CHAPTER 11 DECISION MAKING AND RELEVANT INFORMATION 11-16 (20 min.) Disposal of assets 1.

This is an unfortunate situation, yet the $75,000 costs are irrelevant regarding the decision to remachine or scrap. The only relevant factors are the future revenues and future costs. y ignoring the accumulated costs and deciding on the !asis of e"pected future costs, operating income #ill !e ma"imi$ed (or losses minimi$ed). The difference in favor of remachining is $2,000% !a" !#" Re$a%&i'e S%(ap &uture revenues (educt future costs *perating income (ifference in favor of remachining $'0,000 25,000 $ 5,000 $2,000 $',000 ) $',000

2. This, too, is an unfortunate situation. ut the $100,000 original cost is irrelevant to this decision. The difference in relevant costs in favor of re!uilding is $5,000 as follo#s% !a" Repla%e +e# truc, (educt current disposal price of e"isting truc, -e!uild e"isting truc, $105,000 15,000 ) $ /0,000 $5,000 !#" Re#)il* ) ) $.5,000 $.5,000

(ifference in favor of re!uilding

+ote, here, that the current disposal price of $15,000 is relevant, !ut the original cost (or !oo, value, if the truc, #ere not !rand ne#) is irrelevant.

1101

11-1+ (20 min.) Rele,a't a'* i((ele,a't %osts. 1. Ma-e -elevant costs 1aria!le costs 2voida!le fi"ed costs 3urchase price 5nit relevant cost $1.0 20 4444 $200 .)/

$210 $210

(alton 6omputers should re7ect 3each8s offer. The $'0 of fi"ed costs are irrelevant !ecause they #ill !e incurred regardless of this decision. 9hen comparing relevant costs !et#een the choices, 3each8s offer price is higher than the cost to continue to produce. 2. 6ash operating costs (: years) 6urrent disposal value of old machine 6ost of ne# machine Total relevant costs Keep $.0,000 444444 $.0,000 Repla%e $:.,000 (2,500) .,000 $5',500 Diffe(e'%e $'2,000 2,500 (.,000) $2;,500

23 <anufacturing should replace the old machine. The cost savings are far greater than the cost to purchase the ne# machine. 11-10 (15 min.) M)ltiple %&oi%e 1. (!) =pecial order price per unit 1aria!le manufacturing cost per unit 6ontri!ution margin per unit >ffect on operating income ? $1.50 20,000 units ? $'0,000 increase $1,200,000 $:. / $57 1,1:0,000 ;0,000 25,000 $ .5,000 $;.00 :.50 $1.50

2. (!) 6osts of purchases, 20,000 units $;0 Total relevant costs of ma,ing% 1aria!le manufacturing costs, $;: ) $1; &i"ed costs eliminated 6osts saved !y not ma,ing <ultiply !y 20,000 units, so total costs saved are $57 20,000 >"tra costs of purchasing outside <inimum overall savings for -eno +ecessary relevant costs that #ould have to !e saved in manufacturing 3art +o. 575

1102

11-11

('0 min.) Spe%ial o(*e(2 a%ti,it/-#ase* %osti'3

1. 2#ard 3lus8 operating income under the alternatives of accepting@re7ecting the special order are% 4it&o)t O'e4it& O'eTi$e O'l/ Ti$e O'l/ Spe%ial O(*e( Spe%ial O(*e( +2566 7'its 162666 7'its -evenues 1aria!le costs% (irect materials (irect manufacturing la!or atch manufacturing costs &i"ed costs% &i"ed manufacturing costs &i"ed mar,eting costs Total costs *perating income
1

Diffe(e'%e 82566 7'its $250,000 .7,500 100,000 12,500 )) )) 200,000 $ 50,000

$1,125,000 2;2,500 '00,000 75,000 275,000 175,000 1,0.7,500 $ '7,500

2

$1,'75,000 '50,0001 :00,0002 .7,500' 275,000 175,000 1,2.7,500 $ .7,500

'

$2;2,500 10,000 7,500

$'00,000 10,000 7,500

$75,000 A (25 $500)

2lternatively, #e could calculate the incremental revenue and the incremental costs of the additional 2,500 units as follo#s% Bncremental revenue $100 2,500 Bncremental direct manufacturing costs Bncremental direct manufacturing costs Bncremental !atch manufacturing costs Total incremental costs Total incremental operating income from accepting the special order
$2;2,500 2,500 7,500

$250,000 .7,500 100,000 12,500 200,000 $ 50,000 $'00,000 2,500 7,500 $500 25

2#ard 3lus should accept the one0time0only special order if it has no long0term implications !ecause accepting the order increases 2#ard 3lus8 operating income !y $50,000. Bf, ho#ever, accepting the special order #ould cause the regular customers to !e dissatisfied or to demand lo#er prices, then 2#ard 3lus #ill have to trade off the $50,000 gain from accepting the special order against the operating income it might lose from regular customers.

110'

2. 2#ard 3lus has a capacity of /,000 medals. Therefore, if it accepts the special one0time order of 2,500 medals, it can sell only ;,500 medals instead of the 7,500 medals that it currently sells to e"isting customers. That is, !y accepting the special order, 2#ard 3lus must forgo sales of 1,000 medals to its regular customers. 2lternatively, 2#ard 3lus can re7ect the special order and continue to sell 7,500 medals to its regular customers. 2#ard 3lus8 operating income from selling ;,500 medals to regular customers and 2,500 medals under one0time special order follo#% -evenues (;,500 $150) A (2,500 $100) (irect materials (;,500 $'51) A (2,500 $'51) (irect manufacturing la!or (;,500 $:02) A(2,500 $:02) atch manufacturing costs (1'0' $500) A (25 $500) &i"ed manufacturing costs &i"ed mar,eting costs Total costs *perating income
1

$1,225,000 '15,000 ';0,000 77,500 275,000 175,000 1,202,500 $ 22,500

$'5 ?

'

7,500 2#ard 3lus ma,es regular medals in !atch si$es of 50. To produce ;,500 medals reCuires 1'0 (;,500 D 50) !atches.

$2;2,500 7,500

$:0 ?

$'00,000

2ccepting the special order #ill result in a decrease in operating income of $15,000 ($'7,500 ) $22,500). The special order should, therefore, !e re7ected. 2 more direct approach #ould !e to focus on the incremental effects))the !enefits of accepting the special order of 2,500 units versus the costs of selling 1,000 fe#er units to regular customers. Bncrease in operating income from the 2,5000unit special order eCuals $50,000 (reCuirement 1). The loss in operating income from selling 1,000 fe#er units to regular customers eCuals% Eost revenue, $150 1,000 =avings in direct materials costs, $'5 1,000 =avings in direct manufacturing la!or costs, $:0 1,000 =avings in !atch manufacturing costs, $500 20 *perating income lost $(150,000) '5,000 :0,000 10,000 $ (;5,000)

2ccepting the special order #ill result in a decrease in operating income of $15,000 ($50,000 ) $;5,000). The special order should, therefore, !e re7ected. '. 2#ard 3lus should not accept the special order. Bncrease in operating income !y selling 2,500 units under the special order (reCuirement 1) *perating income lost from e"isting customers ($10 7,500) +et effect on operating income of accepting special order The special order should, therefore, !e re7ected. $ 50,000 (75,000) $(25,000)

110:

11-86 ('0 min.) Ma-e ,e(s)s #)/2 a%ti,it/-#ase* %osti'3 1. The e"pected manufacturing cost per unit of 6<6 s in 200/ is as follo#s% Total Ma')fa%t)(i'3 Costs of CMC. !1" $1,700,000 :50,000 120,000 '20,000 .00,000 $','/0,000 Ma')fa%t)(i'3 Cost pe( 7'it !8" 9 !1" : 162666 $170 :5 12 '2 .0 $''/

(irect materials, $170 10,000 (irect manufacturing la!or, $:5 10,000 1aria!le !atch manufacturing costs, $1,500 .0 &i"ed manufacturing costs 2voida!le fi"ed manufacturing costs 5navoida!le fi"ed manufacturing costs Total manufacturing costs

2. The follo#ing ta!le identifies the incremental costs in 200/ if =venson (a) made 6<6 s and (!) purchased 6<6 s from <inton. Total I'%(e$e'tal Costs Ma-e .)/ $',000,000 $1,700,000 :50,000 120,000 '20,000 $2,5/0,000 $',000,000 ;:10,000 Pe(-7'it I'%(e$e'tal Costs Ma-e .)/ $'00 $170 :5 12 '2 $25/ $'00 $:1

I'%(e$e'tal Ite$s 6ost of purchasing 6<6 s from <inton (irect materials (irect manufacturing la!or 1aria!le !atch manufacturing costs 2voida!le fi"ed manufacturing costs Total incremental costs (ifference in favor of ma,ing

+ote that the opportunity cost of using capacity to ma,e 6<6 s is $ero since =venson #ould ,eep this capacity idle if it purchases 6<6 s from <inton. =venson should continue to manufacture the 6<6 s internally since the incremental costs to manufacture are $25/ per unit compared to the $'00 per unit that <inton has Cuoted. +ote that the unavoida!le fi"ed manufacturing costs of $.00,000 ($.0 per unit) #ill continue to !e incurred #hether =venson ma,es or !uys 6<6 s. These are not incremental costs under either the ma,e or the !uy alternative and hence, are irrelevant.

