2-1.

A company in the process industry produces a chemical compound that is sold to manufacturers for
use in the production of certain plastic products. The plant that produces the compound employs
approximately 300 people. Develop a list of six different cost elements that would be fixed and a similar
list of six cost elements that would be variable. (2.2)
2-2. Refer to Problem 2-1 and your answer to it. (2.2)
a. develop a table that shows the cost elements you defined and classified as fixed and
variable. Indicate which of these costs are also recurring, nonrecurring, direct, or indirect.
b. Identify one additional cost element for each of the cost categories: recurring, nonrecurring,
direct, and indirect.
2-3. Classify each of the following cost items as mostly fixed or variable: (2.2)
Raw materials
Direct labor
Depreciation
Supplies
Utilities
Property taxes
Administrative salaries
Payroll taxes
Insurance (building and equipment)
Clerical salaries
Sales commissions
Rent
Interest on borrowed money
2-4. In your own words, describe the life-cycle cost concept. Why is the potential for achieving life-cycle
cost savings greatest in the acquisition phase of the life cycle? (2.2)
2-5. Explain why perfect competition is an ideal that is difficult to attain in the United States. List several
business situations in which perfect competition is approached. (2.3)
𝐷
2-6. Suppose we know that 𝑝 = 1000 − , where p = price in dollars and D = annual demand. The total
5

cost per year can be approximately by $1,000 + 2D2. (2.3)

a. Determine the value of D that maximizes profit.

b. Show in part (a) that profit has been maximized rather than minimized.

2-7. A company produces circuit boards used to update outdated computer equipment. The fixed cost is
$42,000 per month and the variable cost is $53 per circuit board. The selling price per unit is 𝑝 =
$150 − 0.02𝐷. Maximum output of the plant is 4,000 units per month. (2.3)

a. Determine optimum demand for this product.

b. What is the maximum profit per month?
c. At what volumes does breakeven occur?
d. What is the company’s range of profitable demand?

2.8. A company has established that the relationship between the sales price for one of its products and
the quantity sold per month is approximately D = 780 -10p units (D is the demand or quantity sold per
month, and p is the price in dollars). The fixed cost is $800 per month, and the variable cost is $30 per
unit produced. What number of units, D*, should be produced per month and sold to maximize net
profit? What is the maximum profit per month related to the product? (2.3)
2.9. A company estimates that the relationship between unit price and demand per month for a
potential new product is approximately by p = $100.00 - $0.01D. The company can produce the product
by increasing fixed costs $17,500 per month, and the estimated variable cost is $40.00 per unit. What is
the optimal demand, D*, and based on this demand, should the company produce the new product?
Why? (2.3)

a. Worked out the solution by differential calculus, starting with the formula for profit or loss
per month.

b. Solve graphically for an approximate answer.

2.10. A large wood products company is negotiating a contract to sell plywood overseas. The fixed cost
that can be allocated to the production of plywood is one million dollars per month. The variable cost
per thousand board feet is $131.50. The price charged will be determined by p = $700 – (0.05)D per
1,000 board feet (2.3)

a. For this situation determine the optimal monthly sales volume for this product and calculate
the profit (or loss) at the optimal volume.

b. What is the range of profitable demand during a month?

2.11. A company produces and sells a consumer product, and thus far has been able to control the
volume of the product by varying the selling price. The company is seeking to maximize its net profit. It
has been concluded that the relationship between price and demand, per month, is approximately D =
500 – 5p, where p is the price per unit in dollars. The fixed cost is $1,000 per month, and the variable
cost is $20 per unit. Obtain the answer, both mathematically and graphically, to the following question:
(2.3)

a. What is the optimal number of units that should be produced and sold per month?

Average hauling distance 4 miles 3 miles

Annual rental fee for solid $5,000 $100,00
waste site
Hauling cost $1.50/yd3-mile $1.50/yd3-mile

b. What is the maximum profit per month?

c. What are the breakeven sales quantities (range of profitable demand volume)?

