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Relevant Costs!
1
CMA Ontario, 2011
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problem solving:!
calculate the incremental income from the special order= CM
from special order - any differential fixed costs!
if positive and does not displace regular sales, accept if it can
be contained!
if positive and displaces regular sales, consider long-term
impact of lost customers!
2
CMA Ontario, 2011
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$9.00
$2.50
3.00
1.00
Total costs
$6.50
According to the specifications provided by JCP,Inc., the special-order case requires less expensive raw
materials. Consequently, the raw materials will cost only $2.25 per case. Management has estimated that
the remaining costs, labor time, and machine time will be the same as for the Anchor jewelry case.
The second special order was submitted by the Krage Company for 7,500 jewelry cases at $7.50 per case.
Like the JCP cases, these jewelry cases would be marketed under the Krage label and have to be shipped
by October 1, 20x6. However, the Krage jewelry case is different from any jewelry case in the Anchor
line. The estimated per-unit costs of this case are as follows:
Raw materials
Direct labor 0.5 hours @ $6.00
Overhead 0.5 machine hours @ $4.00
$3.25
3.00
2.00
Total costs
$8.25
In addition, Anchor will incur $1,500 in additional setup costs and will have to purchase a $2,500 special
device to manufacture these cases; this device will be discarded once the special order is completed.
The Anchor manufacturing capabilities are limited to the total machine hours
available. The plant
capacity under normal operations is 90,000 machine hours per year or 7,500 machine hours per month.
The budgeted fixed overhead for 20x6 amounts to $216,000. All manufacturing overhead costs are
applied to production on the basis of machine hours at $4.00 per hour.
Anchor will have the entire third quarter to work on the special orders. Management does not expect any
repeat sales to be generated from either special order. Company practice precludes Anchor from
subcontracting any portion of an order when special orders are not expected to generate repeat sales.
Required: Should Anchor Company accept either special order? Justify your answer and
show your calculations.
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cost to make = !
all variable costs!
any avoidable fixed costs!
any opportunity costs of making the
component: alternative uses of space, lost CM!
1
CMA Ontario, 2011
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Problem 2 Make/Buy
Powell Dentistry Services operates in a large metropolitan area. Currently, Powell has its
own dental laboratory to produce porcelain and gold crowns. The unit costs to produce
the crowns are as follows:
Porcelain
Gold
Raw materials
$ 55
$ 94
Direct labour
22
22
Variable overhead
5
5
Fixed overhead
22
22
Total
$104
$143
Fixed overhead is detailed as follows:
Salary (supervisor)
Depreciation
Rent (lab facility)
$24,000
5,000
26,000
Overhead is applied on the basis of direct labour hours. The rates above were computed
using 5,500 direct labour hours.
A local dental laboratory has offered to supply Powell all the crowns it needs. Its price is
$100 for porcelain crowns and $132 for gold crowns; however, the offer is conditional on
supplying both types of crowns-it will not supply just one type for the price indicated. If
the offer is accepted, the equipment used by Powell's laboratory would be scrapped (it is
old and has no market value), the lab facility would be closed and the supervisor would
be laid off. Powell uses 1,500 porcelain crowns and 1,000 gold crowns per year.
Required
1.
2.
3.
Should Powell continue to make its own crowns or should they be purchased from
the external supplier? What is the dollar effect of purchasing?
Suppose that the lab facility is owned rather than rented and that the $26,000 is
depreciation rather than rent. What effect does this have on the analysis in
requirement 1?
Refer to the original data. Assume that the volume of crowns is 3,000 porcelain
and 2,000 gold. Should Powell make or buy the crowns? Explain the outcome.
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consider:!
fixed cost allocations!
cannibalization of existing products!
alternative uses of space!
1
CMA Ontario, 2011
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Problem 3 Add/Drop
Sales have never been good in Department C of Staceys Department Stores, For this
reason, management is considering the elimination of the department. A summarized
income statement for the store, by departments, for the most recent month is given below:
Sales
Variable expenses
Total
$1,000,000
574,300
Contribution margin
Fixed expenses
Salaries
Utilities
Direct advertising
General advertising 1
Rent on building 2
Employment taxes 3
Depreciation of fixtures
Insurance and property taxes
On inventory and fixtures
General office expenses
Service department expenses
Net income (loss)
1
2
3
Department
A
B
$500,000
$320,000
338,000
166,000
C
$180,000
70,300
425,700
162,000
154,000
109,700
49,000
6,200
89,000
25,000
38,000
4,900
36,000
18,000
2,600
32,000
12,500
16,000
1,800
12,000
16,000
2,000
27,000
8,000
12,000
1,600
15,000
15,000
1,600
30,000
4,500
10,000
1,500
9,000
7,900
54,000
81,000
391,000
2,300
18,000
27,000
142,200
4,000
18,000
27,000
130,600
1,600
18,000
27,000
118,200
34,700
$ 19,800
$ 23,400
$ (8,500)
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9 of 31
problem solving:!