1105

'. =venson should continue to ma,e 6<6 s. The simplest #ay to analy$e this pro!lem is to recogni$e that =venson #ould prefer to ,eep any e"cess capacity idle rather than use it to ma,e 6 's. 9hyF ecause e"pected incremental future revenues from 6 's, $2,000,000, are less than e"pected incremental future costs, $2,150,000. Bf =venson ,eeps its capacity idle, #e ,no# from reCuirement 2 that it should ma,e 6<6 s rather than !uy them. 2n important point to note is that, !ecause =venson forgoes no contri!ution !y not !eing a!le to ma,e and sell 6 's, the opportunity cost of using its facilities to ma,e 6<6 s is $ero. Bt is, therefore, not forgoing any profits !y using the capacity to manufacture 6<6 s. Bf it does not manufacture 6<6 s, rather than lose money on 6 's, =venson #ill ,eep capacity idle. 2 longer and more detailed approach is to use the total alternatives or opportunity cost analyses sho#n in >"hi!it 1107 of the chapter. C&oi%es fo( S,e'so' Ma-e CMC.s .)/ CMC.s .)/ CMC.s a'* Do Not a'* Do Not a'* Ma-e Rele,a't Ite$s Ma-e C.<s Ma-e C.<s C.<s T*T2E02ET>-+2TB1>= 233-*26G T* <2H>0*-0 5I (>6B=B*+= Total incremental costs of ma,ing@!uying 6<6 s (from reCuirement 2) >"cess of future costs over future revenues from 6 's Total relevant costs

$2,5/0,000 0 $2,5/0,000

$',000,000 0 $',000,000

$',000,000 150,000 $',150,000

=venson #ill minimi$e manufacturing costs !y ma,ing 6<6 s. *33*-T5+BTI06*=T 233-*26G T* <2H>0*-0 5I (>6B=B*+= Total incremental costs of ma,ing@!uying 6<6 s (from reCuirement 2) $2,5/0,000 $',000,000 *pportunity cost% profit contri!ution forgone !ecause capacity #ill not !e used to ma,e 6 's 0J 0J Total relevant costs $2,5/0,000 $',000,000
J

$',000,000 0 $',000,000

*pportunity cost is 0 !ecause =venson does not give up anything !y not ma,ing 6 's. =venson is !est off leaving the capacity idle (rather than manufacturing and selling 6 's).

110;

11-81 (10 min.) I',e'to(/ *e%isio'2 oppo(t)'it/ %osts 1. 5nit cost, orders of 20,000 5nit cost, order of 2:0,000 (0./; $/.00) Alternatives under consideration% (a) uy 2:0,000 units at start of year. (!) uy 20,000 units at start of each month. Average investment in inventory: (a) (2:0,000 $..;:) D 2 (!) ( 20,000 $/.00) D 2 (ifference in average investment $1, 0';,.00 /0,000 $ /:;,.00 $/.00 $..;:

*pportunity cost of interest forgone from 2:0,0000unit purchase at start of year ? $/:;,.00 0.10 ? $/:,;.0 2. +o. The $/:,;.0 is an opportunity cost rather than an incremental or outlay cost. +o actual transaction records the $/:,;.0 as an entry in the accounting system. '. The follo#ing ta!le presents the t#o alternatives% Alte('ati,e A= Alte('ati,e .= P)(%&ase P)(%&ase 8>62666 862666 spa(- pl)3s at spa(- pl)3s #e3i''i'3 of at #e3i''i'3 /ea( of ea%& $o't& Diffe(e'%e !1" !8" !<" 9 !1" ? !8" 2nnual purchase0order costs (1 $200K 12 $200) 2nnual purchase (incremental) costs (2:0,000 $..;:K 2:0,000 $/) 2nnual interest income that could !e earned if investment in inventory #ere invested (opportunity cost) (10L $1,0';,.00K 10L $/0,000) -elevant costs $ 200 2,07',;00 $ 2,:00 2,1;0,000 $ (2,200) (.;,:00)

10',;.0 $2,177,:.0

/,000 $2,171,:00

/:,;.0 $ ;,0.0

6olumn (') indicates that purchasing 20,000 spar, plugs at the !eginning of each month is preferred relative to purchasing 2:0,000 spar, plugs at the !eginning of the year !ecause the opportunity cost of holding larger inventory e"ceeds the lo#er purchasing and ordering costs. Bf other incremental !enefits of holding lo#er inventory such as lo#er insurance, materials handling, storage, o!solescence, and !rea,age costs #ere considered, the costs under 2lternative 2 #ould have !een higher, and 2lternative #ould !e preferred even more.

1107

11-88 (20)25 min.) 1.

Rele,a't %osts2 %o't(i#)tio' $a(3i'2 p(o*)%t e$p&asis Nat)(al O(a'3e @)i%e $'/.20 '0.20 $ /.00

=elling price (educt varia!le cost per case 6ontri!ution margin per case

Cola $1...0 1:.20 $ :.;0

Le$o'a*e $20.00 1;.10 $ './0

P)'%& $27.10 20.70 $ ;.:0

2. The argument fails to recogni$e that shelf space is the constraining factor. There are only 12 feet of front shelf space to !e devoted to drin,s. =e"ton should aim to get the highest daily contri!ution margin per foot of front shelf space% Nat)(al O(a'3e @)i%e $ /.00 5

6ontri!ution margin per case =ales (num!er of cases) per foot of shelf space per day (aily contri!ution per foot of front shelf space '.

Cola $ :.;0 25

Le$o'a*e $ './0 2:

P)'%& $ ;.:0 :

$115.00

$/'.;0

$25.;0

$:5.00

The allocation that ma"imi$es the daily contri!ution from soft drin, sales is% Feet of S&elf Spa%e ; : 1 1 Dail/ Co't(i#)tio' pe( Foot of F(o't S&elf Spa%e $115.00 /'.;0 :5.00 25.;0 Total Co't(i#)tio' Ma(3i' pe( Da/ $ ;/0.00 '7:.:0 :5.00 25.;0 $1,1'5.00

6ola Eemonade +atural *range Muice 3unch

The ma"imum of si" feet of front shelf space #ill !e devoted to 6ola !ecause it has the highest contri!ution margin per unit of the constraining factor. &our feet of front shelf space #ill !e devoted to Eemonade, #hich has the second highest contri!ution margin per unit of the constraining factor. +o more shelf space can !e devoted to Eemonade since each of the remaining t#o products, +atural *range Muice and 3unch (that have the second lo#est and lo#est contri!ution margins per unit of the constraining factor) must each !e given at least one foot of front shelf space.

110.

11-8< (10 min.) Sele%tio' of $ost p(ofita#le p(o*)%t *nly <odel 1: should !e produced. The ,ey to this pro!lem is the relationship of manufacturing overhead to each product. +ote that it ta,es t#ice as long to produce <odel /K machine0hours for <odel / are t#ice that for <odel 1:. <anagement should choose the product mi" that ma"imi$es operating income for a given production capacity (the scarce resource in this situation). Bn this case, <odel 1: #ill yield a $/.50 contri!ution to fi"ed costs per machine hour, and <odel / #ill yield $/.00% Mo*el 1 =elling price 1aria!le costs per unit (total cost ) &<*G) 6ontri!ution margin per unit -elative use of machine0hours per unit of product 6ontri!ution margin per machine hour $100.00 .2.00 $ 1..00 D 2 $ /.00 Mo*el 1> $70.00 ;0.50 $ /.50 D 1 $ /.50

11-8> (20 min.) 4&i%& #ase to %lose2 (ele,a't-%ost a'al/sis2 oppo(t)'it/ %osts The future outlay operating costs #ill !e $:00 million regardless of #hich !ase is closed, given the additional $100 million in costs at >verett if 2lameda is closed. &urther, one of the !ases #ill permanently remain open #hile the other #ill !e shut do#n. The only relevant revenue and cost comparisons are a. $500 million from sale of the 2lameda !ase. +ote that the historical cost of !uilding the 2lameda !ase ($100 million) is irrelevant. +ote also that future increases in the value of the land at the 2lameda !ase is also irrelevant. *ne of the !ases must !e ,ept open, so if it is decided to ,eep the 2lameda !ase open, the (efense (epartment #ill not !e a!le to sell this land at a future date. !. $;0 million in savings in fi"ed income note if the >verett !ase is closed. 2gain, the historical cost of !uilding the >verett !ase ($150 million) is irrelevant. The relevant costs and !enefits analysis favors closing the 2lameda !ase despite the o!7ections raised !y the 6alifornia delegation in 6ongress. The net !enefit eCuals $::0 ($500 ) $;0) million.

