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CHAPTER 14

Decision Making: Relevant Costs and Benefits
ANSWERS TO REVIEW QUESTIONS
14-12 An opportunity cost is the potential benefit given up when the choice of one action
precludes a different action. For example, one opportunity cost associated with
getting a college education is the student’s forgone wages from a job that might
have been held during the educational period.
14-15 In a differential-cost analysis, the decision maker determines the difference in each
cost or revenue item that will occur under each of the alternatives under
consideration. Then the decision maker focuses on the differences in the costs and
revenues in making the decision.
14-21 Sensitivity analysis may be used to cope with uncertainty in decision making by
analyzing how sensitive a decision problem is to the estimates of certain parameters.
One important question that can be answered is: How much can a particular
parameter estimate change before the optimal decision changes?

SOLUTIONS TO PROBLEMS
PROBLEM 14-46 (25 MINUTES)
1.
Food
Blender Processor
Unit cost if purchased from an outside supplier .............................. $60
$114
Incremental unit cost if manufactured:
Direct material ................................................................................... $18
$ 33
12
27
Direct labor ........................................................................................
Variable overhead
18
$48 – $30 per hour fixed ...............................................................
$96 – (2)($30 per hour fixed) ........................................................
36
$ 96
Total ................................................................................................ $48
Unit cost savings if manufactured ..................................................... $12
$ 18
1
2
Machine hours required per unit ........................................................
Cost savings per machine hour if manufactured
$12 ÷ 1 hour ...................................................................................... $12
$18 ÷ 2 hours ....................................................................................
$ 9
Therefore, each machine hour devoted to the production of blenders saves the
company more than a machine hour devoted to food processor production.
McGraw-Hill/Irwin
Managerial Accounting, 6/e

© 2005 The McGraw-Hill Companies, Inc.
14-1

...000 food processors 15........................00 1 MH 2 MH $12.....400 McGraw-Hill/Irwin 14-2 © 2005 The McGraw-Hill Companies........... 50................000 9........................................................................000 – $39............................................................................................... Food Blender Processor $12............000 food processors......... Total ...........................000 food processors Purchase: 20.....50 Therefore...000 20......................000 Remaining machine hours ............ Increase in unit cost if purchased ($54.000 food processors Purchase 13.. Variable manufacturing overhead ($36... Conclusion: Manufacture 20........................................................................000 Incremental unit cost if manufactured: Direct material .......................................... Machine hours needed to manufacture 20.............. $33 ÷ 2 hours ..........000 food processors Purchase: 3..000 If the company’s management team is able to reduce the direct material cost per food processor to $18 ($15 less than previously assumed)...................00 $33................................... Machine hours available .............................................................................000 blenders Manufacture 15........ Inc...........000 blenders PROBLEM 14-47 (25 MINUTES) 1.......................000 Number of food processors to be produced (30....................2. then the cost savings from manufacturing a food processor are $33 per unit ($18 savings computed in requirement (1) plus $15 reduction in material cost): New unit cost savings if manufactured ........... devote all 50.......................000 × 1/3) .................................................. $ 3...............00 $16..................000 $ 54.......................................................... Machine hours required per unit ................................ Incremental unit cost if purchased: Purchase price ........000 12...........................000 blenders ............................................................. Total .....600 $ 14.............. Direct labor .........................................000 $ 39... Conclusion: Manufacture: 25........... Cost savings per machine hour if manufactured $12 ÷ 1 hour ......600) .................000 ÷ 2) ............................ Material handling ...................000 hours to the production of 25..... 30...... $ 45..............................................................................000 600 24.......................................... Solutions Manual ......................... Material handling ...