calculate the contribution margin for each
product!
divide by the units of scarce resource to obtain
the CM per unit of scarce resource!
maximize profits by meeting demand for
products which have a higher CM/unit of
scarce resource!
1
CMA Ontario, 2011
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B12
B18
2.5
3.0
$ 2.25
4.00
$ 3.75
4.50
2.00
3.75
$12.00
2.25
4.50
$15.00
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Cool
Warm
Hot
600
$16
500
$18
400
$14
8
6
5
12
2
18
The company has existing stocks of 300 units of Cool and 200 units of Hot, but is
adopting just-in-time inventory management and expects to reduce inventory to zero by
the end of next year.
All three products use the same direct materials. In the next year, the available supply of
materials will be restricted to 5,000 kilograms of material Y9 and 12,000 litres of heat
sensitive paint. Material Y9 costs $0.95 per kilogram and the heat sensitive paint costs
$0.50 per litre. All other costs are fixed.
Required Calculate the number of units of each product Innovate Design Inc. should produce next
year to maximize company profits.
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1
CMA Ontario, 2011
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Linear Programming!
10
Linear Programming!
11
1
CMA Ontario, 2011
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Selling Price
Raw materials
Direct labor
Variable overhead
X
$30.00 per unit
10 kg per unit
12 minutes per unit
$7.00 per DLH
Y
$32.00 per unit
8 kg per unit
18 minutes per unit
$8.50 per DLH
Required:
(a)
Formulate and solve the linear programming problem required to determine the
production mix plan that will maximize the total contribution margin during the
month of July. Calculate the optimum contribution margin for July.
(b)
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Problem 11
a.
X
30.00
-12.50
-4.00
-1.40
12.10
Selling price
Raw materials: 10kg x 1.25 | 8kg x 1.25
Direct labour: .2 x 20 | .3 x 20
Variable overhead: .2 x 7 | .3 x 8.50
Objective Function
Subject to:
Y
32.00
-10.00
-6.00
-2.55
13.45
Maximize
Direct labour
Direct materials
Demand
Demand
Non-negative
B
X 2,500
1,500
DL
1,000
500
DM
X
500
1,000
1,500
2,000
2,500
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Point
A
B
C
X
1,500
1,714
2,500
Y
2,000
1,857
875
TCM
45,050
45,716
42,019
Point B is optimal.
b.
Y
\
Y
2,500
Y 2,000
DL
2,000
D
X 2,500
1,500
1,000
500
DM
X
500
1,000
1,500
2,000
2,500
We get a new point, D which it at the intersection of the direct materials and the Y
demand lines.
Point
D
X
1,600
Y
2,000
TCM
46,260
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18 of 31
Problem 13 - Uncertainty
Enrico, a renowned pastry chef employed by a four-star hotel, has decided to leave his
job at the hotel and invest $100,000 to open his own upscale pastry shop. His preliminary
investigations have uncovered the following:
i) There is a 55% chance that the market size in the area will be 600,000 pastries per
year and a 45% chance that it will be 450,000 pastries per year.
ii) The size of market share that Enrico will capture will depend on the location of his
shop. Two possibilities are available: location A, which costs $36,000 annual rent,
and location B, which costs $8,000 annual rent. It is estimated that Enrico will
capture a 30% share of the total market if he opens a shop in location A and a 21%
share of the total market if he opens a shop in location B.
The predicted market shares are based on a selling price of $2.00 per pastry. Variable
costs are estimated to be $0.80 per pastry and fixed costs, other than rent, are estimated to
be $80,000 per year at location A and $50,000 per year at location B.
Required a. Determine at which location Enrico should open his shop.
b. How much should Enrico be willing to pay to know with certainty the total market
size?
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12
Uncertainty!
States
State 1
P = x
State 2
P = 1 - x
Expected
Payoff
Action 1
Action 2
13
1
CMA Ontario, 2011
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Uncertainty Example!
Jacques operates a hot dog stand on Sunday mornings in the
market. Every Friday he has to let the market management
know whether or not he will set up his stand inside or outside.