110/

11-85 (25'0 min.) Closi'3 a'* ope'i'3 sto(es 1. =olution >"hi!it 11025, 6olumn 1, presents the relevant loss in revenues and the relevant savings in costs from closing the -hode Bsland store. Eope$ is correct that =anche$ 6orporation8s operating income #ould increase !y $7,000 if it closes do#n the -hode Bsland store. 6losing do#n the -hode Bsland store results in a loss of revenues of $.;0,000 !ut cost savings of $.;7,000 (from cost of goods sold, rent, la!or, utilities, and corporate costs). +ote that !y closing do#n the -hode Bsland store, =anche$ 6orporation #ill save none of the eCuipment0 related costs !ecause this is a past cost. 2lso note that the relevant corporate overhead costs are the actual corporate overhead costs $::,000 that =anche$ e"pects to save !y closing the -hode Bsland store. The corporate overhead of $:0,000 allocated to the -hode Bsland store is irrelevant to the analysis. 2. =olution >"hi!it 11025, 6olumn 2, presents the relevant revenues and relevant costs of opening another store li,e the -hode Bsland store. Eope$ is correct that opening such a store #ould increase =anche$ 6orporation8s operating income !y $11,000. Bncremental revenues of $.;0,000 e"ceed the incremental costs of $.:/,000 (from higher cost of goods sold, rent, la!or, utilities, and some additional corporate costs). +ote that the cost of eCuipment #ritten off as depreciation is relevant !ecause it is an e"pected future cost that =anche$ #ill incur only if it opens the ne# store. 2lso note that the relevant corporate overhead costs are the $:,000 of actual corporate overhead costs that =anche$ e"pects to incur as a result of opening the ne# store. =anche$ may, in fact, allocate more than $:,000 of corporate overhead to the ne# store !ut this allocation is irrelevant to the analysis. The ,ey reason that =anche$8s operating income increases either if it closes do#n the -hode Bsland store or if it opens another store li,e it is the !ehavior of corporate overhead costs. y closing do#n the -hode Bsland store, =anche$ can significantly reduce corporate overhead costs presuma!ly !y reducing the corporate staff that oversees the -hode Bsland operation. *n the other hand, adding another store li,e -hode Bsland does not increase actual corporate costs !y much, presuma!ly !ecause the e"isting corporate staff #ill !e a!le to oversee the ne# store as #ell. SOL7TION EAHI.IT 11-85 -elevant0-evenue and -elevant06ost 2nalysis of 6losing -hode Bsland =tore and *pening 2nother =tore Ei,e Bt.
(Loss i' Re,e')es" a'* Sa,i'3s i' Costs f(o$ Closi'3 R&o*e Isla'* Sto(e !1" -evenues 6ost of goods sold Eease rent Ea!or costs (epreciation of eCuipment 5tilities (electricity, heating) 6orporate overhead costs Total costs >ffect on operating income (loss) $(.;0,000) ;;0,000 75,000 :2,000 0 :;,000 ::,000 .;7,000 $ 7,000 I'%(e$e'tal Re,e')es a'* !I'%(e$e'tal Costs" of Ope'i'3 NeB Sto(e Li-e R&o*e Isla'* Sto(e !8" $ .;0,000 (;;0,000) (75,000) (:2,000) (22,000) (:;,000) (:,000) (.:/,000) $ 11,000

11010

11-86 (20 min.) C&oosi'3 %)sto$e(s Bf road#ay accepts the additional !usiness from Helly, it #ould ta,e an additional 500 machine0hours. Bf road#ay accepts all of Helly8s and Taylor8s !usiness for &e!ruary, it #ould reCuire 2,500 machine0hours (1,500 hours for Taylor and 1,000 hours for Helly). road#ay has only 2,000 hours of machine capacity. Bt must, therefore, choose ho# much of the Taylor or Helly !usiness to accept. To ma"imi$e operating income, road#ay should ma"imi$e contri!ution margin per unit of the constrained resource. (&i"ed costs #ill remain unchanged at $100,000 regardless of the !usiness road#ay chooses to accept in &e!ruary, and is, therefore, irrelevant.) The contri!ution margin per unit of the constrained resource for each customer in Manuary is% Ta/lo( Co(po(atio' 6ontri!ution margin per machine0hour
$7.,000 ? $52 1,500

Kell/ Co(po(atio'
$'2,000 ? $;: 500

=ince the $.0,000 of additional Helly !usiness in &e!ruary is identical to 7o!s done in Manuary, it #ill also have a contri!ution margin of $;: per machine0hour, #hich is greater than the contri!ution margin of $52 per machine0hour from Taylor. To ma"imi$e operating income, road#ay should first allocate all the capacity needed to ta,e the Helly 6orporation !usiness (1,000 machine0hours) and then allocate the remaining 1,000 (2,000 ) 1,000) machine0hours to Taylor. Co(po(atio' 6ontri!ution margin per machine0hour <achine0hours to !e #or,ed 6ontri!ution margin &i"ed costs *perating income Ta/lo( Co(po(atio' $52 1,000 $52,000 Kell/ Total $;: 1,000 $;:,000

$11;,000 100,000 $ 1;,000

11011

11-8+ ('0):0 min.) Rele,a'%e of eC)ip$e't %osts 1a. State$e'ts of Cas& Re%eipts a'* Dis#)(se$e'ts Keep Ea%& Dea( 82 <2 >
$150,000 (110,000) (15,000)

Dea( 1
-eceipts from operations% -evenues (educt dis!ursements% *ther operating costs *peration of machine 3urchase of NoldO machine 3urchase of Nne#O eCuipment 6ash inflo# from sale of old eCuipment +et cash inflo# $150,000 (110,000) (15,000) (20,000)J

Fo)( Dea(s To3et&e(

$;00,000 (::0,000) (;0,000) (20,000)

.)/ NeB Ma%&i'e Ea%& Fo)( Dea( Dea(s Dea( 1 82 <2 > To3et&e(
$150,000 (110,000) (/,000) (20,000) (2:,000) .,000 $ (5,000) $150,000 (110,000) (/,000) $;00,000 (::0,000) (';,000) (20,000) (2:,000) .,000 $ ..,000

$ 5,000

$ 25,000

$ .0,000

$ '1,000

J=ome students ignore this item !ecause it is the same for each alternative. Go#ever, note that a statement for the entire year has !een reCuested. *!viously, the $20,000 #ould affect Iear 1 only under !oth the N,eepO and N!uyO alternatives.

The difference is $.,000 for four years ta,en together. Bn particular, note that the $20,000 !oo, value can !e omitted from the comparison. <erely cross out the entire lineK although the column totals are affected, the net difference is still $.,000. 1!. 2gain, the difference is $.,000% I'%o$e State$e'ts .)/ NeB Ma%&i'e Ea%& Fo)( Ea%& Fo)( Dea(s Dea( Dea(s Dea( To3et&e( 12 82 <2 > To3et&e( Dea( 1 82 <2 > $150,000 $;00,000 $150,000 $150,000 $;00,000 110,000 5,000 15,000 1'0,000 ::0,000 20,000 ;0,000 520,000 110,000 ;,000 /,000 125,000 110,000 ;,000 /,000 125,000 ::0,000 2:,000 ';,000 500,000 20,000J (.,000) 12,000 512,000 $ ..,000 Keep

-evenues 6osts (e"cluding disposal)% *ther operating costs (epreciation *perating costs of machine Total costs (e"cluding disposal) Eoss on disposal% oo, value (NcostO) 3roceeds (NrevenueO) Eoss on disposal Total costs *perating income
J

1'0,000 520,000 $ 20,000 $ .0,000

20,000 (.,000) 12,000 1'7,000 125,000 $ 1',000 $ 25,000

2s in part (1), the $20,000 !oo, value may !e omitted from the comparison #ithout changing the $.,000 difference. This ad7ustment #ould mean e"cluding the depreciation item of $5,000 per year (a cumulative effect of $20,000) under the N,eepO alternative and e"cluding the !oo, value item of $20,000 in the loss on disposal computation under the N!uyO alternative.

11012

1c. The $20,000 purchase cost of the old eCuipment, the revenues, and the other operating costs are irrelevant !ecause their amounts are common to !oth alternatives. 2. The net difference #ould !e unaffected. 2ny num!er may !e su!stituted for the original $20,000 figure #ithout changing the final ans#er. *f course, the net cash outflo#s under !oth alternatives #ould !e high. The 2uto 9ash manager really !lundered. Go#ever, ,eeping the old eCuipment #ill increase the cost of the !lunder to the cumulative tune of $.,000 over the ne"t four years. '. oo, value is irrelevant in decisions a!out the replacement of eCuipment, !ecause it is a past (historical) cost. 2ll past costs are do#n the drain. +othing can change #hat has already !een spent or #hat has already happened. The $20,000 has !een spent. Go# it is su!seCuently accounted for is irrelevant. The analysis in reCuirement (1) clearly sho#s that #e may completely ignore the $20,000 and still have a correct analysis. The only relevant items are those e"pected future items that #ill differ among alternatives. (espite the economic analysis sho#n here, many managers #ould ,eep the old machine rather than replace it. 9hyF ecause, in many organi$ations, the income statements of part (2) #ould !e a principal means of evaluating performance. +ote that the first0year operating income #ould !e higher under the N,eepO alternative. The conventional accrual accounting model might motivate managers to#ard ma"imi$ing their first0year reported operating income at the e"pense of long0run cumulative !etterment for the organi$ation as a #hole. This criticism is often made of the accrual accounting model. That is, the action favored !y the NcorrectO or N!estO economic decision model may not !e ta,en !ecause the performance0evaluation model is either inconsistent #ith the decision model or !ecause the focus is on only the short0run part of the performance0evaluation model. There is yet another potential conflict !et#een the decision model and the performance evaluation model. -eplacing the machine so soon after it is purchased may reflect !adly on the manager8s capa!ilities and performance. 9hy didn8t the manager search and find the ne# machine !efore !uying the old machineF -eplacing the old machine one day later at a loss may ma,e the manager appear incompetent to his or her superiors. Bf the manager8s !osses have no ,no#ledge of the !etter machine, the manager may prefer to ,eep the e"isting machine rather than alert his or her !osses a!out the !etter machine.

1101'

11-80 ('0 min.)

EC)ip$e't )p3(a*e ,e(s)s (epla%e$e't.