$144...................400 as computed in requirement 1) .............................. Therefore........... CFT should purchase the pumps because the purchase price of $102 is less than the $108 relevant cost to manufacture............................ Less: rental revenue from idle space ........................ 6/e Cost of 10............. if potential labor cost improvements are ignored.... 14-3 .............. these costs would not increase.................................................... 3..000 PROBLEM 14-48 (20 MINUTES) The analysis prepared by the engineering............................................ Inc...............080........................000 Unit Assembly Run Per Unit $ 180..... and accounting departments of Cincinnati Flow Technology (CFT) was not correct... manufacturing.......... their recommendation was correct..000 $108 © 2005 The McGraw-Hill Companies......... Assembly labor .............................. fixed factory overhead costs and general and administrative overhead costs have not been included because they are not relevant............ Incremental cost analysis: Purchased components ............. An incremental cost analysis similar to the following table should have been prepared to determine whether the pump should be purchased or manufactured.....000 $1............... because no additional equipment................000 $ 18 450. Total relevant cost . McGraw-Hill/Irwin Managerial Accounting.000 75....... space..000 $ 12......400.....................000 $156.......... Variable manufacturing overhead .....000 45 45 450.... Increase in monthly cost of acquiring part RM67 if purchased (10 × $14....... or supervision would be required if the pumps were manufactured....000 144.................. provided that potential labor-cost improvements are ignored.. However................. Contribution forgone by not manufacturing alternative product .... Increase in monthly cost ........................2......... Savings in the cost of acquiring RM67 (10 × $14......... In the following analysis.... as computed above) . Net cost of using limited capacity to produce part RM67 ...............000 $ 69............

50 $495. on existing product sales Break-even points McGraw-Hill/Irwin 14-4 © 2005 The McGraw-Hill Companies.000 Less: Marketing and advertising……………… 195.50 195. $2. Inc. Unit contribution margin…………………… Enhanced $375. Per-unit contribution margins: Standard Selling price…………………………………. Variable manufacturing overhead … Sales commission $375 x 10%. $2.000 units x 20%). On the basis of this sales forecast.400.000 units x 25%) or 8.000 Enhanced units (40.00 138..000 The quantitative difference between the profitability of Standard and Enhanced is relatively small.00 $67. Inc.PROBLEM 14-49 (25 MINUTES) 1.100.00 2. These factors include: - Competitive products in the marketplace Data validity Growth potential of the Standard and Enhanced models Production feasibility Effects.000 Standard units (40..000 units x $237. 8.00 48.000 $2. which may prompt the firm to look at other factors before a final decision is made. Solutions Manual .370..00 $42.00 $300. the company would be advised to select the Standard model.000 300. Total unit variable cost……………….00 49.00 $237.50 36.00 22.000 units x $300…. $495 x 10%………….50 30. Martinez.00 37.000 Income……………………………………………. expects to sell 10. 4. if any. The following costs are not relevant to the decision: • Development costs—sunk • Fixed manufacturing overhead—will be incurred regardless of which product is selected • Sales salaries—identical for both products • Market study—sunk 3. Less: Variable costs: Direct material………………………… Direct labor……………………………. Standard Enhanced Total contribution margin: 10.175..000 $2.

Variable manufacturing overhead (. Total contribution margin (11.500 Options include the following: • Sacrificing some current business in the hope that a long-term relationship with Venus can be established and proves to be profitable • Acquiring more machine capacity • Outsourcing some units • Working overtime McGraw-Hill/Irwin Managerial Accounting.500 Available hours……………………………………………… 4.000 units x $7..000 ÷ 60.PROBLEM 14-51 (25 MINUTES) 1.00 ..20 $ 7.40 .20 4. Planned machine hours (5. Less: Additional setup costs…………………………… Special device……………………………………….100 * Fixed manufacturing overhead: $1.5 hours x $15.300 $7.000 units x . Unit contribution margin…………………………………. Yes.00*)…………………………….00 = $15. $31. 10.000 Current usage (15.$25.30)……. Selling price………………………………………………… Less: Direct material ($16.500.50 7.50 $12.00 2.00 per hour Variable manufacturing overhead: $40..000 hours x 70%)…………………….5 hours)…… 3. Note: The fixed administrative cost is irrelevant to the decision.800 12.30 $80. Inc.400 4. Mercury lacks adequate machine capacity to manufacture the entire order.000 machine hours = $25.100 for the firm.000 hours x 3 months)…… 15.500 Required machine hours (11. Net contribution to profit…………………………………. No.20)………………….$4. Direct labor…………………………………………..50 24.. because this cost will be incurred regardless of whether Mercury accepts or rejects the order. the order should be accepted because it generates a profit of $68. 14-5 . 6/e © 2005 The McGraw-Hill Companies..200 $68. 5.