Solution to Chapter 14 E14‐31,34,15,37, E39,40,41,44 EXERCISE 14-31 (15 MINUTES)
The owner’s analysis incorrectly includes the following allocated costs that will be
incurred regardless of whether the ice cream counter is operated:
Utilities ......................................................................................................................
Depreciation of building ..........................................................................................
Deli manager’s salary ..............................................................................................
Total ...........................................................................................................................
$ 4,350
6,000
4,500
$14,850
It is possible that closing the ice cream counter might save a portion of the
utility cost, but that is doubtful.
A better analysis follows:
Sales .....................................................................................................
Less: Cost of food ...............................................................................
Gross profit ..........................................................................................
Less: Operating expenses
Wages of counter personnel ...............................................
Paper products ......................................................................
Depreciation of counter equipment and furnishings* ........
Total ........................................................................................
Profit on ice cream counter
$67,500
30,000
37,500
$18,000
6,000
3,750
27,750
$ 9,750
*Depreciation on the counter equipment and furnishings is included because it is traceable
to the ice cream operation and is an expense in the determination of income. If a cash-flow
analysis is desired, this noncash expense should be excluded.
EXERCISE 14-34 (15 MINUTES)
1.
The owner’s reasoning probably reflects the following calculation:
Savings in annual operating expenses if old pizza oven is replaced .................. $3,000
Write-off of old oven’s remaining book value ($10,500 ÷ 3) ................................ (3,500)
“Loss” associated with replacement ...................................................................... $ (500)
2.
The owner’s analysis is flawed, because the book value of the old pizza oven is a sunk
cost. It should not enter into the equipment replacement decision.
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3.
Correct analysis:
Savings in annual operating expenses if old pizza oven is replaced .................. $3,000
Acquisition cost of new oven, which will be operable for one year .................... (2,200)
Net benefit from replacing old pizza oven .............................................................. $ 800
14-15 In a differential-cost analysis, the decision maker determines the difference in
each cost or revenue item that will occur under each of the alternatives under
consideration. Then the decision maker focuses on the differences in the costs
and revenues in making the decision.
EXERCISE 14-37 (15 MINUTES)
Dear (president’s name):
We recommend against processing banolide into kitrocide. The incremental
cost of further processing, $7,900, exceeds the incremental revenue, $7,500. This
$7,500 incremental revenue is the difference between the sales value of the kitrocide,
$11,000, and the sales value of the banolide, $3,500. We would also like to point out
that the cost of the joint process, $17,500, and the allocation of that cost to the joint
products is irrelevant to the decision.
Sincerely,
I.M. Student
Partner, Student Consulting Associates
EXERCISE 14-39 (15 MINUTES)
1.
The relevant cost of the theolite to be used in producing the special order is the
21,750p sales value that the company will forgo if it uses the chemical. This is an
example of an opportunity cost.
p denotes Argentina’s peso.
2.
(a) 21,750p sales value: Discussed in requirement (1).
(b) 24,000p book value (8,000 kilograms × 3p per kilogram): Irrelevant, since the
book value is a sunk cost.
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(c) 28,800p current purchase cost (8,000 kilograms × 3.60p per kilogram): Irrelevant,
since the company will not be buying any theolite.
EXERCISE 14-40 (20 MINUTES)
1.
The relevant cost of genatope is calculated as follows:
Cost of replacing the 1,000 kilograms to be used in the special order
(1,000 kilograms × 13.05p) ..................................................................................... 13,050 P
*Additional cost incurred on the next order of genatope as a result of
having to place the order early [4,000 kilograms × (13.05p – 12.45p)] ............... 2,400 P
Total relevant cost .................................................................................................... 15,450 p
p denotes Argentina’s peso.
*This cost would not be incurred if the special order were not accepted.
2.
(a) 97,200p book value (8,000 kilograms × 12.15p per kilogram): Irrelevant, since it is
a sunk cost.
(b) 1,000 kilograms to be used in the special order: Relevant, as shown in
requirement (1).
(c) 13.05p price if next order is placed early: Relevant, since this is the cost of
replacing the used genatope.
(d) 12.45p price if next order is placed on time: Relevant, because an additional 4,000
kilograms in the next order will be purchased at a .60p per kilogram premium.
This .60p premium is the difference between the 13.05p price and the 12.45p
price.
EXERCISE 14-41 (10 MINUTES)
The most profitable product is the one that yields the highest contribution margin
per unit of the scarce resource, which is direct labor. We do not know the amount of
direct-labor time required per unit of either product, but we do know that Beta
requires six times as much direct labor per unit as Alpha. Define an arbitrary time
period for which direct laborers earn $1.00, and call this a “time unit.” The two
products’ contribution margins per “time unit” are calculated as follows:
Unit contribution margin .....................................................
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Alpha
$9.00
Beta
$36.00
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“Time units” required per unit of product .........................
Contribution margin per “time unit”
Alpha: ($9.00 ÷ 3) ................................................................
Beta: ($36.00 ÷ 18) ..............................................................
3
18
$3.00
$ 2.00
Therefore, Alpha is a more profitable product. Any arbitrary amount of direct
labor time expended on Alpha production will result in a greater contribution margin
than an equivalent amount of labor time spent on Beta production.
PROBLEM 14-44 (25 MINUTES)
1.
Contemporary Trends will be worse off by $6,400 if it discontinues wallpaper
sales.
Sales……………………..
Less: Variable costs….
Contribution margin….
Paint and
Supplies
Carpeting Wallpaper
$190,000
114,000
$ 76,000
$230,000
161,000
$ 69,000
$ 70,000
56,000
$ 14,000
If wallpaper is closed, then:
Loss of wallpaper contribution margin…... $(14,000)
Remodeling…………………………………….
(6,200)
Added profitability from carpet sales*……
32,500
Fixed cost savings ($22,500 x 40%)……….
9,000
Decreased contribution margin from paint
and supplies ($76,000 x 20%)……………..
(15,200)
Increased advertising……………………….. (12,500)
Income (loss) from closure………………… $ (6,400)
* The current contribution margin ratio for carpeting is 30% ($69,000 ÷
$230,000). This ratio will increase to 35%, producing a new
contribution for the line of $101,500 [($230,000 + $60,000) x 35%].
The end result is that carpeting’s contribution margin will rise by
$32,500 ($101,500 - $69,000), boosting firm profitability by the same
amount.
2.
This cost should be ignored. The inventory cost is sunk (i.e., a past cost that
is not relevant to the decision). Regardless of whether the department is
closed, Contemporary Trends will have a wallpaper inventory of $11,850.
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3.
The Internet- and magazine-based firms likely have several advantages:
• These companies probably carry little or no inventory. When a customer
places an order, the firm simply calls its supplier and acquires the goods.
The result may be lower expenditures for storage and warehousing.
• These firms do not need retail space for walk-in customers.
• Internet- and magazine-based firms can conduct business globally.
Contemporary Trends, on the other hand, is confined to a single store in
Baltimore.
4. In the electronic version of the solutions manual, press the CTRL key and click
on the following link: BUILD A SPREADSHEET
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