Chapter 24 (9) Differential Analysis and Product Pricing Study Guide Solutions Fill-in-the-Blank Equations

Chapter 24 (9)
Differential Analysis and Product Pricing

Study Guide Solutions
Fill-in-the-Blank Equations
1. Differential revenue
2. Differential costs
3. Differential income (Loss)
4. Markup per unit
5. Estimated units produced and sold
6. Total selling and administrative expenses
7. Desired rate of return
8. Target cost
9. Production bottleneck hours per unit
Exercises
1. Charleston Affair currently has a piece of equipment that is no longer needed. The
current book value of the piece of the equipment is $12,000. The company has the
option to lease the equipment for the next three years for $5,500 each year, or sell the
equipment for $16,000. If leased, the equipment would have no residual value at the
end of the lease. The company expects that maintenance and other expenses during the
lease would total $2,000. If sold, Charleston Affair would pay a 5% commission. Prepare
a differential analysis to determine if the company should sell (Alternative 1) or lease
(Alternative 2) the equipment.
Revenues
Costs
Income (loss)
Differential Analysis
Sell (Alt. 1) or Lease (Alt. 2)
Differential Effect
Sell (Alt. 1) Lease (Alt. 2) on Income (Alt. 2)
$16,000
$16,500
$ 500
(800)
(2,000)
(1,200)
$15,200
$14,500
$ (700)
Charleston Affair should sell the asset.
1
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Chapter 24 (9)
2. Wake Coffee Co. has a piece of equipment no longer needed for production. The
company purchased the equipment for $75,000 and has accumulated depreciation of
$10,000 related to the equipment. Wake Coffee Co. has determined it can either lease
the equipment for the next ten years, for yearly revenues of $9,000, or sell the
equipment for $70,000. If leased, the company expects to incur repairs and other
expenses of $22,000 over the life of the lease. The equipment would also have a $3,500
salvage value. If sold, the broker requires a 4% broker commission. Prepare a differential
analysis to determine if the company should sell (Alternative 1) or lease (Alternative 2)
the equipment.
Revenues
Costs
Income (loss)
Differential Effect on
Sell (Alt. 1) Lease (Alt. 2)
Income (Alt. 2)
$70,000
$ 93,500
$ 23,500
(2,800)
(22,000)
(19,200)
$67,200
$ 71,500
$ 4,300
Revenues if leased = $90,000 + $3,500

Wake Coffee Co. should lease the asset.
3. Blair Designs is considering two alternatives for an outdated piece of machinery: leasing
the machinery for five years, which would produce revenue of $8,000 year or selling the
machinery for $38,000. The asset has a current book value of $25,000. If leased, the
company expects to incur $7,000 of expenses for maintenance and taxes, and the
equipment will have a $4,000 salvage value. If sold, the broker charges a 5% commission
fee. Prepare a differential analysis to determine if the company should sell (Alternative
1) or lease (Alternative 2) the machinery.
Revenues
Costs
Income (loss)
Sell (Alt. 1) Lease (Alt. 2)
Income (Alt. 2)
$38,000
$44,000
$ 6,000
(1,900)
(7,000)
(5,100)
$36,100
$37,000
$ 900
Blair Designs should lease the asset.
Differential Analysis and Product Pricing 3
Strategy: When determining whether to sell or lease an asset, first determine the
revenues in each situation. If sold, the revenue is the selling price, and if leased, the
revenue is the lease revenue and the salvage value, if any. Next determine the costs,
which usually include a sales commission when selling and cost of upkeep when leasing.
Determine the differential effect on income. If positive, the company should proceed
with Alternative 2.
4. Product B at Charleston Affair generates sales of $59,000 for 10,000 units. Each unit has
variable costs of $4.50 apiece and total fixed costs of $18,000. Prepare a differential
analysis to determine if Product B should be continued (Alternative 1) or discontinued
(Alternative 2) if the fixed costs are unaffected by the decision.
Continue (Alt. 1) or Discontinue (Alt. 2) Product B
Differential Effect
Continue (Alt. 1) Discontinue (Alt. 2) on Income (Alt. 2)
$ 59,000
$
0
$(59,000)
Revenues
Costs:
Variable
Fixed
Total costs
Income (loss)
$(45,000)
(18,000)
$(63,000)
$ (4,000)
$
0
(18,000)
$(18,000)
$(18,000)
$ 45,000
0
$ 45,000
$(14,000)
Product B should be continued because the income generated from the product will
cover some of fixed costs.
Chapter 24 (9)
5. Wake Coffee Co. incurs a loss from operations for the Standard Coffee line. Sales
revenues for the line total $72,000, while incurring variable costs of goods sold of
$19,500, variable selling expenses of $17,400, and fixed costs of $49,000. Prepare a
differential analysis to determine if the Standard Coffee line should be continued
(Alternative 1) or discontinued (Alternative 2). Assume the company will incur the fixed
costs regardless of the decision.
Continue (Alt. 1) or Discontinue (Alt. 2) Standard Coffee
Differential Effect
Continue (Alt. 1) Discontinue (Alt. 2) on Income (Alt. 2)
Revenues
$ 72,000
$
0
$(72,000)
Costs:
Variable
$(36,900)
$
0
$ 36,900
Fixed
(49,000)
(49,000)
0
Total costs
$(85,900)
$(49,000)
$ 36,900
Income (loss)
$(13,900)
$(49,000)
$(35,100)
The Standard Coffee Line should be continued.