If he sets up inside, the rent is $100 for the day. If he sets up
outside, the rent s $200 for the day. Each hot dog sells for $2.00
and variable costs per hot dog are $0.50. It is 3:00 on Friday
afternoon and Jacques has one hour to decide where the stand
will be located. The Weather Network s forecast of rain is 30%
for Sunday. He estimates sales volumes to be the following: !
Rain
No Rain
Inside
Outside
300
180
70
400
14
2
CMA Ontario, 2011
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Accelerated Program
Week 18
Suggested study plan for this week:
Primary List
1.
3.
Secondary List
3.
4.
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Problem 6 Add/Drop
Profits have been decreasing for several years at Oceanic Airlines. In an effort to improve
the company's performance, consideration is being given to dropping several flights that
appear to be unprofitable. A typical income statement for one such flight (flight 482) is
given below (per flight):
Ticket revenue (175 seats x 40%
occupancy x $200 ticket price)
Less variable expenses ($15 per person)
$14,000
1,050
100.0%
7.5
Contribution margin
12,950
92.5%
1,800
750
1,550
6,800
4,200
500
1,700
300
17,600
-$4,650
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As he rushed off for his meeting, Giterman indicated that if production exceeds 62,000
units per month, an additional supervisor must be hired and costs will increase by $7,700
per month.
Required:
Note: All requirements are independent situations. Expected activity levels do not include
the 10,000 units.
1.
2.
3.
Assume that the company already expects to be working at a level of 50,000 units
for the month. Calculate the minimum price the company could charge for this
special order without reducing its expected net income.
If the company expects to produce and sell 55,000 units this month, calculate the
minimum price the company could charge the customer for this special-order job
without reducing its expected net income.
Assume that the company expects to produce and sell 65,000 units this month.
Should the manager accept the customer's order? Support your decision with
appropriate calculations.
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Problem 8 Make/Buy
Sportway, Inc., is a wholesale distributor supplying a wide range of moderately priced
sporting equipment to large chain stores. About 60 percent of Sportway's products are
purchased from other companies, while the remainder of the products are manufactured
by Sportway. The company's Plastics Department is currently manufacturing molded
fishing tackle boxes. Sportway is able to manufacture and sell 8,000 tackle boxes
annually, making full use of its direct labour capacity at available workstations.
Following are the selling price and costs associated with Sportway's tackle boxes.
Selling price per box
Costs per box:
Molded plastic
Hinges, latches, handle
Direct labour ($15/hour)
Manufacturing overhead
Selling and administrative expenses
Profit per box
$86.00
$ 8.00
9.00
18.75
12.50
17.00
65.25
$20.75
Because Sportway believes it could sell 12,000 tackle boxes if it had sufficient
manufacturing capacity, the company has looked into the possibility of purchasing the
tackle boxes for distribution. Maple Products, a steady supplier of quality products,
would be able to provide up to 9,000 tackle boxes per year at a price of $68 per box
delivered to Sportway's facility.
Bart Johnson, Sportway's product manager, has suggested that the company could make
better use of its Plastics Department by manufacturing skateboards. To support his
position, Bart has a market study that indicates an expanding market for skateboards and
a need for additional suppliers. He believes that Sportway could expect to sell 17,500
skateboards annually at a price of $45 per skateboard. Bart's estimate of the costs to
manufacture the skateboards follows:
Selling price per skateboard
Costs per skateboard:
Molded plastic
Wheels, hardware
Direct labor ($15/hour)
Manufacturing overhead
Selling and administrative expenses
Profit per skateboard
$45.00
$5.50
7.00
7.50
5.00
9.00
34.00
$11.00
In the Plastics Department, Sportway uses direct labor hours as the application base for
manufacturing overhead. Included in the manufacturing overhead for the current year is
$50,000 of factory-wide, fixed manufacturing overhead that has been allocated to the
Plastics Department. For each unit of product that Sportway sells, regardless of whether
the product has been purchased or is manufactured by Sportway, an allocated $6 fixed
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overhead cost per unit for distribution is included in the selling and administrative
expenses for all products. Total selling and administrative expenses for the purchased
tackle boxes would be $10 per unit.
Required
In order to maximize the company's profitability, prepare an analysis based on the data
presented that will show which product or products Sportway, Inc., should manufacture
and/or purchase. It should also show the associated financial impact. Support your answer
with appropriate calculations.
