Chapter 9: Decision Making With Relevant Costs and A Strategic Emphasis

Blocher,Stout,Cokins,Chen:Cost Management, 4e 9-1 The McGraw-Hill Companies, Inc.
, 2008

CHAPTER 9: DECISION MAKING WITH RELEVANT
COSTS AND A STRATEGIC EMPHASIS

QUESTIONS

9-1 Relevant costs are costs to be incurred at some future time and differ for each
option available to the decision maker.
Relevant costs in replacing equipment would include the cost of purchasing and
installing the new equipment, the operating costs of the new equipment, and the
disposal costs of the old equipment, the cost of repair of the old equipment, and
so on. The purchase price of the old equipment would not be relevant to the
decision.

9-2 When a firm chooses to have a basic service function provided by a
subcontractor outside the firm, it is called outsourcing. Relevant cost analysis is
used to identify the relevant costs in the decision to outsource or to retain the
production or service activity within the firm. An example of a non-relevant cost in
this context is a cost which would not differ between the options. For example, if
there is no alternative use for the space occupied by the internal production, then
the costs of the space is not relevant since these costs will continue whether the
production is retained or outsourced.

9-3 Decisions where relevant cost analysis might be used effectively include:
1. The special order decision
2. Make, lease, or buy
3. Outsourcing
4. Sale before or after additional processing
5. Keep or drop products or services
6. Profitability analysis: evaluating programs

9-4 Relevant cost analysis is applied in the same way for manufacturing and for
service firms. Both types of firms are subject to the types of decisions outlined in
Question 9-3.

9-5 The relevant cost is only the incremental cost incurred for the additional
processing.

9-6 Strategic factors include:
1. The level of capacity usage of the plant
2. The time value of money
3. Quality
4. Functionality
5. Timeliness of delivery
6. Reliability in shipping
7. Service after the sale
Blocher,Stout,Cokins,Chen: Cost Management, 4e 9-2 The McGraw-Hill Companies, Inc., 2008

9-7 Not relevant, or sunk costs are costs which are irrelevant in decision making
because they are committed and therefore there is no longer any discretion
regarding these costs. Examples include the purchase price of equipment
already owned and all related costs of installing the equipment.

9-8 Variable costs are usually more relevant in decision making than fixed costs
because they are more likely to be discretionary, not yet incurred. In contrast,
many times fixed costs are sunk because they relate to assets which have been
purchased some time ago.

9-9 A firm can decrease variable costs by increasing fixed costs by, for example,
purchasing new equipment that has lower operating costs. For example, a more
technologically advanced and therefore more expensive machine will likely have
lower variable operating costs, but a higher purchase cost.

9-10 A firm can decrease fixed cost by increasing variable costs, by for example,
purchasing less technologically advanced equipment (see Question 9-9).
Generally, the amount of fixed costs as compared with variable costs can be
reduced by replacing equipment with labor, to become a more labor-intensive
operation.

9-11 A well-known problem in business today is the tendency of managers to focus on
short-term goals and neglect the longer-term strategic goals, because their
compensation is based upon short-term accounting measures such as net
income. This issue has been raised by many critics of relevant cost analysis. As
noted throughout the chapter, it is critical that the relevant cost analysis be
supplemented by a careful consideration of the long-term, strategic concerns of
the firm. Without strategic considerations, management could improperly use
relevant cost analysis to achieve a short-term benefit and potentially suffer a
significant long-term loss. For example, a firm might choose to accept a special
order because of a positive relevant cost analysis, without properly considering
that the nature of the special order will have a significant negative impact on the
firm's image in the marketplace, and perhaps a negative effect on sales of the
other products. The important message for managers is to keep the strategic
concerns in mind, and to start with the strategic objectives in any decision
situation.
9-12 The limitations of relevant cost analysis include:
1. Excessive focus on short-term decisions (see Question 9-11)
2. Tendency to focus on quantitative factors only, and to not include the
important strategic factors (see Question 9-6)
3. Managers tendency to include irrelevant costs, such as sunk costs, in the
decision making
4. Tendency to focus on a single product or department in isolation of others,
and then to perhaps not find the strategically correct analysis

Blocher,Stout,Cokins,Chen:Cost Management, 4e 9-3 The McGraw-Hill Companies, Inc., 2008

9-13 Strategic management principles require a more integrative focus, as noted in
the chapter:

9-14 Some of the behavioral, implementation, and legal issues in using relevant cost
analysis include:
1. The tendency of managers to focus on short term goals, and to not attend
satisfactorily to longer-term strategic goals of the firm. The techniques described
in relevant cost analysis can have the effect of encouraging this bias, unless
specific steps are taken, such as to use the balanced scorecard in management
evaluation (see chapter 18).
2. If variable costs are given too much focus, as suggested in relevant cost
analysis, managers can tend to ignore fixed costs. Moreover, some managers
might replace variable costs with fixed costs where possible, to improve the
evaluation of their unit. The result might be higher overall costs for the firm.
3. Researchers have shown a strong human tendency to rely upon and use
irrelevant factors such as sunk costs in decision making. Thus, the proper use of
relevant cost analysis requires the management accountant to carefully explain
the techniques and to carefully present the relevant cost reports to management.
4. Predatory pricing, the lowering of prices to where the effect may be to
substantially damage the competition in an industry is unlawful under the
provisions of the Robinson Patman Act.

9-15 When there is only one production constraint and excess demand it is generally
best to produce only one of products to maximize income, and that is the product
with the highest contribution per unit of scarce resource. When the production
process requires two or more production activities, the choice of sales mix
involves a more complex analysis, and in contrast to the case of one production
constraint, the solution can include both products. The determination of best
product mix in this case involves mathematical programming techniques, which
RELEVANT COST ANALYSIS STRATEGIC COST ANALYSIS

Financial Focus Customer Focus

Not Linked to Strategy Linked to the Firm's Strategy

Precise and Quantitative Broad and Subjective

Focused on Individual Integrative;
Product or Decision Considers all
Situation Customer-related Factors

Short-term Focus Long-term Focus


are employed using either a graphical analysis or a computer-based solution
technique.

9-16 Relevant cost analysis and cost-volume-profit analysis (Chapter 7) are similar in
that they both rely on the distinction of variable versus fixed costs and they both
use the contribution margin (price less unit variable cost) as the focal point of the
analysis. Both cost-volume-profit analysis and relevant cost analysis focus on
the relationship of profit to volume, and therefore on the unit contribution margin
for the product or service.

9-17 Depreciation is a not relevant cost because it is a sunk cost. The purchase cost
of plant or equipment is irrelevant, as well as the depreciation charges which are
used to expense the purchase cost over time.