1. ased on the analysis in the ta!le !elo#, Tech<ech #ill !e !etter off !y $1.0,000 over three years if it replaces the current eCuipment.
Co$pa(i'3 Rele,a't Costs of 7p3(a*e a'* Repla%e Alte('ati,es 6ash operating costs $1:0K $.0 per des, ;,000 des,s per yr. ' yrs. 6urrent disposal price *ne time capital costs, #ritten off periodically as depreciation Total relevant costs O,e( < /ea(s 7p3(a*e Repla%e !1" !8" $2,520,000 2,700,000 $5,220,000 $1,::0,000 (;00,000) :,200,000 $5,0:0,000 Diffe(e'%e i' fa,o( of Repla%e !<" 9 !1" ? !8" $1,0.0,000 ;00,000 (1,500,000) $ 1.0,000

+ote that the !oo, value of the current machine ($/00,000) #ould either !e #ritten off as depreciation over three years under the upgrade option, or, all at once in the current year under the replace option. Bts net effect #ould !e the same in !oth alternatives% to increase costs !y $/00,000 over three years, hence it is irrelevant in this analysis. 2. =uppose the capital e"penditure to replace the eCuipment is $P. &rom reCuirement 1, column (2), su!stituting for the one0time capital cost of replacement, the relevant cost of replacing is $1,::0,000 ) $;00,000 A $P. &rom column (1), the relevant cost of upgrading is $5,220,000. 9e #ant to find P such that $1,::0,000 ) $;00,000 A $P Q $5,220,000 (i.e., Tech<ech #ill favor replacing) =olving the a!ove ineCuality gives us P Q $5,220,000 ) $.:0,000 ? $:,'.0,000. Tech<ech #ould prefer to replace, rather than upgrade, if the replacement cost of the ne# eCuipment does not e"ceed $:,'.0,000. +ote that this result can also !e o!tained !y ta,ing the original replacement cost of $:,200,000 and adding to it the $1.0,000 difference in favor of replacement calculated in reCuirement 1. '. =uppose the units produced and sold over ' years eCual y. 5sing data from reCuirement 1, column (1), the relevant cost of upgrade #ould !e $1:0y A $2,700,000, and from column (2), the relevant cost of replacing the eCuipment #ould !e $.0y ) $;00,000 A $:,200,000. Tech<ech #ould #ant to upgrade if $1:0y A $2,700,000 Q $.0y ) $;00,000 A $:,200,000 $;0y Q $/00,000 y Q $/00,000 $;0 ? 15,000 units or upgrade #hen y Q 15,000 units (or 5,000 per year for ' years) and replace #hen y R 15,000 units over ' years. 9hen production and sales volume is lo# (less than 5,000 per year), the higher operating costs under the upgrade option are more than offset !y the savings in capital costs from upgrading. 9hen production and sales volume is high, the higher capital costs of replacement are more than offset !y the savings in operating costs in the replace option.

1101:

:. *perating income for the first year under the upgrade and replace alternatives are sho#n !elo#% Dea( 1 7p3(a*e Repla%e !1" !8" $',000,00 $',000,00 -evenues (;,000 $500) 0 0 6ash operating costs $1:0K $.0 per des, ;,000 des,s per year .:0,000 :.0,000 (epreciation ($/00,000a A $2,700,000) 'K $:,200,000 ' 1,200,000 1,:00,000 '00,00 Eoss on disposal of old eCuipment (0K $/00,000 ) $;00,000) 0 0 2,0:0,00 2,1.0,00 Total costs 0 0 $ $ *perating Bncome /;0,000 .20,000
a

The !oo, value of the current production eCuipment is $1,500,000 useful life of ' years.

' 5 ? $/00,000K it has a remaining

&irst0year operating income is higher !y $1:0,000 under the upgrade alternative, and (an (oria, #ith his one0year hori$on and operating income0!ased !onus, #ill choose the upgrade alternative, even though, as seen in reCuirement 1, the replace alternative is !etter in the long run for Tech<ech. This e"ercise illustrates the possi!le conflict !et#een the decision model and the performance evaluation model.

11015

11-81 (20 min.) Spe%ial O(*e(. 1. -evenues from special order ($25 10,000 !ats) 1aria!le manufacturing costs ($1;1 10,000 !ats) Bncrease in operating income if -ip,in order accepted
1 (irect

$250,000 (1;0,000 ) $ /0,000

materials A (irect manufacturing la!or A 1aria!le manufacturing overhead ? $12 + $1 + $' = $1;

Eouisville should accept -ip,in8s special order !ecause it increases operating income !y $/0,000. =ince no varia!le selling costs #ill !e incurred on this order, this cost is irrelevant. =imilarly, fi"ed costs are irrelevant !ecause they #ill !e incurred regardless of the decision. 2a. -evenues from special order ($25 10,000 !ats) 1aria!le manufacturing costs ($1; 10,000 !ats) 6ontri!ution margin foregone (S$'2T$1.1U 10,000 !ats) (ecrease in operating income if -ip,in order accepted
1 (irect

matls. A (irect manuf. la!or A 1aria!le manuf. overhead A 1aria!le selling e"p. ? $12 + $1 + $' + $2 = $1.

$250,000 (1;0,000) (1:0,000) $ (50,000)

ased strictly on financial considerations, Eouisville should re7ect -ip,in8s special order !ecause it results in a $50,000 reduction in operating income. 2!. Eouisville #ill !e indifferent !et#een the special order and continuing to sell to regular customers if the special order price is $'0. 2t this price, Eouisville recoups the varia!le manufacturing costs of $1;0,000 and the contri!ution margin given up from regular customers of $1:0,000 (S$1;0,000 A $1:0,000U D 10,000 units ? $'0). Eoo,ed at a different #ay, Eouisville e"pects the full price of $'2 less the $2 saved on varia!le selling costs. 2c. Eouisville may !e #illing to accept a loss on this special order if the possi!ility of future long0term sales seem li,ely. Go#ever, Eouisville should also consider the effect on customer relationships !y refusing sales from e"isting customers. 2lso, Eouisville cannot afford to adopt the special order price long0term or #ith other customers #ho may as, for price concessions.

1101;

11-<6 ('0 min.) Co't(i#)tio' app(oa%&2 (ele,a't %osts. 1. 2verage one0#ay fare per passenger 6ommission at .L of $500 +et cash to 2ir &risco per tic,et 2verage num!er of passengers per flight -evenues per flight ($:;0 V 200) &ood and !everage cost per flight ($20 V 200) Total contri!ution margin from passengers per flight $ $ V $ $ $ 500 (:0) :;0 200 /2,000 :,000 ..,000 :.0.00 ('..:0) ::1.;0 20.00 :21.;0

2.

Bf fare is 6ommission at .L of $:.0 +et cash per tic,et &ood and !everage cost per tic,et 6ontri!ution margin per passenger Total contri!ution margin from passengers per flight ($:21.;0 V 212) 2ll other costs are irrelevant.

$./,'7/.20

*n the !asis of Cuantitative factors alone, 2ir &risco should decrease its fare to $:.0 !ecause reducing the fare gives 2ir &risco a higher contri!ution margin from passengers ($./,'7/.20 versus $..,000). '. Bn evaluating #hether 2ir &risco should charter its plane to Travel Bnternational, #e compare the charter alternative to the solution in reCuirement 2 !ecause reCuirement 2 is preferred to reCuirement 1. 5nder reCuirement 2, contri!ution from passengers (educt fuel costs Total contri!ution per flight $./,'7/.20 1:,000.00 $75,'7/.20

2ir &risco gets $7:,500 per flight from chartering the plane to Travel Bnternational. *n the !asis of Cuantitative financial factors, 2ir &risco is !etter off not chartering the plane and, instead, lo#ering its o#n fares. *ther Cualitative factors that 2ir &risco should consider in coming to a decision are a. The lo#er ris, from chartering its plane relative to the uncertainties regarding the num!er of passengers it might get on its scheduled flights. !. The sta!ility of the relationship !et#een 2ir &risco and Travel Bnternational. Bf this is not a long0term arrangement, 2ir &risco may lose current mar,et share and not !enefit from sustained charter revenues.

11017

11-<1 ('0 min.) Rele,a't %osts2 oppo(t)'it/ %osts 1. >asyspread 2.0 has a higher relevant operating income than >asyspread 1.0. ased on this analysis, >asyspread 2.0 should !e introduced immediately% -elevant revenues -elevant costs% <anuals, dis,ettes, compact discs Total relevant costs -elevant operating income -easons for other cost items !eing irrelevant are Easyspread 1.0 <anuals, dis,ettesWalready incurred (evelopment costsWalready incurred <ar,eting and administrativeWfi"ed costs of period Easyspread 2.0 (evelopment costsWalready incurred <ar,eting and administrationWfi"ed costs of period +ote that total mar,eting and administration costs #ill not change #hether >asyspread 2.0 is introduced on Muly 1, 200/, or on *cto!er 1, 200/. 2 2. *ther factors to !e considered% a. 6ustomer satisfaction. Bf 2.0 is significantly !etter than 1.0 for its customers, a customer driven organi$ation #ould immediately introduce it unless other factors offset this !ias to#ards Ndo #hat is !est for the customer.O !. Xuality level of >asyspread 2.0. Bt is critical for ne# soft#are products to !e fully de!ugged. >asyspread 2.0 must !e error0free. 6onsider an immediate release only if 2.0 passes all Cuality tests and can !e fully supported !y the salesforce. c. Bmportance of !eing perceived to !e a mar,et leader. eing first in the mar,et #ith a ne# product can give asil =oft#are a Nfirst0mover advantage,O e.g., capturing an initial large share of the mar,et that, in itself, causes future potential customers to lean to#ards purchasing >asyspread 2.0. <oreover, !y introducing 2.0 earlier, asil can get Cuic, feed!ac, from users a!out #ays to further refine the soft#are #hile its competitors are still #or,ing on their o#n first versions. <oreover, !y loc,ing in early customers, asil may increase the li,elihood of these customers also !uying future upgrades of >asyspread 2.0. d. <orale of developers. These are ,ey people at asil =oft#are. (elaying introduction of a ne# product can hurt their morale, especially if a competitor then preempts asil from !eing vie#ed as a mar,et leader. Eas/sp(ea* 1 6 $1;0 $ 0 0 $1;0 Eas/sp(ea* 8 6 $1/5 $'0 '0 $1;5

1101.

