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$225,000
$105,000
30,000
18,000
15,000
8,000
176,000
$ 49,000
Note that the variable costs, except for commissions, are affected by production volume, not
sales dollars.
If the special order is accepted, operating income would be $1,000,000 + $49,000 =
$1,049,000.
2.
Whether McMahons decision to quote full price is correct depends on many factors. He is
incorrect if the capacity would otherwise be idle and if his objective is to increase operating
income in the short run. If the offer is rejected, San Carlos, in effect, is willing to invest $49,000 in
immediate gains forgone (an opportunity cost) to preserve the long-run selling-price structure.
McMahon is correct if he thinks future competition or future price concessions to customers will
hurt San Carloss operating income by more than $49,000.
There is also the possibility that Abrams could become a long-term customer. In this case, is
a price that covers only short-run variable costs adequate? Would Holtz be willing to accept a
$8,000 sales commission (as distinguished from her regular $33,750 = 15% $225,000) for every
Abrams order of this size if Abrams becomes a long-term customer?
12-1
1233 Costplusandmarketbasedpricing.
1. Single rate =
Hourly billing rate for HTT and ACT = $11.91 1.45 = $17.27
2. Labor and supervision =
$ 491,840
= $4.64 per test-hour
106,000 test-hours
$402,620
= $503.275 per setup-hour
800 setup hours
$368,000
= $36.80 per machine-hour (MH)
10,000 machine-hours
3.
HTT
Labor and supervision
($4.6463, 600; 42,400 test-hours)1
Setup and facility cost
($503.275200; 600 setup-hours)2
Utilities
($36.805,000; 5,000 machine-hours)3
Total cost
Number of testing hours (TH)
Cost per testing hour
Mark-up
Billing rate per testing hour
ACT
Total
$295,104
$196,736
$ 491,840
100,655
301,965
402,620
184,000
$579,759
63,600 TH
$9.12 per TH
1.45
$ 13.22 per TH
184,000
$682,701
42,400 TH
$ 16.10 per TH
1.45
$ 23.35 per TH
368,000
$1,262,460
106,000 test-hours 60% = 63,600 test-hours; 106,000 test-hours 40% = 42,400 test-hours
800 setup-hours 25% = 200 setup-hours; 800 setup-hours 75% = 600 setup-hours
3
10,000 machine-hours 50% = 5,000 machine-hours; 10,000 machine-hours 50%
= 5,000 machine-hours
1
2
The billing rates based on the activity-based cost structure make more sense. These billing rates
reflect the ways the testing procedures consume the firms resources.
4. To stay competitive, Best Test needs to be more efficient in arctic testing. Roughly 44% of
301,965
activity can be redesigned to achieve cost savings. Best Test should also look for savings in the
labor and supervision cost per test-hour and the total number of test-hours used in arctic testing, as
well as the utility cost per machine-hour and the total number of machine hours used in arctic
testing. This may require redesigning the test, redesigning processes, and achieving efficiency and
productivity improvements.
12-2
$5,000,000
96,000
54,000
135,000
90,000
475,000
150,000
$6,000,000
2.
Projected Life Cycle Income Statement
Revenue ($150 per ton 50,000 tons)
Sale of land (plug after inputting other numbers)
Total life-cycle cost
Life-cycle operating income ($40 per ton 50,000 tons)
Mark-up percentage on project life-cycle cost =
3.
12-3
$7,500,000
500,000
(6,000,000)
$2,000,000
$7,000,000
400,000
$7,400,000
$5,550,000
$ 450,000
$7,000,000
400,000
(5,550,000)
$1,850,000
12-35 (30 min.) Airline pricing, considerations other than cost in pricing.
1. If the fare is $500,
a. Air Eagle would expect to have 200 business and 100 pleasure travelers.
b. Variable costs per passenger would be $65.
c.Contribution margin per passenger = $500 $65 = $435.
If the fare is $2,100,
a. Air Eagle would expect to have 180 business and 20 pleasure travelers.
b. Variable costs per passenger would be $175.
c.Contribution margin per passenger = $2,100 $175 = $1,925.
Contribution margin from business travelers at prices of $500 and $2,100, respectively,
follow:
At a price of $500: $435 200 passengers
At a price of $2,100: $1,925 180 passengers
= $ 87,000
= $346,500
Air Eagle would maximize contribution margin and operating income by charging business
travelers a fare of $2,100.
Contribution margin from pleasure travelers at prices of $500 and $2,100, respectively,
follow:
At a price of $500: $435 100 passengers
At a price of $2,100: $1,925 20 passengers
= $43,500
= $38,500
Air Eagle would maximize contribution margin and operating income by charging pleasure
travelers a fare of $500. Air Eagle would maximize contribution margin and operating income by a
price differentiation strategy, where business travelers are charged $2,100 and pleasure travelers
$500.
In deciding between the alternative prices, all other costs such as fuel costs, allocated
annual lease costs, allocated ground services costs, and allocated flight crew salaries are irrelevant.
Why? Because these costs will not change whatever price Air Eagle chooses to charge.
2.
The elasticity of demand of the two classes of passengers drives the different demands of
the travelers. Business travelers are relatively price insensitive because they must get to their
destination during the week (exclusive of weekends) and their fares are paid by their companies. A
320% increase in fares from $500 to $2,100 will deter only 10% of the business passengers from
flying with Air Eagle.
In contrast, a similar fare increase will lead to an 80% drop in pleasure travelers who are
paying for their own travels, unlike business travelers, and who may have alternative vacation
plans they could pursue instead.
3.
Since business travelers often want to return within the same week, while pleasure
travelers often stay over weekends, a requirement that a Saturday night stay is needed to qualify
for the $500 discount fare would discriminate between the passenger categories. This price
discrimination is legal because airlines are service companies rather than manufacturing
companies and because these practices do not, nor are they intended to, destroy competition.
12-4
12-5