BRIEF EXERCISES

9-18 $35 ($33 - $5) = $7

9-19 Additional Contribution for X = ($25-$20) - $2 = $3
Additional Contribution for Y = ($50-$40) - $4 = $6
Both products should be processed further, but Y should go first as it has the
higher contribution per unit

9-20 The contribution on the order is $3,000 10 x $100 = $2,000, or $200 per sofa;
Adams should accept the order.
If Adams is at full capacity, then the opportunity cost for lost sales is $500 - $100
= $400 per sofa; the opportunity cost is higher than the contribution on the
special order, $200; so now the special order should not be accepted

9-21 Wings will make a profit by selling at any price above variable cost of $2.50

9-22 Relevant Costs:
Repair:
Variable Costs:
Labor = $0.50 x 10,000
= $5,000
Fixed Costs:
Repair Cost = $1,000
Total Costs: = $5,000 + $1,000
= $6,000
Replace:
Variable Costs:
Labor = $0.25 x 10,000
= $2,500
Fixed Costs:
New Machine = $5,000
Total Costs: = $2,500 + $5,000
= $7,500
Relevant Cost Difference: = $7,500 - $6,000
= $1,500 more to replace than repair


9-23 Buying Costs:
= $20 x 500
= $10,000
Manufacturing Costs:
Batch Cost = $1,000
Variable Cost = $10 x 500
= $5,000
Total Cost = $6,000
Ford should manufacture the shirts; the manufacturing cost of $6,000
is less than the purchase cost of $10,000

9-24 Contribution Margin = $100,000
Overhead that can be eliminated = $90,000
Change in Income if Division is eliminated = ($10,000)

Jamison should keep the division.

9-25 Machine Cost = $500,000 + $0.10 x # of bars
Current Cost = $1 x # of bars
Break Even Cost $900,000 + $0.10 x # of bars = $1 x # of bars
$0.90 x # of bars = $900,000
# of bars = 1,000,000 bars
at 500,000 bars, stay with the direct labor, not the machine

9-26 The AAA batteries have a higher contribution per unit and since both the AAA
and AA batteries require the same processing time, ElecPlus should accept the
special order, and reduce the production/sales of AA batteries if needed.

9-27 Cost with machine: $200,000 + $5 x 10,000 = $250,000
Cost without machine: $20 x 10,000 = $200,000

Jackson would recover the cost in 1 and 1/3 years
$200,000 + $5Q = $20 Q
Q = 13,333 loads or 13,333/10,000 = 1.33 years

Total Contribution Margin
$0.10 x 100,000 0.05 x100,000 $1,000
= $4,000

9-29 Lowest price will be variable cost, which in the case of a budget airline that does
not offer many customer services, might very low or near zero per passenger.
The variable costs in this case would be those costs associated with ticketing
and gate operations which are variable per passenger.


9-30 The special order price should cover variable costs, so it should be greater than
$3.50 per meal or $3.50 x 200 = $700. The regular weekly lunch should cover
fixed and variable costs: $3.50 + $1,000/500 = $5.50 per meal.

9-31 In the longer term, all of these costs are relevant, but in the short term, the only
costs that are relevant are the variable costs, in this case housekeeping. If a
room goes unoccupied, the only cost that is saved is that of housekeeping.


EXERCISES

9-32 Special Order Analysis (10 min)

Since there are no marketing costs for the special order, the only
relevant cost is the variable manufacturing cost of $13 per unit.

Revenue for special order less variable manufacturing cost =
(1.35 x $13 - $13) x 4,000 =
($13 x .35) x 4,000 = $18,200

The special order should be accepted, since the revenue of $18,200
exceeds the retooling costs of $12,000.


9-33 Special Order (15 min)
1. Current Special Order
Revenue per unit $ 45 $ 35
Variable costs per unit:
Direct materials $ 9 $ 9
Direct labor $ 8 $ 8
Variable factory overhead $ 4 $ 4
Variable nonmanufacturing costs $ 8 29 $ 4 25
Contribution margin per unit $ 16 $ 10

Contribution margin for 5,000 units $ 80,000 $ 50,000

The difference in favor of continuing with current production and
turning down the special order is $30,000 ($80,000 - $50,000).

Note that because Alton, Inc. is at full capacity, the decision whether
or not to produce the special order is based on the comparison of
current and special order production. If there were additional
capacity, the proper decision would be to accept the special order
since it has a positive contribution of $50,000.

The minimum price for the order would be the relevant total variable
costs of $25.

2. The minimum price would be $28.20.
At 16,000 units of output, Alton does not have enough capacity to
produce the entire order for SHC. Further, the contribution on
regular sales ($16) exceeds the contribution on sales to SHC ($10),
so Alton should try to reduce or delay 1,000 units of the SHC order to
get an order for 4,000 units. Then the special order could be done
without a loss of regular sales. If SHC insists on the full order of
5,000 units, then Alton must figure the costs of lost sales ($16 x
1,000 = $16,000). This loss is less than the contribution of the
special order ($30,000), so the special order would still be accepted
at the $35 price. The minimum price would be the total variable cost
per unit ($25) plus the per unit cost of lost sales ($3.20 =
$16,000/5,000): $25 + $3.20 = $28.20.


9-34 Make or Buy; Continuation of Problem 7-28 (15 min)

1. The answer is zero. In contrast to 7-28, for which Machine X was a
relevant cost (had not been purchased yet), the proper analysis was to
compare the cost of purchasing machine X versus the cost of purchasing
from the outside vendor. The analysis was as follows, showing that Calista
should purchase machine X if volume is expected to exceed 100,000
units.:

Machine X
$2Q = $.65Q + $135,000
Q = 100,000

The answer is different for 9-34 since the cost of machine X is now a sunk
cost, and thus, the unit cost of $ 0.65 is always preferred to the outside
price of $2, irrespective of the volume, even for very low volume levels.

2. Here we use an approach similar to that used in 7-28, except that the
$135,000 purchase cost of machine X is irrelevant. The answer for 7-28
was 197,143 units, but now it is much higher 582,857 units. The
threshold to moving up to machine Y is now much higher because the
purchase cost of machine X is sunk and irrelevant.

Cost of using X = Cost of using Y
$.65S = $.30S + $204,000
$.35S = $204,000
S = 582,857 units



1. The costs fall from $11 to $10 because of the fixed overhead costs
which are the same at each level of production, so that the unit fixed costs
decrease as production level increases.

2. The relevant costs are:
Materials $2 ($80,000/40,000)
Labor 3 ($120,000/40,000)
Variable Overhead 3 ($300,000-$240,000)/20,000
Total $ 8

Alternatively: ($600,000 - $440,000)/20,000 = $8

The relevant costs are $8 per unit, so the bid price should be any price
above $8. The sales mangers price will produce a contribution of 20,000
($9-$8) = $20,000

3. Other factors to consider
Is the order likely to lead to further regular business with this customer?
Is the order in the strategic best interest of the firm, for example, will it
support or undermine Grant Industries desired image in the market?
While Grant has enough capacity to complete the special order, will
there be other costs in addition to the variable manufacturing costs in
order to complete the order, that is, special tooling or set up costs, etc.
Also, are there alternative uses of the capacity which will produce a
greater contribution?


9-36 Profitability Analysis (15 min)

1. T-1
Last year's contribution = $200,000 - $70,000 - $20,000 = $ 110,000
Last year's contribution margin ratio = $110,000/$200,000 = 55%

T-2
Last year's contribution = $260,000 - $130,000 - $50,000 = $80,000
Last year's contribution margin ratio = $80,000/$260,000 = 30.77%

Incremental contribution margin from T-1 if T-2 is dropped =
$110,000 x .1 = $ 11,000

The effect of discontinuing T-2 is the contribution margin less
variable selling costs less the incremental contribution for T-1:

Net loss on discontinuing T-2 = $130,000 - $50,000 - $11,000 =
$69,000

2. The following strategic factors should be considered. What will be
the effect on the firms image if T-2 is dropped? Will this result in an
unfavorable reaction from key customers of T-1 and of other product
lines? Can the production capacity released by T-2 be used for new
products?


