Chapter 10
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Chapter 10
Relevant Information for Decision Making
14.
The minimum price is equal to the incremental cost of selling the obsolete
units. The only cost that will be incurred to sell the units is the variable selling
cost which = $15 × 0.40 = $6. If the firm can sell the units for more than $6, the
firm is better off than it would be by simply destroying the unsold units.
15.
a. The relevant factors include the difference between the starting salaries for
BAs and MAs, time until retirement, time to complete the MA, and the outof-pocket costs to obtain the MA.
b. The opportunity cost associated with earning the master's degree is two
years’ income that could have been earned with the BA degree ($48,400 x 2
= $96,800).
c. The out-of-pocket cost would include the cost of tuition, books, lab fees,
and other direct educational costs ($92,000). It would not include room and
board or other living expenses that would be incurred irrespective of
whether the student works (with the BA degree) or attends school.
17.
d. The other factors to be considered would be the qualitative factors, e.g.,
the relative satisfaction, prestige, and happiness obtained from jobs that
can be secured with each degree, and each alternative's effect on
retirement plans, free time, and travel opportunities.
a. The sunk cost is the original cost of the old equipment, $350,000.
b. Irrelevant future costs include $16,000 of cash operating costs and the
(nondifferential) salvage values in five years.
c. The relevant costs include the cost of the new equipment, $396,000, the
current salvage value of the old equipment, $88,000 and $48,000 of annual
cash operating savings.
d. The opportunity costs associated with keeping the old equipment include
the potential $48,000 savings in cash operating costs, and the current
$88,000 salvage value of the old equipment.
e. The incremental cost to purchase the new equipment is the difference
between the purchase cost of the new machine and the current salvage
value of the old machine, $396,000 - $88,000 = $308,000.
f. Some qualitative factors to be considered would include how the new
machine would affect the quality of production relative to the old machine,
effects on employee morale if purchasing the new machine would require
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layoffs, and whether current employees have the skills to operate the new
machine.
19.
a. Relevant cost to manufacture = $4.80
Relevant cost to buy = $4.00
Advantage of buying: 120,000 x ($4.80 - $4.00) = $96,000
b. Relevant cost to buy
Avoidable variable costs
Minimum avoidable fixed costs
20.
$ 4.00
(3.68)
$ 0.32 per unit
The relevant costs to make the bumpers include only the variable costs:
Direct material
$53 (incl. purchased mounting hardware at $15)
Direct labor
17
Overhead ($45 × 1/3)
15
Total
$85
Incremental profit per bumper = $160 - $85 = $75
Increased profit from released facilities: ($70 x 4,800)
Increased cost of production on first 300,000 units:
($20 - $15) x 300,000
Net profit effect of purchasing mounting hardware
21.
$
336,000
(1,500,000)
$(1,164,000)
a. Cost to make: $27,000 + ($2.70 x 25,000) =
Cost to buy:
25,000 x $3.60 =
Advantage of purchasing
$ 94,500
(90,000)
$ 4,500
b. Cost to make: $27,000 + ($2.70 x 60,000) =
Cost to buy: 60,000 x $3.60
=
Disadvantage of purchasing
$189,000
216,000
$(27,000)
c. Point of indifference occurs at the volume level that equates the cost to
make with the cost to buy:
$27,000 + $2.70X = $3.60X
X = 30,000 units
22.
a.
MP3 Players
Contribution margin
$12
Divide by labor time per unit
÷1
CM per unit of labor time
$12
PDAs
$20
÷2
$10
Because the company can sell as many of either product as it can make, it
should make only MP3 Players. The company should make 100,000 MP3
Players.
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b. The company should consider the need to provide a market assortment of
goods and the possibility of customer preferences permanently changing
to PDAs not made by Michigan Mfg. This is acknowledging the possible
long-term consequences of a short-term problem solution.
23.
a.
Individual
Sales price
$350
Variable costs
(50)
Contribution margin
$300
Estate Corporate
$1,200
$750
(200)
(150)
$1,000
$600
Contribution margin per hour of professional time:
Individual: $300 ÷ 2 = $150
Estate: $1,000 ÷ 8
= $125
Corporate: $600 ÷ 5 = $120
According to the CM generated per hour of professional time, White would
prefer to satisfy demand for services in the following order: individual
taxation, estate taxation, and corporate taxation. Because all of White’s
time could be consumed in providing individual income tax services, all of
her time should be dedicated to providing that service.
b. Contribution margin: 2,000 x $150
Fixed costs
Pretax income
$300,000
(80,000)
$220,000
c. White should carefully consider the relationship between the three services
she offers. For example, much of the demand for individual and estate tax
services may be generated by the services she provides corporate clients.
It may be because of the quality of her corporate tax services that demand
is generated to provide individual income and estate tax services.
Accordingly, there may be long-term negative consequences to providing
only individual income tax services.
d. White could overcome the time constraint in one of two generic ways.
First, she could employ accountants in her firm to do work in all service
lines. Secondly, she could engage in a joint venture or partnership with
other firms to provide the full array of services to clients.
24.
a.
Revenue
Labor costs
Material costs
CM
Fixed costs
Income before taxes
b. Contribution margin
Divide by sales
Grooming
Training
Total
$1,500,000 $1,400,000 $2,900,000
(600,000)
(820,000) (1,420,000)
(180,000)
(140,000)
(320,000)
$ 720,000 $ 440,000 $1,160,000
(250,000)
(260,000)
(510,000)
$ 470,000 $ 180,000 $ 650,000
$ 720,000
1,500,000
$ 440,000
1,400,000
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Contribution margin %
48%
31%
If $1 spent on advertising could increase revenue by either service by $20,
it should be spent on Grooming because it has a higher contribution
margin percent.
c.