6. Product BW of Blair Designs generates sales revenue of $40,000. The product incurs
variable costs of goods sold of $22,000, fixed selling costs of $22,000, and fixed factory
overhead of $21,000. Use a differential analysis to determine if Product BW should be
continued (Alternative 1) or discontinued (Alternative 2). Assume that the company will
incur the fixed factory overhead regardless of the decision.
Revenues
Costs:
Variable
Fixed
Total costs
Income (loss)
Continue (Alt. 1) or Discontinue (Alt. 2) Product BW
Continue (Alt. 1) Discontinue (Alt. 2)
Income (Alt. 2)
$ 40,000
$
0
$(40,000)
$(22,000)
(43,000)
$(65,000)
$(25,000)
$
0
(21,000)
$(21,000)
$(21,000)
$ 22,000
22,000
$ 44,000
$ 4,000
Product BW should be discontinued.
Strategy: If the company continues the product line, the revenues and costs will be equal
to the amounts expected. However, if the company discontinues the product line, no
revenue will be earned and no variable costs will be incurred. However, the fixed costs
may remain since the company will incur the costs regardless of the number of products
finished. Determine the differential effect on income. If positive, the company should
decide Alternative 2.
7. Charleston Affair currently makes the King Component, incurring variable costs of $18
per unit and fixed costs of $4 per unit. The company has the option to purchase the
component for $20 per unit. Prepare a differential analysis to determine if the company
should make (Alternative 1) or buy (Alternative 2) the King Component. Assume that the
fixed costs will be incurred in each situation.
Make (Alt. 1) or Buy (Alt. 2) King Component
Differential Effect
Make (Alt. 1) Buy (Alt. 2) on Income (Alt. 2)
Unit costs:
Purchase price
Variable costs
Fixed costs
Income (loss)
0
(18)
(4)
$(22)
$(20)
0
(4)
$(24)
$(20)
18
0
$ (2)
Charleston Affair should make the King Component.
Chapter 24 (9)
8. The Wake Coffee Co. currently produces the Sealable Coffee Bag and incurs the
following costs per unit: direct materials, $2; direct labor, $3; variable factory overhead,
$2.50; and fixed factory overhead, $3.50. The company also has the option to purchase
the product for $9.50 per unit. The seller charges a $1.25 freight fee per unit. Prepare a
differential analysis to determine if Wake Coffee Co. should make (Alternative 1) or buy
(Alternative 2) the product, assuming that the fixed costs will be incurred regardless of
the decision.
Make (Alt. 1) or Buy (Alt. 2) Sealable Coffee Bag
Differential Effect
Unit costs:
Purchase price
$
0
$ (5.75)
$(5.75)
Freight fee
0
(1.25)
(1.25)
Variable costs
(7.50)
0
7.50
Fixed costs
(3.50)
(3.50)
0
Income (loss)
$(11.00)
$(10.50)
$ 0.50
Wake Coffee Co. should buy the Sealable Coffee Bag.

