PRACTICE PROBLEMS (Module 2: Cost Concepts and Present Economy Studies)

Members (Team 4):

Larroza, John Dave
Obaredes, Leian May
Tilano, Miguel Louis
Beluso, Angeline
Dela Vega, Marianne Grace

Instructions:
Work as a team/group but submit individually. Answer practice problem sets on module 2 hand-
out (both for the cost-volume-Profit/break-even analysis, on page 6 and the Present economy study on
page 9). Make your solution clear and indicate your final answer/s. Be ready to present your solutions
next meeting before our quiz.

1.1 Cost- Volume- Profit/Break Even Concept for Decision Making

1. 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 $800,000 per month. The
variable cost per thousand board feet is $155.50. The price charged will be determined by
p = $600 − (0.5) D per 1,000 board feet.
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 domain of profitable demand during a month?

Given:
 CF = $800,000 / month
 CV = $155.50
 p = $600 – 0.5D

Required:
a. -Optimal Monthly Sales Volume
-Profit (or loss)
b. Domain of Profitable Demand

Solution:
a. D* =

D* =

D* =

D* = 444.5 ≈ 445 units per month

Profit (or loss) = Total Revenue – Total Cost

= (aD – bD2) – (CF + CVD)

= [600 (445) – 0.5 (445)2] – [800,000 + 155.50 (445)]

= (267,000 – 99,012.5) – (800,000 + 69,197.5)

= 167,987.5 – 869,197.5

Profit (or loss) = –$701,210 --- (Loss)

b. Total Revenue = Total Cost ; (Profit = 0)

aD – bD2 = CF + CVD

aD – bD2 – (CF + CVD) = 0

aD – CVD – bD2 – CF = 0

– bD2 + (a – CV)D – CF = 0 (Quadratic Equation)

D’ = – –

D1’ = – –

D1’ = – –

D1’ = –

D1’ = 444.5 – –

D1’ = 444.5 –

D1’ = 444.5 – [( ) ( )]

D1’ = 444.5 – 1184.24i

 – –
D2’ =

D1’ = – –

D1’ = –

D2’ = 444.5 + –

D2’ = 444.5 +

D2’ = 444.5 + [( ) ( )]

D2’ = 444.5 + 1184.24i

2. The annual fixed costs for a plant are $100,000, and the variable costs are $140,000 at 70%
utilization of available capacity, with net sales of $280,000. What is the breakeven point in
units of production if the selling price per unit is $40?

Given:
 CF = $100,000
 CV = $140,000
 Revenue = $280,000
 Price = $40 / unit

Require:
 Breakeven point in units of production

Solution:

 Total Cost = CF + CVD

= $100,000 + $140,000D

 Total Revenue = Price x Demand

$280,000 = $40D
 D = 7,000 units

 Variable Cost (CV) per unit:

= $20 / unit

 Breakeven Point: (Profit=0)

Profit = Total Revenue – Total Cost

0 = pD – (CF + CVD)

pD = CF + CVD

$40D = $100,000 + $20D

$40D – $20D = $100,000

$20D = $100,000

D* = 5,000 units

3. A plant operation has fixed costs 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 that the remaining 10% of production is sold at $70 per unit.

Given:
 CF = $2,000,000
 Dmax = 100,000
 CV = $40
 P = $90

Required:
 Breakeven Chart
 Annual Profit comparison between 90% capacity and 100% capacity (under some
assumptions)
Solution:
a.) Breakeven Point: (Profit=0)

Profit = Total Revenue – Total Cost

0 = pD – (CF + CVD)

pD = CF + CVD

$90D = $2,000,000 + $40D

$90D – $40D = $2,000,000

D = 40,000 units per year

(40,000 x $90 = $3,600,000)

10,000,000
9,000,000
8,000,000
7,000,000
6,000,000
5,000,000
4,000,000
Fixed Cost
3,000,000
2,000,000 Total Cost
Breakeven Point Total Revenue
1,000,000
0

b.)

90% Capacity (D = 90,000)

Profit = Total Revenue – Total Cost

= pD – (CF + CVD)

= [90 (90,000)] – [$2,000,000 + 40 (90,000)]

 = 8,100,000 – 5,600,000

= $2,500,000

100% Capacity

 90% Production (at p = $90 ; D = 90,000)

Profit = Total Revenue – Total Cost

= pD – (CF + CVD)

= [90 (90,000)] – [$2,000,000 + 40 (90,000)]

= 8,100,000 – 5,600,000

= $2,500,000

 10% Production (at p = $70 ; D = 10,000)

Profit = Total Revenue – Total Cost

= pD – (CF + CVD)

= [70 (10,000)] – [2,000,000 + 40 (10,000)]