11-<8 (20 min.) Oppo(t)'it/ %osts 1. The opportunity cost to 9olverine of producing the 2,000 units of *range!o is the contri!ution margin lost on the 2,000 units of -ose!o that #ould have to !e forgone, as computed !elo#% =elling price 1aria!le costs per unit% (irect materials (irect manufacturing la!or 1aria!le manufacturing overhead 1aria!le mar,eting costs 6ontri!ution margin per unit 6ontri!ution margin for 2,000 units $20 $2 ' 2 :

11 $ / $ 1.,000

The opportunity cost is $1.,000. *pportunity cost is the ma"imum contri!ution to operating income that is forgone (re7ected) !y not using a limited resource in its ne"t0!est alternative use. 2. 6ontri!ution margin from manufacturing 2,000 units of *range!o and purchasing 2,000 units of -ose!o from uc,eye is $1;,000, as follo#s% Ma')fa%t)(e O(a'3e#o =elling price 1aria!le costs per unit% 3urchase costs (irect materials (irect manufacturing la!or 1aria!le manufacturing costs 1aria!le mar,eting overhead 1aria!le costs per unit 6ontri!ution margin per unit 6ontri!ution margin from selling 2,000 units of *range!o and 2,000 units of -ose!o $15 ) 2 ' 2 2 / $ ; $12,000 P)(%&ase Rose#o $20 1: Total

: 1. $ 2 $:,000 $1;,000

2s calculated in reCuirement 1, 9olverine8s contri!ution margin from continuing to manufacture 2,000 units of -ose!o is $1.,000. 2ccepting the <iami 6ompany and uc,eye offer #ill cost 9olverine $2,000 ($1;,000 ) $1.,000). Gence, 9olverine should refuse the <iami 6ompany and uc,eye 6orporation8s offers. '. The minimum price #ould !e $/, the sum of the incremental costs as computed in reCuirement 2. This follo#s !ecause, if 9olverine has surplus capacity, the opportunity cost ? $0. &or the short0run decision of #hether to accept *range!o8s offer, fi"ed costs of 9olverine are irrelevant. *nly the incremental costs need to !e covered for it to !e #orth#hile for 9olverine to accept the *range!o offer.

1101/

11-<< ('0):0 min.) P(o*)%t $iE2 (ele,a't %osts 1. =elling price 1aria!le manufacturing cost per unit 1aria!le mar,eting cost per unit Total varia!le costs per unit 6ontri!ution margin per unit 6ontri!uti on margin per hour of the constrained resource (the regular machine) Total contri!ution margin from selling only -' or only G3; -'% $25 50,000K G3;% $'0 50,000 Less Eease costs of high0precision machine to produce and sell G3; +et relevant !enefit R< $100 ;0 15 75 $ 25
$25 ? $25 1

HP6 $150 100 '5 1'5 $ 15

$15 ? $'0 0.5

$1,250,000 $1,250,000

$1,500,000 '00,000 $1,200,000

>ven though G3; has the higher contri!ution margin per unit of the constrained resource, the fact that 3endleton must incur additional costs of $'00,000 to achieve this higher contri!ution margin means that 3endleton is !etter off using its entire 50,0000hour capacity on the regular machine to produce and sell 50,000 units (50,000 hours 1 hour per unit) of -'. The additional contri!ution from selling G3; rather than -' is $250,000 ($1,500,000 $1,250,000), #hich is not enough to cover the additional costs of leasing the high0precision machine. +ote that, !ecause all other overhead costs are fi"ed and cannot !e changed, they are irrelevant for the decision. 2. Bf capacity of the regular machines is increased !y 15,000 machine0hours to ;5,000 machine0hours (50,000 originally A 15,000 ne#), the net relevant !enefit from producing -' and G3; is as follo#s% R< HP6 Total contri!ution margin from selling only -' or only G3; -'% $25 ;5,000K G3;% $'0 ;5,000 Less Eease costs of high0precision machine that #ould !e incurred if G3; is produced and sold Less 6ost of increasing capacity !y 15,000 hours on regular machine +et relevant !enefit

$1,;25,000

$1,/50,000 '00,000

150,000 $1,:75,000

150,000 $1,500,000

11020

Bnvesting in the additional capacity increases 3endleton8s operating income !y $250,000 ($1,500,000 calculated in reCuirement 2 minus $1,250,000 calculated in reCuirement 1), so 3endleton should add 15,000 hours to the regular machine. 9ith the e"tra capacity availa!le to it, 3endleton should use its entire capacity to produce G3;. 5sing all ;5,000 hours of capacity to produce G3; rather than to produce -' generates additional contri!ution margin of $'25,000 ($1,/50,000 $1,;25,000) #hich is more than the additional cost of $'00,000 to lease the high0 precision machine. 3endleton should therefore produce and sell 1'0,000 units of G3; (;5,000 hours 0.5 hours per unit of G3;) and $ero units of -'. '. R< =elling price 1aria!le manufacturing costs per unit 1aria!le mar,eting costs per unit Total varia!le costs per unit 6ontri!ution margin per unit
6ontri!ution margin per hour of the constrained resource (the regular machine) $'5

HP6 $150 100 '5 1'5 $ 15

S< $120 70 15 .5 $ '5

$'5 ? 1

$100 ;0 15 75 $ 25

$25 $15 ? $25 ? $'0 1 0.5

The first step is to compare the operating profits that 3endleton could earn if it accepted the 6arter 6orporation offer for 20,000 units #ith the operating profits 3endleton is currently earning. =' has the highest contri!ution margin per hour on the regular machine and reCuires no additional investment such as leasing a high0precision machine. To produce the 20,000 units of =' reCuested !y 6arter 6orporation, 3endleton #ould reCuire 20,000 hours on the regular machine resulting in contri!ution margin of $'5 20,000 ? $700,000. 3endleton no# has :5,000 hours availa!le on the regular machine to produce -' or G3;. R< Total contri!ution margin from selling only -' or only G3; -'% $25 :5,000K G3;% $'0 :5,000 Less Eease costs of high0precision machine to produce and sell G3 ; +et relevant !enefit HP6

$1,125,000 $1,125,000

$1,'50,000 '00,000 $1,050,000

3endleton should use all the :5,000 hours of availa!le capacity to produce :5,000 units of -'. Thus, the product mi" that ma"imi$es operating income is 20,000 units of =', :5,000 units of -', and $ero units of G3;. This optimal mi" results in a contri!ution margin of $1,.25,000 ($700,000 from =' and $1,125,000 from -'). -elative to reCuirement 2, operating income increases !y $'25,000 ($1,.25,000 minus $1,500,000 calculated in reCuirement 2). Gence, 3endleton should accept the 6arter 6orporation !usiness and supply 20,000 units of ='.

11021

11-<> ('5):0 min.) D(oppi'3 a p(o*)%t li'e2 selli'3 $o(e )'its

1. The incremental revenue losses and incremental savings in cost !y discontinuing the Ta!les product line follo#s%

Diffe(e'%e= I'%(e$e'tal !Loss i' Re,e')es" a'* Sa,i'3s i' Costs f(o$ D(oppi'3 Ta#les Li'e -evenues (irect materials and direct manufacturing la!or (epreciation on eCuipment <ar,eting and distri!ution Yeneral administration 6orporate office costs Total costs *perating income (loss) $(500,000) '00,000 0 70,000 0 0 '70,000 $(1'0,000)

(ropping the Ta!les product line results in revenue losses of $500,000 and cost savings of $'70,000. Gence, Yrossman 6orporation8s operating income #ill !e $1'0,000 lo#er if it drops the Ta!les line. +ote that, !y dropping the Ta!les product line, Gome &urnishings #ill save none of the depreciation on eCuipment, general administration costs, and corporate office costs, !ut it #ill save varia!le manufacturing costs and all mar,eting and distri!ution costs on the Ta!les product line. 2. Yrossman8s #ill generate incremental operating income of $12.,000 from selling :,000 additional ta!les and, hence, should try to increase ta!le sales. The calculations follo#% I'%(e$e'tal Re,e')es !Costs" a'* Ope(ati'3 I'%o$e $500,000 ('00,000) (:2,000)J ('0,000)Z 0JJ 0JJ $12.,000

-evenues (irect materials and direct manufacturing la!or 6ost of eCuipment #ritten off as depreciation <ar,eting and distri!ution costs Yeneral administration costs 6orporate office costs *perating income
J

+ote that the additional costs of eCuipment are relevant future costs for the Nselling more ta!les decisionO !ecause they represent incremental future costs that differ !et#een the alternatives of selling and not selling additional ta!les. Z 6urrent mar,eting and distri!ution costs #hich varies #ith num!er of shipments ? $70,000 ) $:0,000 ? $'0,000. 2s the sales of ta!les dou!le, the num!er of shipments #ill dou!le, resulting in incremental mar,eting and distri!ution costs of (2 $'0,000) ) $'0,000 ? $'0,000. JJ Yeneral administration and corporate office costs #ill !e unaffected if Yrossman decides to sell more ta!les. Gence, these costs are irrelevant for the decision.