Revenue per hr.
Variable costs per hr.
CM per hr.
Grooming
$50
(26)
$24
Training
$70
(48)
$22
Because $1 will yield $24 in CM if spent on grooming, but yield only $22 in
CM if spent on training, the $1 should be spent advertising the company’s
grooming services.
25.
a. Sales (120,000 x $60)
Variable costs [($24 + $12) x 120,000]
Contribution margin
Fixed costs
Projected profit
$ 7,200,000
(4,320,000)
$ 2,880,000
(1,240,000)
$ 1,640,000
b. New sales [(120,000 x 1.20) x ($60 x 0.90)]
New variable costs [(120,000 x 1.20) x $36]
New contribution margin
Old contribution margin
Change in profit
c. Change in CM $2,880,000 x 0.20
Change in fixed costs
Change in profit
26.
$ 7,776,000
(5,184,000)
$ 2,592,000
(2,880,000)
$ (288,000)
$576,000
(185,000)
$391,000
a. Profit effect of option 1:
Cell phones
Ear buds
Charger
Total
Increase in sales*
$10,500,000
$800,000
$400,000 $11,700,000
Increase in V.C.
(8,960,000)
(200,000)
(140,000) (9,300,000)
Contribution margin $ 1,540,000
$600,000
$260,000 $ 2,400,000
Increase in F.C.
(1,000,000)
Increase in profits
$ 1,400,000
* New sales volume would be as follows:
Cell phones: 2,200,000 × .70 = 1,540,000
Ear buds:
2,200,000 × .20 = 440,000
Charger: 2,200,000 × .10
= 220,000
Change in sales volume would be as follows:
Cell phones: 1,540,000 – 1,400,000 = 140,000
Ear buds: 440,000 – 400,000 = 40,000
Charger: 220,000 – 200,000 = 20,000
Profit effect of option 2:
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Cell phones
Ear buds
Increase in sales* $115,500,000
$10,000,000
Increase in V.C.
(112,000,000)
(2,500,000)
Contribution margin $ 3,500,000 $ 7,500,000
Increase in F.C.
Increase in profits
*(1,750,000 × $70) - (1,400,000 × ($75-70))
Charger
Total
$5,000,000 $130,500,000
(1,750,000) (116,250,000)
$3,250,000 $ 14,250,000
(0)
$ 14,250,000
The preferred alternative is to decrease the price of cell phones to $70.
This alternative increases profits by $14,250,000 - $1,400,000 = $12,850,000
relative to the alternative of decreasing the price of cell phones.
b. One alternative is to decrease the price of the ear buds and charger.
Although this alternative would minimally impact cell phone sales volume,
sales volumes for ear buds and chargers should increase. Another
alternative would be to focus promotional efforts on the ear buds and the
charger in addition to the cell phones.
27.
a. Only the variable production costs are relevant to this decision:
$520 + $40 + $50 = $610.
b. Incremental revenue: $620 x 200
Incremental costs: $610 x 200
Incremental profit
$124,000
(122,000)
$ 2,000
Profits would increase by $2,000 if this special order was accepted.
28.
a. The relevant costs include the lost contribution margin associated with the
20 units of regular production that would be sacrificed to accept the special
order, and the variable production costs for the three special stands:
Normal sales price (20 x $230)
$ 4,600
Variable costs (20 x $100)
(2,000)
Lost contribution margin
$ 2,600
Production costs (3 x $690)
2,070
Total costs
$ 4,670
b. Additional sales
Less total relevant costs
Incremental loss
29.
$ 3,800
(4,670)
$ (870)
a. If the U. S. Division had been eliminated, Borderland’s income statement
would have appeared as follows:
Sales
Variable costs
Contribution margin
Fixed costs:
Direct
$ 3,600,000
(2,088,000)
$ 1,512,000
$ 490,000
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Corporate
Operating income (loss)
b.
Sales
Variable costs
Direct fixed costs
Segment margin
Corporate costs
Operating income (loss)
2,790,000
(3,280,000)
$(1,768,000)
United States Mexico
Total
$7,200,000 $3,600,000 $10,800,000
(4,740,000) (2,088,000) (6,828,000)
(800,000)
(490,000) (1,290,000)
$1,660,000 $1,022,000 $ 2,682,000
(2,790,000)
$ (108,000)
If the U. S. Division is eliminated, corporate income would decline by the
$1,660,000 of segment margin currently being generated by that division.
The common corporate costs of $2,790,000 would then need to be covered
in total by the Mexico Division, which it cannot do.
30.
a. Gross margin GL Services
Avoidable fixed and variable operating costs
Segment margin
$ 1,200,000
(1,470,000)
$ (270,000)
Yes, the company should strongly consider dropping the GL service line
because it generates a negative segment margin of $270,000.
b. The pretax profit of the company would rise by $270,000 (the amount of the
negative segment margin of the GL service line) if the GL area was
dropped.
39.
a. Relevant costs include:
Variable production costs: ($0.08 + $0.06 + $0.04) or $0.18 per unit
Annual salary of manager who can be replaced: $50,000
Vendor’s offering price: $0.19 per unit
b. Production costs saved ($0.18 x 4,000,000)
Salary savings
Purchase cost of part ($0.19 x 4,000,000)
Advantage of outsourcing the part
$720,000
50,000
(760,000)
$ 10,000
c. Other considerations include the relative quality of the part acquired from
the vendor and the part produced internally, the ability of the vendor to
deliver in a timely manner, the existence of competitors of the vendor, the
likelihood that future volume levels will differ from present volume levels.