= 700,000 – 2,400,000

= -$1,700,000

100% Production Annual Profit = $2,500,000 - $1,700,000

= $800,000

Therefore, the annual profit of the plant when it is operating at 90% capacity is $2,500,000.
While, the annual profit of the plant when it is operating at 100% capacity (assuming that the first
90% of the capacity output is sold at $90 per unit and the remaining 10% of production is sold at
$70 per unit) is only $800,000; which makes the 90% capacity of production 68% more profitable
compared to the 100% capacity of production, under certain assumptions.
4. A company is planning to produce two products, A and B. The company is planning to sell
100,000 units of A at P4.00 per unit and 200,000 units of B at P3.00 per unit. Variable costs
are 70% of sales for A and 80% of sales for B. In order to realize a total profit of P160,000,
what must be the total fixed cost?

Given:
Product A Product B
D 100,000 200,000
p P4.00 P3.00
CV 70% of Sales 80% of Sales
Total Profit P160,000

Required:
 Total Fixed Cost

Solution:
 Product A

Total Revenue = pD

= 4.00 (100,000)

= 400,000

Total Cost = CF + CVD

= CF + 0.70 (100,000)

= CF + 70,000

 Product B

Total Revenue = pD

= 3.00 (200,000)

= 600,000

Total Cost = CF + CVD

= CF + 0.80 (200,000)

= CF + 160,000

Total Revenue = P400,000 + P600,000 = P1,000,000

Total Cost = (CF + 70,000) + (CF + 160,000) = 2CF + 230,000

 Total Profit = Total Revenue – Total Cost

160, 000 = 1,000,000 – (2CF + 230,000)

160,000 = 770,000 – 2CF

2CF = 770,000 – 160,000

2CF = 610,000

CF = P305,000

5. A company which manufactures electric motor has a capacity of producing 150 motors a
month. The variable costs are P4,000 per month. The average selling price of the motor is
P750 per motor. Fixed costs of the company amounts to P78,000 per month which includes
all taxes. Determine the number of motors to be produced per month to breakeven.

Given:
 DMax = 150 motors / month
 CV = P4,000 / month
 p = P750
 CF = P78,000

Required:
 Breakeven

Solution:
CV
/ motor =

= P26.67 / motor

Breakeven: (Profit = 0)

Profit = Total Revenue – Total Cost

0 = Total Revenue – Total Cost

Total Revenue = Total Cost

pD = CF + CVD

750D = 78,000 +26.67D

 750D – 26.67D = 78,000

D = 107.83 ≈ 108
motors

1.2 Present Economy Studies

1. Sea water contains 2.1 pounds of magnesium per ton. By using the processing method
A, 85% of the metal can be recovered at a cost of $3.25 per ton of sea water pumped and
processed. If process B is used, 70% of the available metal is recovered, at a cost of only
$2.60 per ton of water pumped and processed. The two processes are substantially equal as
to investment cost and time requirements. If the extracted metal can be sold for $2.40 per
pound, which processing method should be used? At what selling price would the two
processes be equally economical?

Given:
 2.1 lb of Magnesium / ton-seawater
 Amount recovered (Method A) = 85% (at $3.25 / ton-seawater)
 Amount recovered (Method B) = 70% (at $2.60 / ton-seawater)
 Selling Price = $2.40 / lb

Required:
 Profitable Method to use
 Selling price of two methods to be equally economical

Solution:
Profit = (Selling Price x Amount Recovered) – Cost

For Method A:

Profit = [($2.40 / lb) (2.1 lb / ton-seawater) x (0.85)] - $3.25 / ton-seawater

= [($5.04 / ton-seawater) (0.85)] – ($3.25 / ton-seawater)

= ($4.284 / ton-seawater) – ($3.25 / ton-seawater)

= $1.03 / ton-seawater

For Method B:

Profit = [($2.40 / lb) (2.1 lb / ton-seawater) x (0.70)] - $2.60 / ton-seawater

= [($5.04 / ton-seawater) (0.70)] – ($2.60 / ton-seawater)

 = ($3.528 / ton-seawater) – ($2.60 / ton-seawater)

= $0.93 / ton-seawater

The result shows that the profit of method A is $1.03 / ton-seawater, while the
profit of method B is $0.93 / ton-seawater. Thus, method A should be used since it is more
profitable that method B.

 Let x = selling price

Profit = (Selling Price x Amount Recovered) – Cost

Profit of Method A = Profit of Method B

[x (2.1 lb / ton) (0.85)] – ($3.25 / ton) = [x (2.1 lb / ton) (0.70)] – ($2.60 / ton)

1.785 x – $3.25 = 1.47 x – $2.60

1.785 x – 1.47 x = – $2.60 + $3.25

0.315 x = $0.65

x = $2.06 / lb

Therefore, the selling price of the two methods (Method A and Method B) should be
$2.06 / lb so both would be equally economical.