9-37 Relevant Cost Problems (5-10 min, each part)

a. Make or Buy
The total costs for producing the product are as follows:

Costs Per Unit:
Direct Materials $ 28
Direct Labor 18
Var. Overhead 16
Total $ 62

($62 x 2,000) + $8,000 = $132,000.
The total cost to purchase the units is $120,000.
Saving to purchase $132,000 - $120,000 = $12,000

Since the purchase price is less than the production cost, Terry Inc.
should purchase the units. Since there is some urgency to the order
Mr. Walters may opt for the alternative which will allow him to deliver
the product as quickly as possible. Quality, reliability, and capacity
utilization are other considerations.

b. Disposal of Assets
Remachine Scrap
Future Revenues $30,000 $2,500
Deduct future costs 25,000
Margin $ 5,000 $2,500

The difference is in favor of remachining. The $50,000
inventory cost is irrelevant.

c. Replacement of Asset
Replace Rebuild
New boat $92,000 -
Deduct current disposal price $ 9,000
Rebuild of existing boat $75,000
Margin $83,000 $75,000

The difference is in favor of rebuilding. The $90,000 purchase
cost is irrelevant.

Exercise 9-37 (continued)

d. Profit from Processing Further
A B C
Addtl costs of further process $28,000 20,000 12,000
Increase in sales 40,000 20,000 10,000
Differential benefit (loss) $12,000 $0 ($2,000)

Deaton Corp. Is indifferent about the further processing for B since
the net benefit is zero. There would be a positive benefit for further
processing of A ($12,000) and a loss from further processing of C
($2,000).

e. Make or Buy
The relevant fixed overhead is $10 per unit ($20 x 50%) because that
amount could be avoided by buying the part from McMillan. All
variable costs are relevant ($75=$35+$16+$24). The relevant cost
per unit is $85 ($75+$10). Eggers should make the part. When you
compare the cost to make of $85 to the cost to buy, $90; there is a
$5 per unit savings.

f. Selection of most Profitable Product
FLASH CLASH
Selling price per unit $250.00 $140.00
Variable cost per unit 200.00 100.00
Contribution margin per unit $ 50.00 $ 40.00
Relative use of labor hours 2 1
(CLASH requires as many as FLASH)
Contribution margin per labor hr. $ 25.00 $ 40.00

Since CLASH requires the labor time, and since labor capacity is a
constraint, and since CLASHs relative contribution per labor hour is
greater, as much production as possible should be devoted to
CLASH. Note that the products have the same per unit profit, but
FLASH has the higher contribution, and CLASH has the higher
contribution per labor hour. Thus, FLASH would be the most
profitable product without a labor constraint, while CLASH is the most
profitable product with the labor constraint. The measure, operating
profit, is not used because it includes the sunk fixed costs.

Exercise 9-37 (continued)

g. Special Order Pricing
The total cost of each meal is variable plus fixed cost or $2.00
+ $1,200/600 = $4.00 per meal. This is a reasonable cost basis for
long term pricing, and Barry is getting a $1.00 margin on each meal.
However, in a special order situation the fixed costs are irrelevant,
and Barry should be willing to do business for any price above
variable cost of $2.00. Thus, the tour operators deal is a good one
for Barry. As long as there is space for the additional meals, and
since daily fixed costs are unaffected by the additional patrons, any
price above $2.00 should be acceptable.
The idea of agreeing to serve 200 patrons on any given day
presents a problem with limited capacity. In this case, 100 of the
regular customers would have to look elsewhere for lunch on these
days, at a loss of $3.00 ($5.00-$2.00 variable cost) per meal or a
total of $300 per day. The additional new patrons at $3.00 each
would bring in a contribution of only $1.00 ($3.00-2.00) per meal or a
total of $200. It turns out the single bus load is a better deal.


9-38 Make or Buy (15 min)

Relevant Cost to Make (per unit):
Direct Materials $ 35
Direct Labor 50
Variable Overhead 10
Fixed Overhead Avoidable 5
$100

Outside Purchase Cost = ($55,000 / 500) = $110

Three Stars Inc. should continue making the doors. The savings
are $10 per unit ($110 - $100) when they are manufactured by Three
Stars.


9-39 Relevant Cost Analysis (20 min)

1. Exercise 9-37 (g) is an example of this type; determining the
price of a meal for a special group

2. An example here would be as follows: should Baileys purchase
its bread and pastries or make them? The same would be true for
desserts.

3. The process further decision; does Baileys want to enhance an
menu item; will the increased price cover the increased cost

4. Profitability analysis can be used to review the menu items to
determine which are most profitable. Lunch and dinner menus can
be compared in this way. Also, Baileys could review the possibility
of opening for a late-night crowd to project the revenues and costs
of that plan, and to assess the expected profitability. In this situation,
the rent costs would be irrelevant, but the additional cost of wait staff
would be incremental; the cost of utilities might or might not change.


PROBLEMS


1.
Price of special order $100
Relevant Cost = ($375,000+262,500)/7,500 = 85
Contribution on special order $15 per unit
$15 x 2,500 = $37,500 total contribution

Positive contribution: Accept the Special Order

2. Other considerations
a. Is the order likely to lead to further regular business with this
customer?
b. Is the order in the strategic best interest of the firm, for example,
will it support or undermine Award Plus desired image in the market?
c. While Award Plus has just enough capacity to complete the
special order, will there be other costs in addition to the variable
manufacturing costs in order to complete the order, that is, special tooling
or set up costs, etc
d. See part 3. below

3. Obviously the controller, LePenn has a conflict of interest in the
sourcing of raw materials for the firm. Cathy has the ethical responsibility
under the IMA code to bring this matter to the attention of the appropriate
person in the firm. Since LePenn is the controller, the appropriate person
for Cathy to contact is likely to be the Vice President of Finance, Chief
Financial Officer, a member of top management, or the audit committee if
Award Plus has one.


9-41 Special Order Analysis (15 min)

1. Net income with the special order will increase by $14,000 = 2,000
x ($28 - $21).

The relevant Variable costs are the $21 manufacturing variable
costs since marketing costs are not charged for the special order.

Note that this answer relies on the availability of production capacity.
The answer might be different if the plant is at full capacity and the
sale of the special order would require Jordan to lose some amount
of current sales. For a good in-class assignment, ask the class to
answer the question again, assuming Jordan is at full capacity. We
now assume that a total of 10,000 units will be produced (full
capacity). The variable marketing costs will be relevant for regular
sales.

Contribution of special order
2,000 x ($28 - $21) $14,000
Less: Lost contribution on loss of regular sales:
2,000 x ($68 - $21 - $8) 78,000
Net loss on the special order under full capacity $64,000

2. The special order has the strategic advantage of helping Jordan
smooth the seasonal and cyclical changes in the business. If special
orders such as this can be planned and scheduled carefully, the
production rate at Jordans plant can be smoothed to improve
scheduling and lower overall costs. Lower overall costs can help
Jordan to become more cost competitive. This is especially
important, since price competition is an important aspect of this
industry. Also, smoothed production levels will help to most
efficiently utilize the plant and thus minimize fixed plant costs.
Moreover, special orders can help Jordan grow the business by
developing new customers and helping the firm to learn new markets,
perhaps for other interior finish items for cars and trucks. Special
orders such as the one to JepCo can lead to additional orders for
existing and new products.