11022

'.=olution >"hi!it 110':, 6olumn 1, presents the relevant loss of revenues and the relevant savings in costs from closing the +orthern (ivision. 2s the calculations sho#, Yrossman8s operating income #ould decrease !y $1:0,000 if it shut do#n the +orthern (ivision (loss in revenues of $1,500,000 versus savings in costs of $1,';0,000). Yrossman #ill save varia!le manufacturing costs, mar,eting and distri!ution costs, and division general administration costs !y closing the +orthern (ivision !ut eCuipment0related depreciation and corporate office allocations are irrelevant to the decision. >Cuipment0related costs are irrelevant !ecause they are past costs (and the eCuipment has $ero disposal price). 6orporate office costs are irrelevant !ecause Yrossman #ill not save any actual corporate office costs !y closing the +orthern (ivision. The corporate office costs that used to !e allocated to the +orthern (ivision #ill !e allocated to other divisions. :. =olution >"hi!it 110':, 6olumn 2, presents the relevant revenues and relevant costs of opening the =outhern (ivision (a division #hose revenues and costs are e"pected to !e identical to the revenues and costs of the +orthern (ivision). Yrossman should open the =outhern (ivision !ecause it #ould increase operating income !y $:0,000 (increase in relevant revenues of $1,500,000 and increase in relevant costs of $1,:;0,000). The relevant costs include direct materials, direct manufacturing la!or, mar,eting and distri!ution, eCuipment, and division general administration costs !ut not corporate office costs. +ote, in particular, that the cost of eCuipment #ritten off as depreciation is relevant !ecause it is an e"pected future cost that Yrossman #ill incur only if it opens the =outhern (ivision. 6orporate office costs are irrelevant !ecause actual corporate office costs #ill not change if Yrossman opens the =outhern (ivision. The current corporate staff #ill !e a!le to oversee the =outhern (ivision8s operations. Yrossman #ill allocate some corporate office costs to the =outhern (ivision !ut this allocation represents corporate office costs that are already currently !eing allocated to some other division. ecause actual total corporate office costs do not change, they are irrelevant to the division. SOL7TION EAHI.IT 11-<> -elevant0-evenue and -elevant06ost 2nalysis for 6losing +orthern (ivision and *pening =outhern (ivision I'%(e$e'tal !Loss i' Re,e')es" Re,e')es a'* a'* Sa,i'3s i' !I'%(e$e'tal Costs" Costs f(o$ Closi'3 f(o$ Ope'i'3 No(t&e(' Di,isio' So)t&e(' Di,isio' !1" !8" $(1,500,000) $1,500,000 .25,000 0 205,000 ''0,000 0 1,';0,000 $ (1:0,000) (.25,000) (100,000) (205,000) (''0,000) 0 (1,:;0,000) $ :0,000

-evenues 1aria!le direct materials and direct manufacturing la!or costs >Cuipment cost #ritten off as depreciation <ar,eting and distri!ution costs (ivision general administration costs 6orporate office costs Total costs >ffect on operating income (loss)

1102'

11-<5 ('0):0 min.) Ma-e o( #)/2 )'-'oB' le,el of ,ol)$e 1. The varia!le costs reCuired to manufacture 150,000 starter assem!lies are (irect materials (irect manufacturing la!or 1aria!le manufacturing overhead Total varia!le costs $200,000 150,000 100,000 $:50,000

The varia!le costs per unit are $:50,000 D 150,000 ? $'.00 per unit. Eet P ? num!er of starter assem!lies reCuired in the ne"t 12 months. The data can !e presented in !oth Nall dataO and Nrelevant dataO formats% All Data Rele,a't Data Alte('ati,e Alte('ati,e Alte('ati,e Alte('ati,e 1= 8= 1= 8= .)/ Ma-e .)/ Ma-e $ 'P ) $ 'P ) 150,000 $150,000 ) ) 100,000 ) 100,000 ) :0,000 50,000 :0,000 $50,000 50,000 ) 50,000 ) ) $':0,000 A $ 'P :P $200,000 A $ :P ) $1/0,000 A $ 'P :P $50,000 A $ :P

1aria!le manufacturing costs &i"ed general manufacturing overhead &i"ed overhead, avoida!le (ivision 2 manager8s salary (ivision ' manager8s salary 3urchase cost, if !ought from Tidnish >lectronics Total

The num!er of units at #hich the costs of ma,e and !uy are eCuivalent is 2ll data analysis% or -elevant data analysis% P $':0,000 A $'P ? $200,000 A $:P P ? 1:0,000 $1/0,000 A $'P ? $50,000 A $:P ? 1:0,000

2ssuming cost minimi$ation is the o!7ective, then [ Bf production is e"pected to !e less than 1:0,000 units, it is prefera!le to !uy units from Tidnish. [ Bf production is e"pected to e"ceed 1:0,000 units, it is prefera!le to manufacture internally (ma,e) the units. [ Bf production is e"pected to !e 1:0,000 units, *"ford should !e indifferent !et#een !uying units from Tidnish and manufacturing (ma,ing) the units internally.

1102:

2. The information on the storage cost, #hich is avoida!le if self0manufacture is discontinued, is relevantK these storage charges represent current outlays that are avoida!le if self0manufacture is discontinued. 2ssume these $50,000 charges are represented as an opportunity cost of the ma,e alternative. The costs of internal manufacture that incorporate this $50,000 opportunity cost are 2ll data analysis% -elevant data analysis% $'/0,000 A $'P $2:0,000 A $'P

The num!er of units at #hich the costs of ma,e and !uy are eCuivalent is 2ll data analysis% -elevant data analysis% $'/0,000 A $'P P $2:0,000 A $'P P ? ? ? ? $200,000 A $:P 1/0,000 $50,000 A $:P 1/0,000

Bf production is e"pected to !e less than 1/0,000, it is prefera!le to !uy units from Tidnish. Bf production is e"pected to e"ceed 1/0,000, it is prefera!le to manufacture the units internally.

11025

11-<6 ('0 min.) Ma-e ,e(s)s #)/2 a%ti,it/-#ase* %osti'32 oppo(t)'it/ %osts 1. -elevant costs under !uy alternative% 3urchases, 10,000 $..20 -elevant costs under ma,e alternative% (irect materials (irect manufacturing la!or 1aria!le manufacturing overhead Bnspection, setup, materials handling <achine rent Total relevant costs under ma,e alternative $.2,000 $:0,000 20,000 15,000 2,000 ',000 $.0,000

The allocated fi"ed plant administration, ta"es, and insurance #ill not change if 2ce ma,es or !uys the chains. Gence, these costs are irrelevant to the ma,e0or0!uy decision. The analysis indicates that 2ce should ma,e and not !uy the chains from the outside supplier. 2. -elevant costs under the ma,e alternative% -elevant costs (as computed in reCuirement 1) -elevant costs under the !uy alternative% 6osts of purchases (10,000 $..20) 2dditional fi"ed costs 2dditional contri!ution margin from using the space #here the chains #ere made to upgrade the !icycles !y adding mud flaps and reflector !ars, 10,000 ($20 ) $1.) Total relevant costs under the !uy alternative $.0,000 $.2,000 1;,000 (20,000) $7.,000

2ce should no# !uy the chains from an outside vendor and use its o#n capacity to upgrade its o#n !icycles. '. Bn this reCuirement, the decision on mud flaps and reflectors is irrelevant to the analysis. 6ost of manufacturing chains% 1aria!le costs, ($: A $2 A $1.50 ? $7.50) ;,200 atch costs, $200@!atcha . !atches <achine rent 6ost of !uying chains, $..20 ;,200
a

$:;,500 1,;00 ',000 $51,100 $50,.:0

$2,000 10 !atches

Bn this case, 2ce should !uy the chains from the outside vendor.

1102;

11-<+ (;0 min.) M)ltiple %&oi%e2 %o$p(e&e'si,e p(o#le$ o' (ele,a't %osts Iou may #ish to assign only some of the parts. <anufacturing costs% (irect materials (irect manufacturing la!or 1aria!le manufac. indirect costs &i"ed manufac. indirect costs <ar,eting costs% 1aria!le &i"ed 1. (!) $'.50 Total $1.00 1.20 0..0 0.50 $1.50 0./0 Pe( 7'it FiEe* Va(ia#le

$'.50 2.:0 $5./0

$0.50 0./0 $1.:0

$'.00 1.50 $:.50

Ma')fa%t)(i'3 Costs 1aria!le $'.00 &i"ed 0.50 Total $'.50

2. (e)

+one of the a!ove. (ecrease in operating income is $1;,.00.

Ol* 2:0,000 $;.00 2:0,000 $'.00 2:0,000 $1.50 $1,::0,000 720,000 ';0,000 1,0.0,000 ';0,000 120,000 21;,000 '';,000 $ 2:,000 Diffe(e'tial A $ /1,200J A 72,000 A ';,000 A 10.,000 ) 1;,.00 )) )) )) ) $ 1;,.00 NeB 2;:,000 $5..0 $1,5'1,200 2;:,000 $'.00 2;:,000 $1.50 7/2,000 '/;,000 1,1..,000 ':',200 120,000 21;,000 '';,000 $ 7,200

-evenues 1aria!le costs <anufacturing <ar,eting and other 1aria!le costs 6ontri!ution margin &i"ed costs <anufacturing <ar,eting and other &i"ed costs *perating income JBncremental revenue% $5..0 2:,000 (educt price reduction $0.20 2:0,000

$0.50 20,000 12 mos. ? $0./0 2:0,000

$1'/,200 :.,000 $ /1,200

11027

'.

(c) $',500

Bf this order #ere not landed, fi"ed manufacturing overhead #ould !e underallocated !y $2,500, $0.50 per unit 5,000 units. Therefore, ta,ing the order increases operating income !y $1,000 plus $2,500, or $',500. 2nother #ay to present the same idea follo#s% -evenues #ill increase !y (5,000 $'.50 ? $17,500) A $1,000 6osts #ill increase !y 5,000 $'.00 &i"ed overhead #ill not change 6hange in operating income $1.,500 (15,000) ) $ ',500

+ote that this ans#er to (') assumes that varia!le mar,eting costs are not influenced !y this contract. These 5,000 units do not displace any regular sales. :. (a) $:,000 less ($7,500 ) $',500) Go,e('$e't Co't(a%t 2s a!ove $',500 Re3)la( C&a''els =ales, 5,000 $;.00 Bncrease in costs% 1aria!le costs only% <anufacturing, 5,000 $'.00 $15,000 <ar,eting, 5,000 $1.50 7,500 &i"ed costs are not affected $ 7,500

$'0,000

22,500 6hange in

operating income 5. (!) $:.15

(ifferential costs% 1aria!le% <anufacturing =hipping &i"ed% $:,000 D 10,000 :,000 $:1,500

$'.00 0.75

$'.75 10,000 0.:0 $:.15

$'7,500

=elling price to !rea, even is $:.15 per unit. ;. (e) $1.50, the varia!le mar,eting costs. The other costs are past costs and therefore, are irrelevant.