2. In connection with surfacing a new highway, a contractor has a choice of two sites
in which to set up the asphalt mixing plant equipment. The contractor estimates that it will
cost $1.15 per cubic yard per mile (yd3 -mile) to haul the asphalt paving material from the
mixing plant to the job location. Factors for the two sites are as follows (production costs at
each site are the same):

Cost Factor Site A Site B

Average Hauling Distance 6 miles 4.3 miles
Monthly Rental of the Site $1,000 $5,000
Cost of Set up and Remove Equipment $15,000 $25,000
Hauling Expense $1.15/yd3 - mil $1.15/yd3 - mil
Flag Person Not required $93/day
The job requires 50,000 yd3 of mixed-asphalt paving material. It is estimated that
four months (17 weeks of five working days per week) will be required for the job. Which is
the better site?
Given:
Cost Factor Site A Site B
Average Hauling Distance 6 miles 4.3 miles
Monthly Rental of the Site $1,000 $5,000
Cost of Set up and Remove Equipment $15,000 $25,000
Hauling Expense $1.15/yd3 - mil $1.15/yd3 - mil
Flag Person Not required $93/day

Required:
 The better site to utilize

Solution:

Compare: (in terms of total cost)

Total Cost = Total Rent (4 months) + Cost to Set up and Remove Equipment + Hauling

Cost + Flag Person Salary

Site A:

 Total Rent = (Monthly Rent) x (4)

= $1,000 x 4

= $4,000

 Cost to Set up and Remove Equipment = $15,000

 Flag Person Salary = $0

 Hauling Cost = (Hauling Expense) x (Average Hauling Distance) x (Required

Mixed-Asphalt Paving Material)

= ($1.15/yd3 – mil) x (6 miles) x (50,000 yd3)

= $345,000

Total Cost = Total Rent (4 months) + Cost to Set up and Remove Equipment + Hauling

Cost + Flag Person Salary

= $4,000 + $15,000 + $0 + $345,000

= $364,000
 Site B:

 Total Rent = (Monthly Rent) x (4)

= $5,000 x 4

= $20,000

 Cost to Set up and Remove Equipment = $25,000

 Flag Person Salary = ($96/day) x (5 working days) x (17 weeks)

= $8,160

 Hauling Cost = (Hauling Expense) x (Average Hauling Distance) x (Required

Mixed-Asphalt Paving Material)

= ($1.15/yd3 – mil) x (4.3 miles) x (50,000 yd3)

= $247,250

Total Cost = Total Rent (4 months) + Cost to Set up and Remove Equipment + Hauling

Cost + Flag Person Salary

= $20,000 + $25,000 + $8,160 + $247,250

= $300,410

Therefore, Site B should be utilized since it has a lower cost compared to Site B.

3. Two workers, A and B, produces the same product on identical machines. A receives
P25.00 per hour and he produces 100 units per hour. B is able to produce 120 units per
hour. The machine rate or cost of operation of the machines used by them is P100.00 per
hour.
(a) Determine the cost per piece for worker A.
(b) Determine the hourly wage of worker B in order that his cost per piece will
equal that of A.
Given:

A B
Production Rate 100 units / hour 120 units / hour
Machine Rate P100 / hour P100 / hour
Required:

(a) Cost per piece of worker A

(b) Hourly wage of worker B in order that his cost per piece will equal that of A

Solution:

(a) Cost per piece =

= P1.25 / unit

(b) Hourly wage of worker B: (let x = hourly wage)

Cost per piece (A) = Cost per piece (B)

P1.25 / unit =

(P1.25 / unit) (120 units / hour) = x + P100 / hour

(P1.25 / unit) (120 units / hour) – P100 / hour = x

x = P150 / hour – P100 / hour

x = P50 /
hour

4. 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
are 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). Based on these data, should
the item be purchased or manufactured?

Given:
Option A: (Purchase)
 No. of items = 10,000 items
 Fixed Price = $8.50 / item
 Option B: (Manufacture)
 No. of items = 10,000 items
 Cost (Direct Materials) = $5.00 / item
 Cost (Direct Labor) = $1.50 / item
 Cost (Overhead) = $3.00 / item
Solution:
 Option A: (Purchase)

Total Cost = (Fixed Price) x (No. of Items)

= ($8.50 / item) x (10,000 items)

= $85,000

 Option B: (Manufacture)

Total Cost = (No. of items) x [(Direct Materials) + (Direct Labor) +

(Overhead)] Cost

= (10,000 items) x ($5.00 / item + $1.50 / item + $3.00 / item)

= (10,000 items) x ($9.5 / item)

= $95,000

Based on the final result, the items should be purchased since it is more
economical than the option B, which is to manufacture the items.