2.12. A company estimates that as it increases its sales volume by decreasing the selling price of its
product, revenue = aD – bD2 (where D represents the units of demand per month, with 0 ≤ D ≤ a/b). The
fixed cost is $1,000 per month, and the variable cost is $4 per unit. If a = $6 and b = $0.001, determine
the sales volume for the maximum profit, and the maximum profit per month. (2.3)
2.13. A municipal solid waste site must be located outside Anytown or Yourtown. After sorting, some
solid refuse will be transported to an electric power plant where it will be used as fuel. Data for the
hauling of refuse from each town to the power plant is shown in the table above.

a. If a power plant will pay $8.00 per cubic yard of sorted solid waste delivered to the plant

yards of refuse will be hauled to the plant for one year only. One site must be selected. (2.2)

b. Referring to the electric power plant above, the cost Y in dollars per hour produce electricity
is Y = 12+0.2+0.27X2, where X is in megawatts. Revenue in dollars per hour from the sale of electricity is
16X – 0.2X2. Find the value of X that gives maximum profit. (2.3)

2.14. A plant has a capacity of 4,100 hydraulic pumps per month. The fixed cost is $504,000 per month.
The variable cost is $166 per pump, and the sales price is $328 per pump (assume that the sales equal
output volume). What is the breakeven point in number of pumps per month? what percentage
reduction will occur in the breakeven point if fixed cost are reduced by 18% and unit variable cost by
6%? (2.3)

2.15. Suppose that the ABC Corporation has a production (and sales) capacity of $1,000,000 per month.
Its fixed costs ─over a considerable range of volume ─are $350,000 per month, and the variable cost are
$0.50 per dollar of sales. (2.3)

a. What was the annual breakeven point volume (D’)? Develop (graph) the breakeven chart.

b. What would be the effect on D’ of decreasing the variable cost per unit by 25% if the fixed
cost thereby increased by 10%?

c. What would be the effect on D’ if the fixed cost is decreased by 10% and the variable cost per
unit increased by the same percentage?

2.16. Refer to the Problem 2.15. Graph the average unit cost function for this situation as originally given
for (a). At what annual output within the present annual production (and sales) capacity of %12,000,000
does the minimum average cost per unit (CU) occur? Why? (2.3)

2.17. The fixed cost related to the production of a product is $500,000 per year. Assume that the
variable cost is $20,000 and the selling price is $30,000 for each percentage point of annual output
capacity (which equals sales demand). Thus, the maximum sales per year are $3,000,000 (at 100% 0f
output capacity), and we have: (2.3)

CF = $500,000 per year (fixed cost)

CV = $20,000/1% of annual (Variable cost/unit)

output capacity

p = $30,000/1% 0f annual output capacity (Selling price/unit)

a. Determine the breakeven point for this situation.

 b. Develop the mathematical expression for profit or loss in this situation as a function of
demand, D.

2.18. A plant operation has fixed cost of $2,000,000 per year, and its output capacity is 100,000
electrical appliances per year. The variable cost is $40 per unit, and the product sells for $90 per unit.

a. Construct the economic breakeven chart.

b. Compare annual profit when the plant is operating at 90% of capacity with the plant
operation at 100% capacity. Assume that the first 90% of capacity output is sold at $90 per unit, and the
remaining 10% of production is sold at $70 per unit. (2.3)

2.19. The fixed cost for a steam line per meter of pipe is $350X + $50 per year. The cost of loss of heat
from the pipe per meter is $4.8/X1/2 per year. Here X represents the thickness of insulation per meters,
and x is a continuous design variable. (2.4)

a. What is the optimum thickness of the insulation?

b. How do you know that your answer in (a) minimizes total cost per year?

c. What is the basic tradeoff being made in this problem?

2.20. A farmer estimates that he harvests his soybean crop now, he will obtain 1,000 bushels, which he
can sell at $3.00 per bushels. However, he estimates that this crop will increase by an additional 1,200
bushels of soybean for each week he delays harvesting, but the price will drop at the rate of 50 cents per
bushels per week; in addition, it is likely that he will experience spoilage of approximately 200 bushels
per week for each week he delays harvesting. When should he harvest his crop to obtain the largest net
cash return, how much will be received for his crop at that time? (2.4)

2.21. A recent engineering graduate was given the job of determining the best production rate for a new
type of casting in a foundry. After experimenting with many combination of hourly production rates and
total production cost per hour, he summarized his findings in Table I below. The engineer then talked to
the firm’s marketing specialist, who provided these estimates of selling price per casting as a function of
production output (see Table II below). (2.4)

a. What production rate would you recommend to maximize total profits?

b. How sensitive is the rate in (a) to change in total production cost per hour?