1102.

7. (e)

+one of these. The correct ans#er is $'.55. This part al#ays gives students trou!le. The short0cut solution !elo# is follo#ed !y a longer solution that is helpful to students.

=hort0cut solution% The highest price to !e paid #ould !e measured !y those costs that could !e avoided !y halting production and su!contracting% 1aria!le manufacturing costs &i"ed manufacturing costs saved $;0,000 D 2:0,000 <ar,eting costs (0.20 $1.50) Total costs Eonger !ut clearer solution% Co$pa(ati,e A'')al I'%o$e State$e't P(ese't Diffe(e'%e P(opose* -evenues 1aria!le costs% <anufacturing, 2:0,000 $'.00 <ar,eting and other, 2:0,000 $1.50 1aria!le costs 6ontri!ution margin &i"ed costs% <anufacturing <ar,eting and other Total fi"ed costs *perating income
J

$'.00 0.25 0.'0 $'.55

$1,::0,000 720,000 ';0,000 1,0.0,000 ';0,000 120,000 21;,000 '';,000 $ 2:,000

$1,::0,000 .52,000J 2..,000 1,1:0,000 '00,000 ;0,000 21;,000 27;,000 $ 2:,000

A1'2,000 ) 72,000

) ;0,000 $ 0

This solution is o!tained !y filling in the a!ove schedule #ith all the ,no#n figures and #or,ing Nfrom the !ottom upO and Nfrom the top do#nO to the un,no#n purchase figure. <a"imum varia!le costs that can !e incurred, $1,1:0,000 ) $2..,000 ? ma"imum purchase costs, or $.52,000. (ivide $.52,000 !y 2:0,000 units, #hich yields a ma"imum purchase price of $'.55.

11-<0 (25 min.) Closi'3 *oB' *i,isio's.

1.

Di,isio' A =ales 1aria!le costs of goods sold ($:50,000 0./0K $'/0,000 0./5) 1aria!le =,Y \ 2 ($100,000 0.;0K $120,000 0..0) Total varia!le costs 6ontri!ution margin $5'0,000 :05,000 ;0,000 :;5,000 $ ;5,000

Di,isio' D $:50,000 '70,500 /;,000 :;;,500 $(1;,500)

1102/

2. Di,isio' A &i"ed costs of goods sold ($:50,000 T $:05,000K $'/0,000 T $'70,500) &i"ed =,Y \ 2 ($100,000 T $;0,000K $120,000 T $/;,000) Total fi"ed costs &i"ed costs savings if shutdo#n ($.5,000 0.;0K $:',500 0.;0) $:5,000 :0,000 $.5,000 $51,000 Di,isio' D $1/,500 2:,000 $:',500 $2;,100

(ivision 28s contri!ution margin of $;5,000 more than covers its avoida!le fi"ed costs of $51,000. The difference of $1:,000 helps cover the company8s unavoida!le fi"ed costs. =ince $51,000 of (ivision 28s fi"ed costs are avoida!le, the remaining $':,000 is unavoida!le and #ill !e incurred regardless of #hether (ivision 2 continues to operate. (ivision 28s $20,000 loss is the rest of the unavoida!le fi"ed costs ($':,000 T $1:,000). Bf (ivision 2 is closed, the remaining divisions #ill need to generate sufficient profits to cover the entire $':,000 unavoida!le fi"ed cost. 6onseCuently, (ivision 2 should not !e closed since it helps defray $1:,000 of this cost. Bn contrast, (ivision ( earns a negative contri!ution margin, #hich means its revenues are less than its varia!le costs. (ivision ( also generates $2;,100 of avoida!le fi"ed costs. ased strictly on financial considerations, (ivision ( should !e closed !ecause the company #ill save $:2,;00 ($2;,100 A $1;,500). 2n alternative set of calculations is as follo#s% Di,isio' A Total varia!le costs 2voida!le fi"ed costs if shutdo#n Total cost savings if shutdo#n Eoss of revenues if shutdo#n 6ost savings minus loss of revenues $:;5,000 51,000 51;,000 5'0,000 $ (1:,000) Di,isio' D $:;;,500 2;,100 :/2,;00 :50,000 $ :2,;00

(ivision 2 should not !e shut do#n !ecause loss of revenues if (ivision 2 is shut do#n e"ceeds cost savings. (ivision ( should !e shut do#n !ecause cost savings from shutting do#n (ivision ( e"ceeds loss of revenues. '. efore deciding to close (ivision (, management should consider the role that the (ivision8s product line plays relative to other product lines. &or instance, if the product manufactured !y (ivision ( attracts customers to the company, then dropping (ivision ( may have a detrimental effect on the revenues of the remaining divisions. <anagement may also #ant to consider the impact on the morale of the remaining employees if (ivision ( is closed. Talented employees may !ecome fearful of losing their 7o!s and see, employment else#here.

110'0

11-<1 (25 min.) P(o*)%t $iE2 %o'st(ai'e* (eso)(%e. 1. =elling price 1aria!le costs% (irect materials ((<) Ea!or and other costs Total varia!le costs 6ontri!ution margin 3ounds of (< per unit1 6ontri!ution margin per l!.
1

A116 $.: 2: 2. 52 $'2 D. l!s. $ : per l!.

?

.<08 $ 5; 15 27 :2 $ 1: D5 l!s. $2..0 per l!.

C65+ $70 / :0 :/ $21 D ' l!s. $ 7 per l!.

2110%

(irect material cost per unit 6ost per pound of istide (irect material cost per unit 6ost per pound of istide (irect material cost per unit 6ost per pound of istide

$2: $' $15 $' $/ $'

= . l!. per unit

'.2%

= 5 l!. per unit

6;57%

= ' l!. per unit

&irst, satisfy minimum reCuirements.

<inimum units Times pounds per unit 3ounds needed to produce minimum units A116 200 V. l!. per unit 1,;00 l!. .<08 200 V5 l!. per unit 1,000 l!. C65+ 200 V' l!. per unit ;00 l!. Total ',200 l!.

The remaining 1,.00 pounds (5,000 T ',200) should !e devoted to 6;57 !ecause it has the highest contri!ution margin per pound of direct material. =ince each unit of 6;57 reCuires ' pounds of istide, the remaining 1,.00 pounds can !e used to produce another ;00 units of 6;57. The follo#ing com!ination yields the highest contri!ution margin given the 5,000 pounds constraint on availa!ility of istide. 2110% 200 units '.2% 200 units 6;57% .00 units (200 minimum A ;00 e"tra)

110'1

2. The demand for 9estford8s products e"ceeds the materials availa!le. 2ssuming that fi"ed costs are covered !y the original product mi", 9estford should !e #illing to pay upto an additional $7 per pound (the contri!ution margin per pound of 6;57) for another 1,000 pounds of istide. That is, 9estford should !e #illing to pay $' A $7 ? $10 per pound of istide1. This cost assumes that sufficient demand e"ists to sell another ''' units (1000 pounds D ' pounds per unit) of 6;57. Bf not, then the ma"imum price falls to an additional $: per pound (the contri!ution margin per pound of 2110) so that 9estford can produce up to 125 more units of 2110 (1,000 pounds D . pounds per unit). Bn this case, 9estford #ould !e #illing to pay $' A $: ? $7 per pound. Bf there is insufficient demand to sell another 125 units of 2110, then the ma"imum price 9estford #ould !e #illing to pay falls to an additional $2..0 per pound (the contri!ution margin per pound of '.2). 9estford #ould !e #illing to pay $2..0 A $' ? $5..0 per pound of istide.
1

2n alternative calculation focuses on column ' for 6;57 of the ta!le in reCuirement 1. =elling price 1aria!le la!or and other costs (e"cluding direct materials) 6ontri!ution margin (ivided !y pounds of direct material per unit (irect material cost per pound that 9estford can pay #ithout contri!ution margin !ecoming negative

$70 :0 $'0 D' l!s. $10

110'2

11->6 ('0):0 min.) Opti$al p(o*)%t $iE 1. Eet ( represent the !atches of (ella8s (elight made and sold. Eet represent the !atches of onny8s our!on made and sold. The contri!ution margin per !atch of (ella8s (elight is $'00. The contri!ution margin per !atch of onny8s our!on is $250. The E3 formulation for the decision is% <a"imi$e =u!7ect to $'00( A $250 '0( A 15 ;;0 (<i"ing (epartment constraint) 15 270 (&illing (epartment constraint) 10( A 15 '00 ( a,ing (epartment constraint)

2. =olution >"hi!it 110:0 presents a graphical summary of the relationships. The optimal corner is the point (1., .) i.e., 1. !atches of (ella8s (elights and . of onny8s our!ons. SOL7TION EAHI.IT 11->6 Yraphic =olution to &ind *ptimal <i", (ella =impson, Bnc.
Della Si$pso' P(o*)%tio' Mo*el
50 :5 0,

::
<i"ing (ept. 6onstraint

:0

'5

>Cual 6ontri!ution <argin Eines *ptimal 6orner (1.,.)

'0

25

20

', 1. 0, 1.

&illing (ept. 6onstraint

. !#at%&es of .o''/Fs .o)(#o's"

15

10

&easi!le -egion a,ing (ept. 6onstraint

0 0 5 10 15 20

22, 0
25 '0 '5 :0

D !#at%&es of DellaFs Deli3&t"

110''

9e ne"t calculate the optimal production mi" using the trial0and0error method. The corner point #here the <i"ing (ept. and calculated as (1., .) !y solving% '0( A 15 10( A 15 a,ing (ept. constraints intersect can !e

? ;;0 (1) <i"ing (ept. constraint ? '00 (2) a,ing (ept. constraint

=u!tracting (2) from (1), #e have 20( ? ';0 or ( ? 1. =u!stituting in (2) (10 1.) A 15 that is, 15 or ? '00 ? '00 1.0 ? 120 ? .