9. Blair Designs currently produces a Subcomponent, incurring variable direct costs of
$4.25 per unit, variable factory overhead of $2.25 per unit, and fixed factory overhead
of $5.00 per unit. The company could also buy the Subcomponent for $7.50 from an
outside provider, which would also charge a freight fee of $2.00 per unit. Prepare a
differential analysis to determine if Blair Designs should make (Alternative 1) or buy
(Alternative 2) the Subcomponent, assuming that fixed factory overhead will be incurred
if the product is made or sold.
Make (Alt. 1) or Buy (Alt. 2) Subcomponent
Differential Effect
Unit costs:
Purchase price
Freight fee
Variable costs
Fixed costs
Income (loss)
0
0
(6.50)
(5.00)
$(11.50)
$ (7.50)
(2.00)
0
(5.00)
$(14.50)
$(7.50)
(2.00)
6.50
0
$(3.00)
Blair Designs should make the Subcomponent.
Strategy: First, determine the costs associated with making the product, which usually
include the variable and fixed costs. Next, determine the costs associated with buying
the product, which include the costs to acquire the good (purchase price, freight fees,
etc.), and fixed costs since the company will incur the costs regardless of the products
produced. Then, determine the differential effect on income, and if positive, the
company should proceed with Alternative 2.
10. Charleston Affair is considering replacing an outdated piece of machinery. Use the
information below for the old piece of machinery and new machinery to prepare a
differential analysis to determine if Charleston Affair should continue (Alternative 1) or
replace (Alternative 2) the old machine.
Old machine:
Estimated annual variable manufacturing costs
Estimated selling price
Estimated residual value
Estimated remaining useful life
New machine:
Purchase price
Estimated useful life
$18,000
$10,000
$6,500
7 years
$110,000
$5,000
$1,500
7 years
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)
Differential Effect
Continue (Alt. 1) Replace (Alt. 2) on Income (Alt. 2)
Revenues:
Proceeds from sale of old machine
Residual Value
Costs:
Purchase price
Variable manufacturing costs (7 years)
Total costs
Income (loss)
0
6,500
$
0
(126,000)
$(126,000)
$(119,500)
10,000
1,500
$ 10,000
(5,000)
$(110,000)
(35,000)
$(145,000)
$(133,500)
$(110,000)
91,000
$ (19,000)
$ (14,000)
Charleston Affair should continue with the old machine.
Chapter 24 (9)
11. Wake Coffee Co. has an outdated piece of machinery that the company is considering
replacing. Use the information below for the two pieces of machinery. Prepare a
differential analysis to determine if the company should continue with the old piece of
machinery (Alternative 1) or replace the piece of machinery (Alternative 2).
Old machine
Estimated annual variable manufacturing costs $15,000
$3,200
5 years
New machine
Purchase price
$42,000
0
5 years
Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)
Continue (Alt. 1) Replace (Alt. 2)
Income (Alt. 2)
Revenues:
Proceeds from sale of old machine
Costs:
Purchase price
Total costs
Income (loss)
$
0
(75,000)
$(75,000)
$(75,000)
3,200
$ 3,200
$(42,000)
(30,000)
$(72,000)
$(68,800)
$(42,000)
45,000
$ 3,000
$ 6,200
Wake Coffee Co. should replace the old machine.
12. Blair Designs has an old piece of equipment that management is considering replacing.
Use the information below for the piece of equipment and its replacement to prepare a
differential analysis to determine if the company should continue with the old piece of
equipment (Alternative 1) or replace the piece of equipment (Alternative 2).
Old equipment
$3,200
10 years
New equipment
Purchase price
$50,000
$5,000
$5,000
10 years
Continue with Old Equipment (Alt. 1) or Replace Old Equipment(Alt. 2)
Differential Effect
Continue (Alt. 1) Replace (Alt. 2) on Income (Alt. 2)
Revenues:
Proceeds from sale of old equipment
Residual value
Costs:
Purchase price
Total costs
Income (loss)
0
0
$
0
(115,000)
$(115,000)
$(115,000)
3,200
5,000
$ (50,000)
(50,000)
$(100,000)
$ (91,800)
3,200
5,000
$(50,000)
65,000
$ 15,000
$ 23,200
Blair Designs should replace the old piece of equipment.