9-42 Special Order; ABC Costing (25 min)

1. First, determine relevant batch related costs:
The special order would cause one new batch, so the relevant batch
related cost is the cost per batch of $10,000.

[Note: Total fixed costs are $25 x 10,000 = $250,000, composed of..
Batch related costs = $10 x 10,000 units = $100,000
Facilities related fixed costs = $15 x 10,000 150,000
Total Fixed costs = $25 x 10,000 $ 250,000 ]

Relevant costs for the special order
Variable manufacturing $21
Batch related costs $10,000/2,000 5
Total unit relevant costs for the special order $26

Total relevant cost for the special order = 2,000 x $26 = $52,000

2. The special order price exceeds the relevant cost of $26, so
Jordan should accept the JepCo offer since there is available
capacity. Profit will increase by ($28-$26) x 2,000 = $4,000.

Alternatively, ($28-$21) x 2,000 - $10,000 = $4,000

Notice that the increase in profits calculated here is less than in
Problem 9-41 because we are taking into account the batch related
costs.

3. If the JepCo order is reduced from, 2,000 to 1,000 units, then the
batch related costs are the same in total, but the unit cost of batch
level costs increases to $10 (=$10,000 per batch/1,000units). The
relevant costs are now:


Problem 9-42 (continued)

Variable manufacturing $21
Batch related costs $10,000/1,000 10
Total unit relevant costs for the special order $31

Total relevant cost for the special order = 1,000 x $31 = $31,000

Now, the JepCo special order should not be accepted because
the unit cost ($31) is greater than the special order price ($28).

9-43 Make or Buy

1. Since the contribution for manufactured fans is higher then for
purchased fans, the answer for part 1 should be to manufacture as many
as possible, or 15,000, and to purchase the remaining 5,000 from Harris
Products.

2. See calculations in the right hand column above. The contribution on
the pumps is $11 lower ($24 - $13) than for the fans, so Jabbour should
continue to manufacture the fans.

Total Relevant Costs Relevant Costs Relevant Costs
Cost to Manufacture to Purchase for Pumps
Selling price per unit $72.00 $72.00 $72.00 50.00 $
Costs per unit 46.00
Electric motor $6.00 $6.00 5.50
Other parts 8.00 $8.00 7.00
Direct labor ($15.00/hr.) 15.00 $15.00 7.50
Manufacturing overhead 15.00 * 5.00 3.00
Selling and adm. Cost 20.00 $64.00 * 14.00 14.00 14.00
Profit per unit $8.00 $24.00 $12.00 13.00 $
Contribution per unit
* Of the total per unit manufacturing overhead of $15, $10 is fixed ($100,000/10,000 units) and the remaining $5 is variable
Of the total per unit selling and administrative cost, $6 is given as fixed, and the remaining $14 is variable.


3 Some of the possible strategic factors to consider are:
Re: The pumps:
Will the sale of pumps introduce Jabbour to new markets and new
customers that might benefit other product lines?
Can Jabbour compete in the marine pump market? How competitive is
this market, and what are the CSFs that are likely to lead to success for
Jabbour?
How reliable are the estimates used to develop the predictions for
revenues and costs for the pumps? How reliable is the market research
that predicted growth in pump sales?
Will the sale of pumps affect Jabbours image in either a positive or
negative fashion? For example, will Jabbours current customers view
Jabbour as a high quality/innovative manufacturer of pumps?
How long is the expected growth in pump sales expected to continue?

Re: The purchase of attic fans from Harris Products:
What are the alternative uses of Jabbours production capacity, in
addition to pumps and attic fans that might produce higher contribution?
How reliable is Jabbours information that Harris is a reliable producer of
quality products?
How will Jabbours customers react, if at all, to know that the attic fans
are not manufactured by Jabbour?



1. Relevant Cost Data (per sheet):
Direct Materials $ 1.20
Direct Labor .20
Variable Overhead .40
$ 1.80

There are 4 sets in each sheet (132 /33) and 25,000 sets being
ordered. BallCards Inc. will need to manufacture 6,250 sheets
(25,000 /4).

Total costs = ($1.80 x 6,250) + $2,000 +$5,500 = $18,750.
Total costs per set = ($18,750 /25,000) = $0.75

Total price per set = ($23,750 /25,000) = $0.95

BallCards Inc. should accept the special order from Pennock Cereal,
since the price per set ($.95) exceeds the relevant cost per set
($.75).

2. BallCards succeeds by developing new customers and keeping
costs down. Also, a critical success factor is the firms ability to
negotiate licensing agreements with the major leagues and the
players. The special order with Pennock Cereal Inc is a competitively
important decision because it will help BallCards to have its product
distributed widely among its key customers. Promotion of the brand
name is a key success factor for BallCards, and this special order is
one important way to accomplish that.



1. and 2. Net income with the special order will decrease by $15,000.
The only relevant variable costs are the $15 manufacturing
variable costs ($15 x 5,000 = $75,000 total) since marketing costs
are not charged for the special order. Other relevant costs include
the delivery cost of $2,000 and the cost of lost sales (since the 5,000
unit order would exceed GGIs capacity. Currently, GGI has only
2,000 units of available capacity, and APAC requires the order to be
filled in full).

Contribution lost on 3,000 units of lost sales
= price variable manufacturing cost variable selling cost
= ($38 - $15 - $2) x 3,000 = $63,000

Summary of relevant costs
Variable manufacturing costs $ 75,000
Delivery costs 2,000
Cost of lost sales 63,000
Total relevant costs $140,000

Since the relevant costs of $140,000 exceed the price of the special
order ($125,000), GGI should not accept the order.

Note that if GGI had available capacity, the only relevant cost would
be the variable manufacturing and the delivery costs of $77,000, and
the special order would then be an acceptable one.

3. These are both ethical and strategic issues for GGI. From a
strategic view, GGI would suffer severe damage to its reputation if
APAC were to have any problems with the purity of the special order.
One of the reasons APAC has requested the special order from GGI
is because of its reputation for quality. It is clear that GGI competes
on differentiation, with quality being a critical success factor.
Also, there is an ethical issue. The use of a competitors
materials would deceive APAC who is expecting the highest quality
product from GGI.


To take into account both strategic and ethical issues, GGI
should make it clear to APAC that it will need to fill a portion of the
order from competitors stock. GGI might request that the shipment
be delayed until it can provide all of the product from its own stock.
Or alternatively, it might offer to reduce the price, or to perform
careful tests of its own on the competitors materials.


9-46 Special Order; ABC Costing (25 min)

1. First, determine relevant batch related costs:
The special order would cause two new batches at a cost of $5,000
each, so the relevant batch related cost is $10,000.

[Note: Total fixed costs are $12 x 20,000 = $240,000, composed of:
Batch related costs ($8 x 20,000 = $160,000)
Costs per batch: 20 batches x $5,000 $100,000
Costs that do not vary with number of batches 60,000
Facilities related fixed costs = $4 x 20,000 80,000
Total Fixed costs $240,000 ]

Variable manufacturing ($15 x 5,000) $75,000
Batch related costs 10,000
Delivery costs 2,000
Cost of 3,000 units of lost sales* 48,000
Total Relevant Costs $135,000

*The cost of lost sales is determined as follows:
Sales ($38 x 3,000) $114,000
Less: Variable Costs ($15 + $2) x 3,000 51,000
Less: Cost for 3 batches ($5,000 x 3) 15,000
Net lost contribution $ 48,000

The total relevant cost of $135,000 is greater than the special order price
of $125,000, so GGI should not accept.