Table I Total cost/hour $1,000 $2,600 $3,200 $3,900 $4,700

Casting produced/hour 100 200 300 400 500

Table II Selling price/casting $20.00 $17.00 $16.00 $15.00 $14.50

Casting produced/hour 100 200 300 400 500

2.22. The cost of operating a large ship (C0) varies as the square of its velocity (v); specifically, C0 = knv2,
where n is the trip length in miles and k is a constant of proportionality. It is known that at 12 miles/hour
the average cost of operation is $100 per mile. The owner of the ship wants to minimize the cost of
operation, but it must be balanced against the cost of the perishable cargo (Cc). which the customer has
set at $1,500 per hour. At what velocity should the trip be planned to minimize the total cost (CT), which
is the sum of the cost of operating the ship and the cost of perishable cargo? (2.4)

2.23. Refer to Example 2-9. If the cost of electricity is $0.04 per kWh (instead of $0.074 per kWh), which
thickness of insulation should be recommended? Recall that the life of an insulation was assumed to be
25 years. Comment on the basic tradeoff that is being made in this problem (relative to Example 2-9).
(2.4)

2.24. A certain item can be readily purchased from a local vendor for $0.50 per unit. The shop foreman
in your company has proposed manufacturing the item in an idle part of the production area. He has
computed that labor, materials, and overhead per unit would be $0.15, $0.20, and $0.15, respectively.
However, he contends that overhead should not be included in the manufactured cost, so that making
the item is less expensive than purchasing it. Do you agree with the foreman’s analysis? What other
factors might have a bearing in this decision? (2.5)

2.25. Two machines are being considered for the production of a part. The material cost and selling price
per part are $6 and $12, respectively. (Refer to the table at the top of the next page.) Assuming that all
parts that are not rejected can be sold, which machine should be selected based on expected daily
profit? The investment cost is the same for both machines and can be ignored. (2.5)

Production rate 100 parts/hour 130 parts/hour

Hours available for production 7 hours/day 6 hours/day

Operator cost $20/hour $20/hour

Parts Rejected (negligible value) 3% 10%

2.26. Either tool steel or carbon steel can be used for the set of tools on a certain lathe. It is necessary to
sharpen the tools periodically. Relevant information for each is shown at the bottom of this page.

The cost of the lathe operator is $14.00 per hour, including the tool-changing time during which
is idle. The tool changer cost $20.00 per hour for just the time he is changing the tools. Variable
overhead cost for the lathe are $28.00 per hour, including tool-changing time. Which type should be
used to minimize overall costs? (2.5)

2.27. An automatic machine can be operated at three speeds, with the following results:

Speed Output (pieces per hour) Time Between Tool Grinds(hours)

A 400 15

B 480 12

C 540 10
 A set of unsharpened tools costs $150 and can be ground 20 times. The cost of each grindings is $25.
The time required to change and reset the tools is1.5 hours, and such changes are made by a tool-setter
who is paid *.00 per hour. Overhead on the machine is charged at the rate of $3.75 per hour, including
tool-changing time. Assume that all output produced can be used. At which speed should the machine
be operated? The basic tradeoff in this problem is between the rate of output and tool usage. (2.5)

2.28. A company is analyzing a make-versus-purchase situation for a component used in several

products, and the engineering department has developed these data:

Option A: Purchase 10,000 items per year at a fixed price of $8.50 per item. The cost of placing the
order is negligible according to the present cost accounting procedure.

Option B: Manufacture 10,000 items per year using available capacity in the factory. Cost estimates
the direct materials = $5.00 per item and direct labor = $1.50 per item. Manufacturing overhead is
allocated at 200% of direct labor (= $3.00 per item).

a. Based on these data, should the item be purchased or manufactured? (2.5)

b. If manufacturing overhead can be traced directly to this item─ thus avoiding the 200%
overhead rate ─and it amounts to $2.15 per item, what choice should be recommended?
(Traceable overhead is possible with an activity-based cost accounting procedure; is
incremental to the manufacture of the part, and consists of such cost elements as employee
training, material handling, quality control, supervision, and utilities.) Traceable overhead
associated with purchasing this item (vendor certification, benchmarking, etc.) is $0.50 per
item.

2.29. In the design of an automobile radiator, an engineer has a choice of using either a brass-cooper
alloy casting or a plastic molding. Either material provides the same service. However, the brass-copper
alloy casting weighs 25 pounds, compared with 16 pounds for the plastic molding. Every pound of extra
weight in the automobile has been assigned a penalty of $4 to account for increased fuel consumption
during the life cycle of the car. The brass-copper alloy casting costs $3.35 per pound, whereas the plastic
molding costs $7.40 per pound. Machining costs per casting are $6.00 for the bass-copper alloy. Which
material should the engineer select, and what is the difference in units costs? (2.5)

2.30. A construction company has a contract to build a sewer in a Central American country. It must dig
ditch 3 feet wide by 5 feet deep and 10,000 feet long. Local laborers are available at 41.50 per hour who
could, on the average, remove one-half cubic yard per hour.