Strategy: First, determine the revenues for each alternative. If continued to use the piece
of equipment, any residual value would be considered revenue. If replaced, the proceeds
from the sale and any residual value of the new equipment would be considered
revenue. Next, determine the costs, which include the variable manufacturing costs for
both situations, or the costs to produce goods with the equipment. The cost to purchase
the new equipment would be considered a cost if replaced. Then, determine the
differential effect on income. If positive, the company should proceed with Alternative 2.
10
Chapter 24 (9)
13. Charleston Affair produces Product K for $8 per pound, which can be sold for $15 per
pound or processed into Product M, which sells for $30 per pound. Each pound requires
an additional $12 to process into Product M. Prepare a differential analysis to determine
if the company should sell Product K (Alternative 1) or process further into Product M
(Alternative 2).
Sell Product K (Alt. 1) or Process into Product M (Alt. 2)
Differential Effect
Sell (Alt. 1) Process Further (Alt. 2) on Income (Alt. 2)
Revenues, per unit
$15
$ 30
$ 15
Costs, per unit
(8)
(20)
(12)
Income (loss), per unit
$ 7
$ 10
$ 3
Charleston Affair should process further into Product M.

14. Wake Coffee Co. processes Standard Coffee in batches of 5,000 pounds, which sell for
$8 per pound and cost $10,000 to produce. The company can process the Standard
Coffee into Deluxe Coffee for additional costs of $6,000 per 5,000 pound batch. Each
batch of Deluxe Coffee produces 3,000 pounds, which sell for $15 per pound. Prepare a
differential analysis to determine if Wake Coffee Co. should sell Standard Coffee
(Alternative 1) or process further into Deluxe Coffee (Alternative 2).
Sell Standard Coffee (Alt. 1) or Process into Deluxe Coffee (Alt. 2)
Differential Effect
Sell (Alt. 1) Process Further (Alt. 2) on Income (Alt. 2)
Revenues
$ 40,000
$ 45,000
$ 5,000
Costs
(10,000)
(16,000)
(6,000)
Income (loss) $ 30,000
$ 29,000
$(1,000)
Wake Coffee Co. should sell Standard Coffee.
15. Blair Designs produces 4,000 yards of Solid Fabric per batch, which sells for $5 per yard.
Each batch of Solid Fabric produced incurs $12,000 of costs. The company can incur an
additional $3,000 in costs to process the batch of Simple Fabric into 2,400 yards of
Patterned Fabric, which sells for $12 per yard. Prepare a differential analysis to
determine if the company should sell Solid Fabric (Alternative 1) or process further into
Patterned Fabric (Alternative 2).
Sell Solid Fabric (Alt. 1) or Process into Patterned Fabric (Alt. 2)
Sell (Alt. 1) Process Further (Alt. 2)
Income (Alt. 2)
Revenues
$ 20,000
$ 28,800
$ 8,800
Costs
(12,000)
(15,000)
(3,000)
Income (loss)
$ 8,000
$ 13,800
$ 5,800
Blair Designs should process further into Patterned Fabric.

Strategy: The revenue in each situation would be the revenues produced by the goods.
The costs are equal to the total costs incurred to produce the product. If processed
further, the costs should include the costs to produce the original product and the costs
to process further into the more finished good. Next, determine the differential effect on
income. If positive, the company should proceed with Alternative 2.
16. Charleston Affair received a special purchase order for 5,000 units at a purchase price of
$10 per unit, which are normally sold at $12 each. Each unit requires $6 of variable
manufacturing costs. Each purchase order incurs processing costs of $2,000. Prepare a
differential analysis to determine if the company should reject (Alternative 1) or accept
(Alternative 2) the order, assuming there is sufficient capacity.
Reject (Alt. 1) or Accept (Alt. 2) Order
Revenues
Costs:
Variable manufacturing costs
Processing costs
Income (loss)
Differential Effect
Reject (Alt. 1) Accept (Alt. 2) on Income (Alt. 2)
$0
$ 50,000
$ 50,000
$0
0
$0
$(30,000)
(2,000)
$ 18,000
$(30,000)
(2,000)
$ 18,000
Charleston Affair should accept the special order.
12
Chapter 24 (9)
17. Wake Coffee Co. normally sells finished goods for $8.50 per unit. The company received
a special order to sell 4,000 units for $4.50 each. The variable manufacturing costs per
unit is $3, and the company will incur an additional $2.50 per unit to rush the order.
Prepare a differential analysis to determine if the company should reject (Alternative 1)
or accept (Alternative 2) the order, assuming there is sufficient capacity to produce the
goods.
Revenues, per unit