2. Operating profit would decline by $10,000 = $135,000 -
$125,000


9-47 Make or Buy; Special Order (25 min)

1. Compare the relevant cost to make a truss ($10,000/200 = $50 per
truss) to the outside purchase cost of $55 per truss. The company
should continue making the truss as this is lowest cost.

2. The following analysis finds the contribution margin for the
additional beams vs. the truss production.

Unit variable cost for beams: $48,000/600 = $80 per beam

Trusses Special order beams
Sales Revenue $12,000 $40,000 (400 x $100)
Less Var. Cost 10,000 32,000 (400 x $80)
Cont. Margin $2,000 $8,000

Less opportunity cost 2,000 (loss of trusses)
$ 6,000

The company should accept the special order as there is a net
benefit of $6,000. The firm should also consider the impact of
dropping the trusses; the company may lose customers that need to
buy 2 or 3 different components, one being trusses. These
customers may like the convenience of one-stop shopping.


9-48 Profitability Analysis, Scarce Resources (25 min)

1. When there is no limit on production capacity, the super model
should be manufactured since it has the highest contribution margin
per unit.

No Frills Standard Super
Model Model Model
Selling Price $30.00 $35.00 $50.00

Direct Materials 9.00 11.00 11.00
Direct Labor ($10/hour) 5.00 10.00 15.00
Variable overhead 3.00 6.00 9.00
Total Variable Cost $17.00 $27.00 $35.00

Contribution Margin $13.00 $8.00 $15.00

2. When labor is in short supply, the No Frills Model should be
manufactured since it has the highest contribution margin per direct
labor hour. See below.

No Frills Standard Super
Model Model Model
Contribution Margin $ 13 $8 $15
Labor Hours Required .5 1 1.5
Contribution Margin/hr. $26.00 $8.00 $10



Note: As an additional in-class assignment, the class can be asked
to determine the best product mix when machine time rather than
labor is the limited resource. Since fixed overhead is applied on the
basis of machine hours, and fixed overhead per unit is given, it is
possible to determine the relative proportion of machine time in each
product. Since the fixed overhead in No Frills is $3 and in the
Standard model is $6, we can infer that there is twice the amount of
machine time in Standard as in No Frills. Similarly, there is twice the
amount of machine time in the Super model relative to No Frills. The
contribution per (relative) machine hour is again greatest for the No
Frills model, as follows:

Contribution Relative Machine Hours Contribution/ Rel. Hour
No Frills $13.00 1 $13.00
Standard 8.00 2 4.00
Super 15.00 2 7.50


9-49 Profitability Analysis (35 min)

1. First, calculate the contribution margin for traffic and commercial paint.
The first step is to determine the unit cost of latex, as follows:

For Traffic Paint: (450 x $13.50) /1,000 = $6.075

For Commercial Paint: (325 x $13.50)/1,000 = $4.3875

The contribution margin is determined as follows-- $0.775 for traffic and
$3.8625 for commercial

Using the contribution margin (CM), the total contribution for each scenario
can be determined as follows, where total traffic paint = 380,000 x .9 =
342,000 gallons, the remainder, 380,000 342,000 = 38,000 gallons, is
commercial paint. The loss of Virginia would reduce the traffic paint to
342,000 88,000 = 254,000 gallons. A doubling of commercial paint using
the promotion would mean 38,000 x 2 = 76,000 gallons.
Traffic Commercial
Selling price per gallon $9.00 $11.00
Direct materials costs:
Latex 6.075 4.3875
Camelcarb 0.38 0.54
Silica 0.37 0.52
Pigment 0.12 0.38
Other ingredients 0.06 0.03
Direct labor cost 0.46 0.85
Freight 0.78 0.43
Total variable cost 8.245 7.1375
Contribution margin $0.7550 $3.8625


2. The proposed promotional campaign, scenario C, has the greatest
contribution, as shown in the calculations above. Strategic issues for the
decision between scenario B and scenario C include the reliability of the
projected sales increase in commercial paint and assumption that the
volume of commercial paint can be doubled without increasing unit variable
costs for fixed costs, other than the cost of the promotion. A strategic
opportunity, on the other hand, is that Wellesley can move from a relatively
low contribution product line (traffic paint) to a relatively high contribution
product line (commercial paint).

Original Original Units w/o CM w/o Units with CM with
units CM/unit CM Virginia Virginia promotion promotion
Traffic 342,000 0.7550 $ 258,210 $ 254,000 191,770 $ 254,000 191,770 $
Commercial 38,000 3.8625 146,775 38,000 146,775 76,000 293,550
380,000 404,985 $ 292,000 338,545 $ 330,000 485,320 $
Less cost of promotional campaign 15,000
Total 470,320 $
Scenario A Scenario B Scenaraio C

9-50 Special Order Analysis; Strategy (20 min)

To begin the analysis, the New Life CFO should recognize that
the $2.50 full cost for its product includes $1.50 of irrelevant fixed
overhead. Only the variable costs of $1.00 per unit are relevant.
From this standpoint, the sales to SuperValue makes good sense,
since there would be a contribution of $1.00 ($2.00 price less $1.00
relevant cost) per unit sold. Moreover, sales to SuperValue would
utilize New Lifes available capacity. If these sales to were to
continue for the long term, then average fixed costs would be
reduced and New Lifes profitability would be improved in the long
term as well.
However, the sales to SuperValue could be a potentially
serious strategic mistake for New Life. New Lifes reputation is built
upon quality and product excellence, features which give it a clear
differentiation in the market. To sell its products in a supermarket,
even under another brand name, would cheapen the image of all
New Life products, and cause it to lose market share in its usual
distribution channels, the pharmacies and department stores. This is
especially true given that SuperValue has the limited right to market
the product as manufactured by New Life. How limited is that right?
New Life could be trading a short-term gain for a potential long-
term disaster in this deal with SuperValue. It should look for
business partners that are more in line with its strategy.


9-51 Project Analysis: Sales Promotions (30 min)

1. The relevant cost analysis follows:

First contest: Gliders Second contest:
Chair and Stool
Per Unit Total Per Unit Total
Number of units
(note 1)
1,250 900
Sales $ 80.00 $100,000 $ 61.00 $ 54,900
Direct material 16.00 20,000 11.00 9,900
Direct labor (note 2) 22.50 28,125 30.88 27,792
Sales commission 15.00 18,750 10.00 9,000
Contribution margin $26.50 $33,125 $9.12 $8,208
Cost of Prize $8,800 $4,685
Excess of CM over cost $24,325 $3,523

Notes:
1. 1,250 = 4,000 2,750; 900 = 8,000 7,100
2. $22.50 = 2.5 x $9.00; $30.88 = 3.25 x $9.50

Both contests have a substantially higher contribution relative to the
cost of the prize: $24,325 and $3,523 net contribution for the first
and second contests, respectively. Thus, the contests appear to be
desirable.