If a ditch-digging machine is rented in the United States and shipped to the job, it would be able to
excavate at the rate of one-half cubic yards per minute. The rental on this machine would be $150 per
day for all the time it was in use or in transit. Five days would be required for shipment each way.
Freight cost would total $4,000. The operator for this machine would be brought from the United States
and would have to be paid $150 per day for his service and equipment maintenance, including travel
time. His roundtrip airplane fare would cost $600, and one day of travel would be required each way. He
would work an 8-hour day while on the job. If the machine is used, three local laborers also would be
required. All workers and machine rental must be paid on a full 8-hour basis. What would you
recommend? (2.5)

2.31. In some countries motorist are required to drive with their headlights on at all time. General
Motors is beginning to equip their cars with daytime running lights. Most people would agree that
driving with the headlights on at night is cost-effective with respect to extra fuel consumption and safety
considerations. Given the following data and any additional assumptions you feel the necessary, analyze
the cost effectiveness of driving with your headlights on during the day by answering the following
questions. Cost-effective means that benefits outweigh (exceed) the cost. (2.5)

75% of driving takes place between dawn and dusk.

2% of fuel consumption is due to accessories (radio, headlights, etc.).

Cost of fuel = $1.15 per gallon.

Average distance traveled per year = 15,000 miles.

Average cost of an accident = $2,500.

Purchase price of headlights = $25.00 per set (2 headlights).

Average time car is in operation per year = 350 hours.

Average life of headlight = 200 operating hours

Average fuel consumption = 1 gallon per 30 miles

a. What are the extra costs associated with driving with your headlights on during the day?
b. What are the benefits associated with driving with your headlights on during the day?
c. What additional assumption (if any) do you need to complete your analysis?
d. It is cost-effective to drive with your headlights on during the day? Be sure to support your
recommendation with the necessary calculations.

2.32. One method for developing a mine containing an estimated 100,000 tons of ore will result in the
recovery of 62% of the available ore deposit and will cost 423 per ton of material removed. A second
method of development will recover only 50% of the ore deposit, but it will cost only 415 per ton of
material removed. Subsequent processing of the removed ore recovers 300 pounds of metal from each
ton processed ore and costs $40 per ton of ore processed. The recovered metal can be sold for $0.80
per pound. Which method for developing the mine should be used if your objective is to maximize total
profit from the mine? (2.5)

2.33. Which of the following statements are true and which are false? (all sections)

a. Working capital is a variable cost.

b. The greatest potential for cost saving occurs in the operation phase of the life cycle.
 c. If the capacity of an operation is significantly changed (e.g., a manufacturing plant), the fixed
costs will also change.

d. The initial investment cost for a project is a nonrecurring cost.

e. Variable costs per output unit are a recurring cost.

f. A noncash cost is a cash flow.

g. Goods and services have utility because they have the power to satisfy human wants and
needs.

h. The demand for necessities is more inelastic than the demand for luxuries.

I. Indirect costs can normally be allocated to a specific output or work activity.

j. Present economy studies are often done when the time value of money is not a significant
factor in the situation.

k. Overhead costs normally include all costs that are not direct costs.

l. Optimal volume (demand) occurs when total costs equal total revenues.

m. Standard costs per unit of output are established in advance of actual production or service
delivery.

n. A related sunk cost will normally affect the prospective cash flows associated with a situation.

o. The life cycle needs to be defined within the context of the specific situation.

p. The greatest commitment of cost occurs in the acquisition phase of the life cycle.

q. The average unit cost function is a linear function of demand.

2-34. BRAIN TEASER

The student chapter of the American Society of Mechanical Engineer is planning a 6-day trip to
the national conference in Albany, New York. For transportation the group will rent a car from either the
State Tech Motor Pool or a local car dealer. The Motor Pool charges $0.26 per mile, has no daily fee, and
the motor pool pays for the gas. The car dealer charges $25 per day and $0.14 per mile, but the group
must pay for the gas. the car’s fuel rating is 20 miles per gallon, and the price of gas is estimated to be
$1.20 per gallon. (2.3)

a. At what point, in miles, is the cost of both options equal?

b. The car dealer has offered a special student discount and will give the students 100 free
miles per day. What is the new breakeven point?
c. Suppose now that the Motor Pool reduces its all-inclusive rate to $0.23 per mile and the car
dealer increases its rate to $25 per day and $0.21 per mile. In this case, the car dealer wants
to encourage student business, so he offers 1,000 free miles for the entire 6-day trip. He
claims that if more than 882 miles are driven, students will come out ahead with one of his
rental cars, If the students anticipate driving 1,600 miles (total), from whom should they
rent a car? Is the car dealer’s claim entirely correct?