Costs, per unit:
Rush order costs
Income (loss)
Differential Effect
$0
$ 4.50
$ 4.50
$0
0
$0
$(3.00)
(2.50)
$(1.00)
$(3.00)
(2.50)
$(1.00)
Wake Coffee Co. should reject the special order.

18. Blair Designs sells its finished goods in batches of 2,000 units for $4 per unit. The
company has received a special order for three batches for a total selling price of
$10,000. Each unit incurs variable manufacturing costs of $1.50 per unit and each batch
incurs variable costs of $200. Prepare a differential analysis to determine whether Blair
Designs should reject (Alternative 1) or accept (Alternative 2) the order, assuming there
is sufficient capacity to produce the goods.
Revenues
Costs:
Per batch variable costs
Income (loss)
Differential Effect
$0
$10,000
$10,000
$0
0
$0
$(9,000)
(600)
$ 400
$(9,000)
(600)
$ 400
Blair Designs should accept the special order.

Strategy: If the company rejects the special order, no revenues will be earned and no
variable costs incurred. However, if the company accepts the special order, the revenue
and costs should be considered. If the differential effect on income is positive, the
company should proceed with Alternative 2.
19. Charleston Affair uses the product cost concept to price its goods. The company plans to
release a new product in the upcoming month. Use the information shown below to
determine:
a. Product cost per unit
$3.50 = $49,000/14,000
b. Desired profit
$12,000 = $120,000 10%
c. Markup percentage
90% = ($12,000 + $32,100)/$49,000
d. Markup per unit
$3.15 = 90% $3.50
e. Normal selling price per unit
$6.65 = $3.50 + $3.15
Total product cost
$49,000
Total selling and administrative expenses
$32,100
Total assets
$120,000
Estimated units produced and sold
14,000
Desired rate of return on assets
10%
14
Chapter 24 (9)
20. Wake Coffee Co. uses the product cost concept to price its goods. With the information
shown, calculate each of the following for a new good:
$4.00 = $24,800/6,200
b. Desired profit
$11,400 = $95,000 12%
c. Markup percentage (round to the nearest percentage)
87% = ($10,200 + $11,400)/$24,800
d. Markup per unit
$3.48 = 87% $4.00
$7.48 = $3.48 + $4.00
Total product cost
$24,800
Total selling and administrative expenses $10,200
Total assets
$95,000
6,200
12%
21. Blair Designs plans the release of a new product in the upcoming year. Use the product
cost concept and the information below to determine the following:
$1.28= $32,000/25,000
b. Desired profit
$21,000 = $140,000 15%
c. Markup percentage (round to the nearest percentage)
91%= ($21,000 + $8,000)/$32,000
d. Markup per unit (round to the nearest cent)
$1.16 = 91% $1.28
$2.44 = $1.28 + $1.16
Total product cost
$32,000
Total selling and administrative expenses
$8,000
Total assets
$140,000
25,000
15%
Strategy: After estimating the costs, determine the product cost per unit, which is equal
to the total product costs divided by the estimated number of units produced and sold.
Next, determine the markup percentage, which is the sum of the desired profit and
selling and administrative expenses divided by the total product cost, similar to the
break-even calculation with a target profit. The desired profit is the amount of income
the company expects to earn on its assets, calculated by multiplying the total assets by
the desired rate of return. The markup per unit is calculated by multiplying the markup
percentage by the product cost per unit. Add the markup and product costs per unit to
determine the normal selling price per unit.
22. Charleston Affair currently sells 1,000 units of Product Z for $64.50 and expects the price
to rise by 12% in the upcoming year. The balance sheet shows total assets of $200,000,
and management has set a required rate of return of 15% on the assets. Use the target
costing method to determine the total target cost the company should achieve.
Selling price= $72.24 = $64.50 1.12
Desired profit = $30,000 = $200,000 15%
Target cost = $42,240 = ($72.24 1,000 units) $30,000
23. Wake Coffee Co. expects for the price of Standard Coffee to be $12 per pound in 2016
and sell 2,000 pounds. The company owns $52,000 in assets, with a required rate of
return on the assets of 12%. Determine the total target cost the company should
achieve using the target costing method.
Desired profit = $6,240 = $52,000 12%
Target cost = $17,760 = ($12 2,000 units) $6,240
24. Blair Designs has a desired profit of $40 per unit of Product T in the upcoming year.
Product T currently sells for $72 a unit, but the price is expected to increase 20% in the
upcoming year. Use target costing to determine the target cost per unit the company
should achieve.
Selling price = $86.40 = $72 1.20
Target cost = $46.40 = $86.40 $40
Strategy: The target costing method determines the maximum costs the company
should incur if the product sells at a specified selling price and the company would like to
earn a desired profit. The target cost is equal to the estimated selling price less the
desired profit.
16
Chapter 24 (9)
25. All products at Charleston Affair must pass through a sealing treatment. When operating
at full capacity, the treatment is considered a production bottleneck. Use the
information below to determine the most profitable product when using bottleneck
resources.
Product X Product Y Product Z
Unit selling price
$ 9
$ 12
$ 18
Unit variable cost
2
6
10
Unit contribution margin
$ 7
$ 6
$ 8
Sealing treatment hours per unit
0.50
0.75
0.80
Unit contribution margin per production bottleneck hour
$ 14
$ 8
$ 10
Product X is the most profitable product when using bottleneck resources.