However, some additional strategic factors should also be
considered:
a. The contest appears to reward an increase of sales in units.
However, the average sales price for each product has already fallen
below budgeted levels. If the contest provides an expected incentive
to reduce price in order to increase sales, then the result could be
lower contributions than expected. Moreover, the price cutting could
have adverse long term effects. Clear Lake should carefully consider
its short and long term pricing strategy to make sure it is consistent
with the firms overall strategy. While it appears that the firms
overall strategy is cost leadership, so that lower prices are
competitively advantageous, the pricing should be based on a long-
term strategy with established profit targets.


b. Clear Lake should evaluate the effectiveness of its
advertising and promotional efforts. Are the targeted customers
being reached?
c. Since the products have a seasonal demand, are the lower
sales the result of failure to meet sales delivery dates or to bad
forecasts of the timing of demand?
d. An unintended effect of the sales contests is that certain
retail customers might buy unusually large orders, at the urging of
sales people, and that some portion of these order might eventually
be returned if not sold by the retailer by the end of the season.
e. While sales of the table are over budget, why does the sales
contest exclude the table? Perhaps this is one of Clear Lakes most
in-demand products, and overall profits would be improved through
incentives on this product.
f. Are Clear Lakes products competitive? Have new
competitors developed superior products, at lower prices? Perhaps
this is time for a careful market research and competitive analysis for
Clear Lake.



1. GianAuto is in a high-growth, highly competitive industry. Auto
makers are increasingly outsourcing the manufacture of parts and
entire brake or seating systems to low-cost producers throughout the
world. In North America, many of these plants are located in Mexico
and throughout Latin America. To be competitive in this business,
Gian must continue to be cost competitive and to also provide the
customer service and reliability that is expected by the auto makers.
Gian can also look for additional ways to be competitive by assisting
the auto makers in improving the design of the parts, developing
modular manufacturing systems, and improving the quality of the
parts.

Continuing to obtain covers from its own Denver Cover Plant would
allow GianAuto to maintain its current level of control over the quality
of the covers and the timing of their delivery. Keeping the Denver
Cover Plant open also allows GianAuto more flexibility than purchasing
the coverings from outside suppliers. GianAuto could more easily alter
the coverings' design and change the quantities produced, especially if
long term contracts are required with outside suppliers. GianAuto
should also consider the economic impact that closing Denver Cover
will have on the community and how this might affect GianAuto's other
operations in the region.

Other items that should be considered by GianAuto before
making a decision include:
The disposal value or alternate uses of the plant.
Any income tax implications including tax rates applicable to
gain/loss on sale of plant, depreciation tax shields, depreciation
and investment tax credit recapture, etc.
Outside supplier's prices in future years.
Cost to manufacture coverings at the Denver Plant in future years
Ethical issues involved in the termination of 400 employees
Should GianAuto continue to manufacture the covers, but in a new,
cost-efficient plant; the location could be anywhere in the world.


2. The following costs can be avoided by closing the plant and are
therefore relevant.

Materials $32,000
Labor
Direct $23,000
Supervisor 3,000
Indirect 4,000 30,000
Differential pension
expenses ($4,000 - 3,000) 1,000
Termination charges on cancelled
material orders($32,000 x .15) $4,800
Employment assistance 1,000
Total $68,800

The following costs are not relevant to the decision.

Depreciation-equipment $ 5,000
Depreciation-building 3,000
Continuing pension expense
($4,000 - 1,000) 3,000
Plant manager and staff 2,000
Corporate allocation 6,000
$ 19,000

The depreciation amounts are not relevant to the decision
because they represent portions of sunk costs that are being written
off during 2007. Three-fourths of the annual pension expense
($3,000) is not relevant because it would continue whether or not the
plant is closed. The amount for plant manager and staff is not relevant
because Vosilo and his staff would continue with GianAuto and
administer three remaining plants. Corporate allocation is not relevant
because this represents costs incurred outside Denver Cover and
assigned to the plant.



1.
Savings Cost to Buy:
Current to Buy Alternative Calculation
Materials 192 $ 68.00 $ $192-$68=$124
Labor 75 7.50 =10% x $75 75-7.50 = 67.50
Variable Overhead 150 15.00 =.1 x $150 150.00 - 15.00 = 135.00
Fixed Overhead 150 0 150.00
Total Cost 567 $ 90.50 $
Add Cost to Buy 105.00
Total Cost to Buy 581.50 $
Less Current Cost to Make 567.00 $
Net advantage to contine to make 14.50 $

The relevant cost to make (i.e., savings to buy) is $90.50 and the
relevant cost to buy is $105, so the analysis favors to make, for a
$14.50 (= $105 - $90.50) advantage. This is shown also by the
equivalent cost to buy calculation in the right-hand column above.

2. Because the firms overall strategy is differentiation based on
quality, the firm must be very sure that the decision to continue to
make the part will best support the desired quality. Usually, by
keeping manufacturing within the firm, as in this case, the firm can
best maintain the desired quality levels. If, however, it can be shown
that the outside supplier can provide the part at significantly higher
quality than RSM can provide, then strategically it makes sense to
forego the $14.50 advantage and buy the part outside, in order to
improve overall quality. We put first priority on quality because of the
differentiation strategy.
Other considerations include whether or not the firm can
develop successful cost reduction plans in other areas, and still
maintain the desired quality.
In addition to the need to maintain differentiation based on
quality, the firm should consider other means to improve profitability
and competitiveness. Some possible ideas include:



a. Get outside suppliers such as Performance Equipment, Inc.
to help the firm improve the design of their product and also improve
the quality of the product. That is, make the suppliers into partners in
achieving the firms goals. That way both the firm and the suppliers
succeed together. Probably some long-term supply agreements
would be necessary.

b. Develop new product designs that improve quality while
reducing cost. Avoid over-emphasis on getting the best out of the
current technology. Look for ways to achieve the desired product
differentiation in new ways not just quality, but perhaps also in
product innovation.
c. Has the firm developed appropriate means to sell its
position as a high-quality manufacturer? Is this well understood in
the market place?
d. The firm should continue to re-evaluate its strategy, as the
demand in the industry changes, and as the nature of the competition
changes.


9-54 Make or Buy; Review of Learning Curves (50 min)

1. If the cylinders are manufactured by Henderson Equipment
Company, the direct labor hour configurations would be as follows
(see below):
a. For the first 800 cylinders (including the pilot run) produced,
the average direct labor hours per unit equal .117.
b. For the first 800 cylinders (including the pilot run) produced,
the total direct labor hours amount to 93.60.