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AA102
$560
0
60
$ 400
800
30
$ 470
800
60
60
120
$800
30
60
$1,320
60
120
$1,510
20
10
30
10
30
10
$830
$1,360
$1,550
300 tons
600 tons
100 tons
400 tons
75 tons
100 tons
Required (a)
(b)
(c)
Determine the production levels for the three products under the present constraint on
plant capacity that will maximize operating income.
Suppose a customer is very interested in the new product AAl0l. It has offered to sign a
long-term contract for 400 tons of AA101. It is also willing to pay a higher price if the
entire plant capacity is dedicated to the production of AA101. What is the minimum price
for AA101 at which it becomes worthwhile for Fisher to dedicate its entire capacity to the
production of AA101?
Suppose, instead, that the capacity can be increased temporarily by 600 hours if the plant
is operated overtime. Overtime premium payments to workers and supervisors will
increase direct labor and variable manufacturing support costs by 50% for all products.
All other costs will remain unchanged. Is it worthwhile operating the plant overtime? If
the plant is operated overtime for 600 hours, what are the optimal production levels for
the three products? Show details to your calculations.
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Dependent variable
Independent variable
First
Regression
Second
Regression
Overhead
Cost
Overhead
Cost
Machine
Hours
Direct
Labour Hours
0.72
4.5
18.54
0.94
11.7
10.62
r2
t value
b coefficient
Required a)
b)
For inventory costing purposes, the Piston Co. used an overhead allocation rate
based on machine hours for its four main product lines. Recent gross margin
statements are as follows:
A
Selling price per unit
Cost of goods sold:
Materials
Labor @ $16/direct labor hour
Overhead @ $20/machine hour
Gross margin per unit
Product
B
$100
$115
$128
$155
12
32
20
64
16
24
40
80
25
40
30
95
30
32
60
122
$ 36
$ 35
$33
$33
Using the results of the second regression run by the controller and the following
additional data, determine the number of units of each of the four product lines (at
standard mix) that the Piston Co. will need to sell in order to achieve its target of a
9% after-tax return on sales. The company's effective tax rate is 40%.
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Additional data:
Fixed manufacturing overhead costs
Fixed selling costs
Standard product mix
(e.g., Product A accounts for 3 of every 10 company
products sold)
c)
$335,000
$ 50,000
A:B:C:D = 3:1:2:4
It is expected that, next year, the Piston Co.'s production capacity of 30,000
machine hours will be reached. Demand for each of the four product lines next
year is estimated as follows:
A
B
C
D
Units
5,000
1,500
3,500
7,000
Determine the optimal production strategy for the Piston Co. (i.e., how many units
of each product line should be produced and sold?). Use the data and assumptions
provided in part (b). (Ignore standard mix.)
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4 pounds
2 pounds
2/3 hour
1 hour
1.25 hours
1 hour
0.5 hour
0 hours
0.5 hour
1 hour
Baxter's overhead costs are accumulated on a plantwide basis and are assigned to
products on the basis of the number of direct labor-hours required to manufacture the
product. This base is appropriate for overhead assignment because most of the variable
overhead costs vary as a function of labor time. The estimated overhead cost per direct
labor-hour follows:
Variable overhead cost
Fixed overhead cost
Total overhead cost per direct labor-hour
$6
6
$12
The production department formulated the following equations for the linear
programming statement of the problem:
A = Number of units of X-10 to be produced.
B = Number of units of Y-12 to be produced
Objective function to minimize costs:
Constraints:
4A + 2B 1,800 pounds
2/3A + 1B 400 hours
1.25A + 1B 600 hours
A 0, B 0
Material
Department 1 labor
Department 2 labor
Other
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Required
a.
b.
c.
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Problem 14 - Uncertainty
Jackson, Inc., manufactures and distributes a line of toys. The company neglected to
keep its doll house line current. As a result, sales have decreased to approximately
10,000 units per year from a previous high of 50,000 units. The doll house was recently
redesigned and is considered by company officials to be comparable to its competitors'
models. Joan Blocke, the sales manager, is not sure how many units can be sold next
year, but she is willing to place probabilities on her estimates. Blocke's estimates of the
number of units that can be sold during the next year and the related probabilities are as
follows:
Estimated
Sales in Units
Probability
20,000
30,000
40,000
50,000
.10
.40
.30
.20
$8
2
Fixed costs are $140,000 for production volumes of 20,000 to 30,000 and $160,000 for
volumes of 40,000 and more.
The company must decide on the optimal size of the production run.
Required
1.
2.