margin so operationsshould continue. 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publiclyaccessible ebsite, in hole or in part.61Chapter 10HouseSafe CompoundsCincinnati PlantPro Forma Contribution StatementFor the Six-Month Period Ending December 31, 2014($000s omitted)Heavy-Regular DutyTotalSales $1,150 $1,225 $2,375Variable costsSelling & admin. $ 200 $ 245 $ 445Manufacturing600490 1,090Total variable costs $ 800 $ 735 $1,535Contribution margin $ 350 $ 490 $ 840(2) Clean-N-Brite should consider the following qualitative factors when makingthe decision to keep the Cincinnati plant open or to close it: The effect on employee morale The effect on market share The disruption of production and sales due to shut-down The effect on the local community(CMA adapted) 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible ebsite, in hole or in part.