Average Direct
Cumulative Labor Hours Total Direct
Output Per Unit Labor Hours
50 .285 14.25
100 (.8 X .285)=.228 22.80
200 (.8 X .228)=.182 36.40
400 (.8 X .182)=.146 58.40
800 (.8 X .146)=.117 93.60

2. The total manufacturing costs for Henderson to produce the
additional 1,600 cylinders, assuming the first 800 cylinders produced
(including the pilot run) required 100 direct labor hours and the 800th
unit produced required .079 direct labor hours, amounts to
$12,381.94, calculated as follows:

Total units to be produced = 1,650
Additional units required = 1,600 (1,650 - Pilot Run of 50)
Units available to meet
the 1,600 requirement = 750 (800 - Pilot Run of 50)
Add. production requirement = 850 (1,600 - 750)



Manufacturing costs

First 750 units
Direct labor
hours consumed = 85.75 hours (100 hours, Pilot Run 14.25 hrs)

Direct labor = 85.75 hours X $12.00/hr $ 1,029.00
Variable overhead = 85.75 hrs X $10.00/hr = $ 857.50
Fixed overhead = 85.75 hrs X $16.60/hr = $ 1,423.45
Material = 750 units X $4.05/unit = $ 3,037.50
$ 6,347.45

Last 850 units
Aggregate cost {850 units x .079 ($12.00 + $10.00
+ $16.60) + 850 x $4.05)} 6,034.49

Total manufacturing costs for remaining 1,600 units $12,381.94

3. To maximize profits, Henderson Equipment Company should
manufacture the additional 1,600 cylinders as the cost to
manufacture is $2,156.20 less than the cost to purchase from Lytel
Machine Company, calculated as shown below:

Purchase cost (1,600 units @ $7.50 per unit) $12,000.00
Manufacturing cost:
From Requirement (2). $12,381.94
Less: Fixed overhead
750 units (85.75 hrs. x $16.60) $1,423.45
850 units (850 X .079 x $16.60) 1,114.69 2,538.14 9,843.80

Savings by manufacturing $2,156.20


9-55 Profitability Analysis; Review Master Budget; Strategy (50 min)
1. The dollar value of DimLok's present annual fixed costs is
calculated as follows:
Profit target based on 20% of annual fixed costs $ 800,000
Total fixed costs = $800,000 /.20 = $4,000,000

2. DimLok must sell 64,000 units in order to achieve both profit
objectives of 20 percent return on fixed costs and $20 per unit sold.

Supporting Calculations
First: The solution must consider the following constraints:

40,000 unit capacity for the current facility.
$1,000,000 additional fixed charge for production up to 80,000
units.
a sales discount of $20 per unit for sales beyond 40,000 units.
a variable cost decrease of $20 per unit after the production of
60,000 units.

Second: The calculation with the current facility at the capacity level
of 40,000 units will not meet the profit objectives.

Contribution per unit below the 40,001 unit level
= $200 selling price - ($80 variable cost per unit + $20 profit per unit)
= $100 contribution per unit up to 40,000

Calculation of the number of units to achieve the desired profit
objectives
= (Fixed charges + Desired profit) / Contribution per unit.
= ($4,000,000 + $800,000) / $100 per unit
= 48,000 units

48,000 units exceeds capacity by 8,000 units.



Third: In order to achieve the profit targets, DimLok must increase
plant capacity, thus incurring an additional $1,000,000 in fixed costs.
This in turn will increase the profit target based on fixed costs to
$1,000,000 {.20($4,000,000 + $1,000,000)}
The contribution for production in the 40,001 to 60,000 units
range, with the selling price reduced to $180 per unit is as follows:

= $80 contribution per unit.

Calculation of the number of units to achieve overall profit objectives
= (Fixed charges + Desired profit) = Contribution
= ($5,000,000 + $1,000,000) = ($100 per unit x 40,000 units) +
$80(X - 40,000 Units)
= 65,000 units

65,000 units exceeds the 60,000 unit constraint; variable
costs are reduced by $20 per unit for production in
excess of 60,000 units.

Fourth: The contribution margin for production in the 60,000 to
80,000 units range, with the variable cost per unit reduced to $60 per
unit is determined as follows:

= $100 contribution per unit

Calculation of the number of units to achieve overall profit objectives
= (Fixed charges + desired profit) = contribution
= ($5,000,000 + $1,000,000) = ($100 per unit x 40,000 units)
+ ($80 x 20,000 units) + $100 (X - 60,000 units)
= 64,000 units



3. DimLok Division
Pro Forma Income Statement

Revenue
40,000 units x $200 $8,000,000
24,000 units x $180 4,320,000 $12,320,000
Variable costs
60,000 units x $80 4,800,000
4,000 units x $60 240,000 5,040,000
Contribution 7,280,000
Fixed costs 5,000,000
Operating income $ 2,280,000

The profit objectives {(20 percent of the annual fixed costs) + ($20
per unit produced)} are met as shown below.

= (.20 x $5,000,000) + ($20 x 64,000 units produced)
= $1,000,000 + $1,280,000
= $2,280,000

4. DimLok has a competitive strategy based on differentiation. The
differentiation is based on the secret process that DimLok has
developed and the advertising program stresses completely new
products each year. Given the innovative nature of the firms
products, this strategy seems to be a very appropriate one.

5. Critical success factors for DimLok include research and
development to maintain the technological advantage of their unique
products and strong advertising programs to stress the firms
differentiation based on innovation. Other strategic success factors
include quality of production and customer service to maintain
product differentiation.


9-56 Profitability Analysis; Pricing (25 min)

The objective of this problem is to provide an opportunity for students to
use Excel as a way to study a What-if analysis in the context of a pricing
question. A variety of possible answers are likely.

The analysis below removes hotel-level overhead and selling and
administrative costs, which are fixed costs (see note to table in text of
problem) and should not affect the decision about pricing. Based on the
consultants advice, sales of 6,000,000 rooms are projected at a market
price of $76. The contribution at the $76 price ($280,920,000) is
somewhat higher than the present contribution ($235,280,000), or even the
contribution at the original price of $80 ($254,100,000). Since the
consultants estimate of a 50% increase in sales might be optimistic, we
also calculate the contribution for 5,500,000 rooms, a figure that falls
between the 5,000,000 rooms the consultant promised for reducing price,
and the 6,000,000 estimate. Again, it is also a higher contribution than
under the either the $80 or $88 price.

Total Market 50,000,000
Market Share 8.00% 10.00% 11.00% 12.00%
Sale Price 88.00 $ 80.00 $ 76.00 $ 76.00 $
Volume 4,000,000 5,000,000 5,500,000 6,000,000
Revenue 352,000,000 $ 400,000,000 $ 418,000,000 $ 456,000,000 $
Variable Costs
Supplies 3.30 3.30 3.30 3.30
Direct Labor 15.38 15.38 15.38 15.38
Room-level Overhead 10.50 10.50 10.50 10.50
Total variable cost/room 29.18 $ 29.18 $ 29.18 $ 29.18 $
Contribution
Unit 58.82 $ 50.82 $ 46.82 $ 46.82 $
Total 235,280,000 $ 254,100,000 $ 257,510,000 $ 280,920,000 $
Price = $80 to $88 Price =$88 to $76.00
Note: To get unit variable costs, we average the unit costs over the different levels of room occupancies.

The key strategic question is how the price changes will affect customers
perceptions about HomeSuites for the longer term. Will the price change
cause the hotel chain to appear less high quality, and damage it appeal to
its current customer base? Or will the price change attract new customers
who are looking for a value in business travel hotels?

9-57 Make or Buy; Strategy; Ethics (45 min)

1. An analysis of per unit and total costs for 32,000 units shows that
the Midwest Division should purchase the parts for a saving of
$15,440 ($575,040 - $559,600).