The corner point #here the &illing and a,ing (epartment constraints intersect can !e calculated as (',1.) !y su!stituting ? 1. (&illing (epartment constraint) into the a,ing (epartment constraint% 10 ( A (15 1.) ? '00 10 ( ? '00 270 ? '0 (? ' The feasi!le region, defined !y 5 corner points, is shaded in =olution >"hi!it 110:0. 9e ne"t use the trial0and0error method to chec, the contri!ution margins at each of the five corner points of the area of feasi!le solutions. T(ial 1 2 ' : 5 Co('e( !D2." (0,0) (22,0) (1.,.) (',1.) (0,1.) Total Co't(i#)tio' Ma(3i' ($'00 0) A ($250 0) ? $0 ($'00 22) A ($250 0) ? $;,;00 ($'00 1.) A ($250 .) ? $7,:00 ($'00 ') A ($250 1.) ? $5,:00 ($'00 0) A ($250 1.) ? $:,500

The optimal solution that ma"imi$es contri!ution margin and operating income is 1. !atches of (ella8s (elights and . !atches of onny8s our!ons.

110':

11->1

('0 min.) Ma-e ,e(s)s #)/2 et&i%s

1. (irect materials per unit ? $1/5,000 '0,000 ? ;.50 (irect manufacturing la!or per unit ? $120,000 '0,000 ? $: 1aria!le manufacturing overhead for '0,000 units ? :0L of $225,000 ? $/0,000 1aria!le manufacturing overhead as a percentage of direct manufacturing la!or ? $/0,000 $120,000 ? 75L &i"ed manufacturing overhead ? ;0L of $225,000 ? $1'5,000 SOL7TION EAHI.IT 11->1A
Ma')fa%t)(i' 3 Costs fo( <62666 7'its !1" $1/5,000 120,000 .:,000 ';,000 /0,000 1'5,000 $;;0,000 Ma')fa%t)(i' 3 Costs fo( <82666 7'its Bit& Po(te( Esti$ates !8" $20.,000 12.,000 .:,000 ';,000 /;,000 1'5,000 $;.7,000 P)(%&ase Costs fo( <82666 7'its Bit& Po(te( Esti$ates !<" $55',;00 10,000 5,000 1'5,000 $70',;00

3urchasing costs ($17.'0@unit '2,000 units) (irect materials ($;.50@unit '0,000K '2,000 units) (irect manufacturing la!or ($:@unit '0,000K '2,000 units) 3lant space rental (or penalty to terminate) >Cuipment leasing (or penalty to terminate) 1aria!le overhead (75L of direct manufacturing la!or) &i"ed manufacturing overhead Total manufacturing or purchasing costs

*n the !asis of 3orter8s estimates, =olution >"hi!it 110:12 suggests that in 200/, the cost to purchase '2,000 units of <T-02000 #ill !e $70',;00, #hich is greater than the estimated $;.7,000 costs to manufacture <T-02000 in0house. ased solely on these financial results, the '2,000 units of <T-02000 for 200/ should !e manufactured in0house. 2. SOL7TION EAHI.IT 11->1. Ma')fa%t)(i'3 Costs fo( <82666 7'its Bit& Ha(t Esti$ates !>" $22:,;:0 1':,:00 .:,000 ';,000 100,.00 1'5,000 $71:,.:0 P)(%&ase Costs fo( <82666 7'its Bit& Ha(t Esti$ates !5" $55',;00 10,000 ',000 1'5,000 $701,;00

3urchasing costs ($17.'0@unit '2,000 units) (irect materials ($20.,000 1.0.) (irect manufacturing la!or ($12.,000 1.05) 3lant space rental (or penalty to terminate) >Cuipment leasing (or penalty to terminate) 1aria!le overhead (75L of direct mfg. la!or) &i"ed manufacturing overhead Total manufacturing or purchasing costs

110'5

ased solely on the financial results sho#n in =olution >"hi!it 110:1 , Gart8s estimates suggest that the '2,000 units of <T-02000 should !e purchased from <arley. The total cost from <arley #ould !e $701,;00, or $1',2:0 less than if the units #ere made !y 3ai!ec. '. 2t least four other factors that 3ai!ec 6orporation should consider !efore agreeing to purchase <T-02000 from <arley 6ompany include the follo#ing% Bn future years, 3ai!ec #ill not incur the rental and lease contract termination costs on its annual contacts that it #ill incur in 200/. This #ill ma,e the purchase option even more attractive, in a financial sense. ut then, <arley8s o#n longevity, its a!ility to provide the reCuired units of <T-02000, and its demanded price should !e considered, since terminating the contracts may ma,e the ma,e0versus0!uy decision a long0term one for 3ai!ec. The Cuality of the <arley component should !e eCual to, or !etter than, the Cuality of the internally made component. *ther#ise, the Cuality of the final product might !e compromised and 3ai!ec8s reputation affected. <arley8s relia!ility as an on0time supplier is important, since late deliveries could hamper 3ai!ec8s production schedule and delivery dates for the final product. Eayoffs may result if the component is outsourced to <arley. This could impact 3ai!ec8s other employees and cause la!or pro!lems or affect the company8s position in the community. Bn addition, there may !e la!or termination costs, #hich have not !een factored into the analysis.

:. -eferring to N=tandards of >thical 6onduct for <anagement 2ccountants,O in >"hi!it 10 7, Eynn Gart #ould consider the reCuest of Mohn 3orter to !e unethical for the follo#ing reasons. Competence 3repare complete and clear reports and recommendations after appropriate analysis of relevant and relia!le information. 2d7usting cost num!ers violates the competence standard. Integrity -efrain from either actively or passively su!verting the attainment of the organi$ation8s legitimate and ethical o!7ectives. 3ai!ec has a legitimate o!7ective of trying to o!tain the component at the lo#est cost possi!le, regardless of #hether it is manufactured internally or outsourced to <arley. 6ommunicate unfavora!le as #ell as favora!le information and professional 7udgments or opinions. Gart needs to communicate the proper and accurate results of the analysis, regardless of #hether or not it favors internal production. -efrain from engaging in or supporting any activity that #ould discredit the profession. &alsifying the analysis #ould discredit Gart and the profession.

110';

Credibility 6ommunicate information fairly and o!7ectively. Gart needs to perform an o!7ective ma,e0 versus0!uy analysis and communicate the results fairly. (isclose fully all relevant information that could reasona!ly !e e"pected to influence an intended user8s understanding of the reports, comments, and recommendations presented. Gart needs to fully disclose the analysis and the e"pected cost increases.

Confidentiality +ot affected !y this decision. Gart should indicate to 3orter that the costs she has derived under the ma,e alternative are correct. Bf 3orter still insists on ma,ing the changes to lo#er the costs of ma,ing <T-02000 internally, Gart should raise the matter #ith 3orter8s superior, after informing 3orter of her plans. Bf, after ta,ing all these steps, there is a continued pressure to understate the costs, Gart should consider resigning from the company, rather than engage in unethical conduct.

110'7

11.:2('0 min.) P(o*)%t $iE2 %o'st(ai'e* (eso)(%e

1.

+ealy Tersa 3elta Total

2.

7'its !1" 1,.00 :,500 '/,000

Ma%&i'e H(s Pe( 7'it !8" 9 Va( Ma%& CostG7'it : ;866GHo)( $;00 D $200 ? ' $500 D $200 ? 2.5 $200 D $200 ? 1

Ma%&i'e H(s De$a'*e* !<" 9 !1" H !8" 5,:00 11,250 '/,000 55,;50 Pelta $.00 100 200 .0 '.0 $:20

=elling price 1aria!le costs% (irect materials 1aria!le machining =ales commissions (5L, 5L, 10L) Total varia!le costs 6ontri!ution margin per unit

Neal/ $',000 750 ;00 150 1,500 $1,500

Te(sa $2,100 500 500 105 1,105 $ //5

'. Total machine hours needed to satisfy demand e"ceed the machine hours availa!le (55,;50 needed R 50,000 availa!le). 6onseCuently <arion Taylor needs to evaluate these products !ased on the contri!ution margin per machine hour. 5nit contri!ution margin <achine0hours (<G) per unit 5nit contri!ution margin per <G Neal/ $1,500 D' <G $ 500 Te(sa $//5 D2.5 <G $'/. Pelta $:20 D1 <G $:20

ased on this analysis, <arion Taylor should produce to meet the demand for products #ith the highest unit contri!ution margin per machine hour, first +ealy, then 3elta, and finally Tersa. The optimal product mi" #ill !e as follo#s% +ealy 3elta Tersa Total 1,.00 units ? 5,:00 <G '/,000 units ? '/,000 <G 2,2:0 (5,;00 <G D 2.5 <G@unit) units ? 5,;00 <G (50,000 T 5,:00 T '/,000) 50,000 <G

:. The optimal product mi" in 3art ' satisfies the demand for +ealy and 3elta and leaves only 2,2;0 units (:,500 T 2,2:0) of Tersa unfilled. These remaining units of Tersa reCuire 5,;50 machine hours (2,2;0 units 2.5 <G per unit). The ma"imum price <arion Taylor is #illing to pay for e"tra machine hours is $'/., #hich is the unit contri!ution per machine hour for additional units of Tersa. That is, total cost per machine0hour for these units #ill !e $'/. A $200 (varia!le cost per machine0hour) ? $5/. per machine0hour.

110'.