ACTY 7212 Class activities – relevant costs

Question 1

Tim’s Tech manufactures three different product lines: Tech A, Tech B, and Tech C. Considerable market
demand exists for all models. The following per unit data apply:
Tech A Tech B Tech C
Selling price $180 $100 $140
Direct materials 120 30 69
Direct labour ($15 per hour) 30 15 30
Variable support costs ($5 per machine hour) 5 10 15
Fixed support costs 20 20 20

a. For each model, calculate the contribution margin per unit.

b. For each model, calculate the contribution margin per machine hour.
c. If there is excess capacity, which model is the most profitable to produce? Why?
d. If there is a machine breakdown, which model is the most profitable to produce? Why?
e. How can Tim encourage his sales people to promote the more profitable model?

Question 2
Noel’s Novelties manufactures Green Bay Packer cheese heads (small, medium, and large) that are sold to
area retailers. Production takes 0.20, 0.25, and 0.30 machine hours to manufacture one unit of the small,
medium, and large cheese heads, respectively. The company has a monthly capacity of 2,500 machine
hours. The following per unit data apply for the month of August:
Small Medium Large
Projected maximum sales 2,500 4,000 3,000
Machine hours required 0.20 0.25 0.30

Selling price $30 $36 $42

Direct materials 8 10 12
Direct labour 3 3 4
Variable support costs 4 5 5
Fixed support costs 2 2 2

a. For each size of cheese head, calculate the contribution margin per unit.
b. For each size of cheese head, calculate the contribution margin per machine hour.
c. How many units of each size should Noel’s produce this month to maximize profits?
d. Suppose a foreign firm places a special order for the purchase of an additional 1,000 medium cheese
heads at $50 each.
1. Determine the opportunity cost for this order.
2. What other issues might Noel want to consider before accepting this special order?
e. Suppose available machine hour capacity is reduced to 2000 machine hours due to a machine
breakdown. How many units of each size should Noel’s produce to maximize profits?

Question 3

Nanny McPhee, the owner and manager of Nanny’s Roasted Chicken Company, replaced the company’s
convection ovens just six months ago. Today, Green Valley Oven Manufacturing announced the
availability of a new convection oven that cooks much more quickly with lower operating expenses.
Nanny is considering the purchase of this faster, lower-operating cost, convection oven to replace the
existing one they recently purchased. Selected information about the two ovens is given below:

Existing New Turbo Oven

Original cost $120,000 $100,000
Accumulated depreciation $ 10,000 ---
Current salvage value $80,000 ---
Remaining life 10 years 10 years
Annual operating expenses $20,000 $15,000
Disposal value in 10 years $ 0 $ 0

Required:
a. What costs are sunk?
b. What costs are relevant?
c. What are the net cash flows over the next 10 years assuming that Nanny purchases the new
convection oven?
d. What other factors should Nanny consider when making this decision?
Class activities (Week 2) , Relevant Costs Solutions
Question 1
a. The contribution margin per unit is $25 for Tech A ($180 - $120 - $30 - $5),
$45 for Tech B ($100 - $30 - $15 - $10),
and $36 for Tech C ($140 - $59 - $30 - $15).
b. The contribution margin per machine hour is
$25 for Tech A ($25 contribution margin / 1.0 machine hours per unit),
$22.50 for Tech B ($45 / 2.0), and
$12 for Tech C ($36 / 3.0).
c. When there is excess capacity, Tech B is the most profitable because it has the greatest contribution
margin per unit.
d. When there are machine hour capacity constraints, Tech A is the most profitable because it has the
greatest contribution margin per constrained resource.
e. To encourage salespersons to promote specific products, Tim may want to provide marketing
incentives such as higher sales commissions for products contributing the most to profits. Brent
may also want to educate salespeople about the effects of constrained resources.

Question 2
a. The contribution margin per unit is
$15 for Small ($30 - $8 - $3 - $4),
$18 for Medium ($36 - $10 - $3 - $5), and
$21 for Large ($42 - $12 - $4 - $5).
b. The contribution margin per machine hour is
$75 for Small ($15 contribution margin / 0.20 machine hours per unit),
$72 for Medium ($18 / 0.25) and
$70 for Large ($21 / 0.30).
c. Machine hours required: Small (2,500 x 0.20) = 500 mh
Medium (4,000 x 0.25) = 1,000 mh
Large (3,000 x 0.30) = 900 mh
Total machine hours required 2,400 mh

Since total machine hours required are less than the capacity of 2,500 machine hours, to maximize
profits Noel’s should produce enough to meet projected sales for each size. That is, Noel’s should
produce 2,500 small, 4,000 medium, and 3,000 large cheese heads.

d. 1. Contribution margin for the special order:

Unit selling price $ 50
Unit variable costs ($10 + $3 + $5) 18
Contribution margin per unit $ 32

Machine hours available: 2,500

Machine hours required:
Special order (1,000 units x 0.25) 250
Current demand (total above) 2,400
(2,650)
Machine hour shortage (150)
Since the large size has the lowest contribution margin per machine hour, 500 (500 units x .3
mh/unit = 150 mh) units of the large size would not be produced if the special order was
accepted. Therefore, the opportunity cost for the special order would be $10,500 ($21
contribution margin per unit x 500 units), the contribution margin that would be sacrificed
when the production and sale of 500 units of large size cheese heads would be given up.
2. Noel’s will want to consider the impact of this special order on her regular customers now
and in the future. For example, will manufacturing fewer large cheese heads result in
shortages and, therefore, angry customers?

e. Available machine hours 2,000

Machine hours required:
Small (2500 x 0.20) = 500
Medium (4000 x 0.25) = 1,000
Machine hours remaining 500
Number of the large size that can be
produced is 1,666 units = (500 mh / 0.30 per unit)

The optimal production plan is as follows:

Small size 2500 units, Medium size 4000 units, Large size 1,666 units.
Question 3

a. Sunk costs include the original cost of the existing convection oven and the accompanying accumulated
depreciation.

b. Relevant costs include:

Acquisition cost of the new Turbo oven
Current disposal value of the existing convection oven
Annual operating expenses for the existing and the new Turbo oven

c. Net cash flows over 10 years with the new Turbo oven:

Cash inflow:
Decrease in annual operating expenses ($5,000 x 10) $ 50,000
Sale of the existing oven 80,000

Cash outflow:
Acquisition of the new Turbo oven (100,000)

Net cash inflow $ 30,000

d. Other items the manager should consider when making this decision include:
 The Turbo Oven’s reliability and efficiency is still unknown since it is a brand new
product.
 If the Turbo Oven bakes faster as it claims, the company may be able to increase
sales due to the quicker baking time.