Cost per unit Total Cost
Cost to purchase MTR-2000 from Marley
Bid price from Marley $17.30 $553,600
Equipment lease penalty [($36,000/12)x2] 6,000
Total cost to purchase $559,600

Cost for Midwest to Make MTR-2000

Direct material ($195,000/30,000)x1.08 7.02 $224,640
Direct labor ($120,000/30,000)x1.05 4.20 134,400
Factory space rental ($84,000/32,000) 2.625 84,000
Equipment leasing costs($36,000/32,000) 1.125 36,000
Variable manufacturing overhead 3.00 96,000
Total cost to make $17.97 $575,040

2. At least three strategic factors that the Midwest Division and
Paibec Corporation should consider before agreeing to purchase
MTR-2000 from Marley Company include the following:
The quality of the Marley component should be equal to, or better
than, the quality of the internally made component, or else the
quality of the final product might be compromised and Paibec's
reputation affected.
Marley's reliability as an on-time supplier is important, since late
deliveries could hamper Paibec's production schedule and delivery
dates for the final product.
Layoffs may result if the component Is outsourced to Marley, This
could impact Midwest's and Paibec's other employees and cause
labor problems or affect the company's position in the community,
In addition, there may be termination costs which have not been
factored into the analysis.
Giving up production capability risks dependence upon Marleys
future pricing.


3. Referring to the specific standards for ethical practice by a
management accountant, Lynn Hardt should consider the ethical
standards of competence, integrity, and objectivity:
Competence
Prepare complete and clear reports and recommendations after
appropriate analysis of relevant and reliable information. John has
asked Lynn to adjust and falsify her report and leave out some
manufacturing overhead costs.
Integrity
Refrain from either actively or passively subverting the attainment
of the organization's legitimate and ethical objectives, Paibec has
a legitimate objective of trying to obtain the component at the
lowest cost possible, regardless of whether it is manufactured by
Midwest or outsourced to Marley.
Communicate unfavorable as well as favorable information and
professional judgments. Hardt needs to communicate the proper
and accurate results of the analysis, regardless of whether or not
it is favorable to Midwest.
Refrain from engaging in or supporting any activity that would
discredit the profession. Falsifying the analysis would discredit
Hardt and the profession.

Credibility
Communicate information fairly and objectively. Hardt needs to
perform an objective make-or-buy analysis and communicate the
results objectively.
Disclose all relevant information that could reasonably be
expected to influence an intended users understanding of the
reports, comments, and recommendations presented. Hardt
needs to fully disclose the analysis and the expected cost
increases.


9-58 Profitability Analysis; Excel (80 min)

1. The profit report Hal is using is not contribution based, so the first step
is to produce a contribution income statement for the three product lines,
as shown below. Note that fixed costs are not allocated to the product
lines since they are irrelevant to the short-term profitability analysis.

The analysis shows that all three lines have a positive contribution,
including the Weldon line. The short term effect of dropping the Weldon
line would be the loss of $15,543,000 contribution. For a longer-term
perspective, Hal should expect the Weldon product to cover the full
operating costs, including the fixed costs. Thus, there should be a
consideration of sales trends and alternative uses of the plants capacity.
For example, if sales in the Weldon line are expected to fall and there are
attractive alternative uses of the plants capacity, then the Weldon line
might be discontinued now, suffering a short term loss as noted above, for
the purpose of the longer-term gain.

2. Since the Weldon product has a positive contribution of $94.20 per unit,
the total contribution will be positive irrespective of the level of sales, and
the analysis in part one will continue to favor keeping the line. Hal and
Joan might want to consider alternate uses of the plant facilities if Weldon
sales continue to fall.
Total
Per Unit Total Per Unit Total Per Unit Total
Sales units 150,000 335,000 165,000
Sales dollars 459.00 68,850,000 365.00 122,275,000 248.00 40,920,000 232,045,000
Factory Costs
Labor 125.00 18,750,000 118.00 39,530,000 62.00 10,230,000 68,510,000
Raw Materials 88.50 13,275,000 66.00 22,110,000 78.00 12,870,000 48,255,000
Power 23.50 3,525,000 15.60 5,226,000 13.80 2,277,000 11,028,000
Variable Costs 237.00 35,550,000 199.60 66,866,000 153.80 25,377,000 127,793,000
Contribution 222.00 33,300,000 165.40 55,409,000 94.20 15,543,000 104,252,000
Fixed Costs
Repairs 7,962,500
Factory Equipment 21,775,000
Other Costs 8,473,750
Selling Expense 22,935,000
Administrative Expense 10,920,000
Other Admin. Expense 17,875,000
Interest 4,225,000
94,166,250
Operating Profit 10,085,750
Parker Virginian Weldon


3. The 10% sales increase has total sales of 165,000 units for Parker and
368,500 units for Virginian. The analysis for dropping Weldon is as
follows. The new total profit of $3,413,650 falls short of the profit with
Weldon, $10,085,750, so in the short run it would be better to retain
Weldon.

4. The most convenient way to solve this problem, once you have a
spreadsheet, is to use Goal Seek in Excel. Goal Seek is available under
the Tools menu. The dialog box that executes Goal Seek is illustrated
below:

Total
Sales units 165,000 0 368,500 -
Sales dollars 459.00 75,735,000 365.00 134,502,500 248.00 - 210,237,500
Factory Costs
Labor 125.00 20,625,000 118.00 43,483,000 62.00 - 64,108,000
Raw Materials 88.50 14,602,500 66.00 24,321,000 78.00 - 38,923,500
Power 23.50 3,877,500 15.60 5,748,600 13.80 - 9,626,100
Variable Costs 237.00 39,105,000 199.60 73,552,600 153.80 - 112,657,600
Contribution 222.00 36,630,000 165.40 60,949,900 94.20 - 97,579,900
Fixed Costs
Repairs 7,962,500
Office Expense 10,920,000
Administrative Expense 17,875,000
Other Admin. Expense 4,225,000
94,166,250




The result of the Goal Seek is shown below

The analysis shows that sales in the Parker line would have to increase
to 220,014 units (a 70,014 unit or nearly 50% increase) in order to maintain
operating income at $10,085,750 if Weldon is discontinued.

Total
Sales units 220,014 335,000 -
Sales dollars 459.00 100,986,203 365.00 122,275,000 248.00 - 223,261,203
Factory Costs
Labor 125.00 27,501,689 118.00 39,530,000 62.00 - 67,031,689
Raw Materials 88.50 19,471,196 66.00 22,110,000 78.00 - 41,581,196
Power 23.50 5,170,318 15.60 5,226,000 13.80 - 10,396,318
Variable Costs 237.00 52,143,203 199.60 66,866,000 153.80 - 119,009,203
Contribution 222.00 48,843,000 165.40 55,409,000 94.20 - 104,252,000
Fixed Costs
Repairs 7,962,500
Office Expense 10,920,000
Office Depreciation 17,875,000
Other Adm Expense 4,225,000
94,166,250

9-59 Profitability Analysis; Linear programming (50 min)

1. Solve for all three constraints:
The solution is 15 units of Premier and 30 units of Haute, as
shown in Exhibit 9-59 B, cells B5 and B6. The Solver set up for this
solution is shown in Exhibit 9-59 A, and the Answer report is shown
in Exhibit 9-59 C.

Exhibit 9-59 A



Exhibit 9-59 B



Exhibit 9-59 C



2. Solve with the preparation time constraint removed. The
constraint to remove is H7 <= 60.
The solution is 45 units of Premier and 10 units of Haute, as
shown in Exhibit 9-59 D, cells B5 and B6.

Exhibit 9-59 D

Chapter 9: Decision Making With Relevant Costs and A Strategic Emphasis

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 9: Decision Making With Relevant Costs and A Strategic Emphasis

Uploaded by

Copyright:

Available Formats

Blocher,Stout,Cokins,Chen:Cost Management, 4e 9-1 The McGraw-Hill Companies, Inc.

You might also like