Chapter 10

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. 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. 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

15.

17.

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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. a. Cost to make: $27,000 + ($2.70 x 25,000) = Cost to buy: 25,000 x $3.60 = Advantage of purchasing b. Cost to make: $27,000 + ($2.70 x 60,000) = Cost to buy: 60,000 x $3.60 = Disadvantage of purchasing

336,000

(1,500,000) $(1,164,000)

$ 94,500 (90,000) $ 4,500 $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 Whites 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 companys 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, Borderlands 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 Vendors 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.