26. All finished goods at Wake Coffee Co. must pass through a sanitizing wash, which is a
production bottleneck when operating at full capacity. Use the information below to
determine the most profitable product when using bottleneck resources.
Unit selling price
Unit variable cost
Sanitizing wash hour per unit
Unit contribution margin per production bottleneck hour
Standard Deluxe French Roast

$ 100
$ 150
$ 200
40
80
120
$ 60
$ 70
$ 80
1.20
1.25
1.60
$ 50
$ 56
$ 50
The Deluxe would be the most profitable product when using bottleneck resources.
27. When operating at full capacity at Blair Designs, the stitching process is considered to be
a production bottleneck. Use the information below to determine which product is most
profitable when using bottleneck resources. Round answers to the nearest cent.
Solid Patterned Print
Unit selling price
$ 150
$ 210 $ 240
Unit variable cost
80
95
100
$ 70
$ 115 $ 140
Stitching process hours per unit
1.00
1.70
1.80
Unit contribution margin per production bottleneck hour $70.00
$67.65 $77.78
The Print product would be the most profitable when using bottleneck resources.
Strategy: If a bottleneck exists, the company must determine which product will be most
profitable for the amount of time it must spend in the production bottleneck. The unit
contribution margin per production bottleneck hour is calculated by dividing the unit
contribution margin by the time each unit spends in the production bottleneck.

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Chapter 24 (9)

Differential Analysis and Product Pricing

Charleston Affair should sell the asset.

Revenues if leased = $90,000 + $3,500

Blair Designs should lease the asset.

Differential Analysis and Product Pricing 3

The Standard Coffee Line should be continued.

Product BW should be discontinued.

Differential Analysis and Product Pricing 5

Charleston Affair should make the King Component.

Wake Coffee Co. should buy the Sealable Coffee Bag.

Blair Designs should make the Subcomponent.

Differential Analysis and Product Pricing 7

Charleston Affair should continue with the old machine.

Wake Coffee Co. should replace the old machine.

Differential Analysis and Product Pricing 9

Blair Designs should replace the old piece of equipment.

Charleston Affair should process further into Product M.

Wake Coffee Co. should sell Standard Coffee.

Differential Analysis and Product Pricing 11

Blair Designs should process further into Patterned Fabric.

Charleston Affair should accept the special order.

Revenues, per unit

Wake Coffee Co. should reject the special order.

Blair Designs should accept the special order.

Differential Analysis and Product Pricing 13

Differential Analysis and Product Pricing 15

Product X is the most profitable product when using bottleneck resources.

Standard Deluxe French Roast

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