Problem Set Management Accounting and Finance

1. (5 pts)

Mountain Goat Cycles is a producer of mountain bikes. The company is currently producing itself
the gear shifters used in its most popular line of mountain bikes. The company’s accounting
department reports the following costs of producing 8000 units of these shifters internally each
year:

Per Unit 8000 units

Direct Materials $6 $48000

Direct Labour $4 $32000
Variable overhead $1 $8000
Depreciation of special equipment $2 $16000
Allocated general overhead $5 $40000

Total cost $18 $144000

An outside supplier has offered to sell 8000 shifters a year to Mountain Goat Cycles for a price of
only $13 each, or a total of $104000. Should the company stop producing the shifters internally
and buy them from the outside supplier? Assume the special equipment has no salvage value as it
has no other use except making the gear shifters.
Explain the reasoning behind your calculations.

2. (5 pts)

A company produces small parts that it uses in the production of its standard line of engines. The
company’s unit product cost for the part, based on a production level of 60.000 parts per year, is
as follows:

Cost type Per part Total

Direct materials 4,0 EUR
Direct labor 2,75 EUR
Variable manufacturing 0,50 EUR
overhead
Fixed manufacturing 3,00 EUR 180.000 EUR
overhead, traceable
Fixed manufacturing 2,25 EUR 135.000 EUR
overhead, common (allocated
on the basis of labor-hours)
Unit product cost 12,50 EUR

An outside supplier has offered to supply the parts to the company for only 10,00 EUR per part.
One-third of the traceable fixed manufacturing cost is supervisory salaries and other costs that can
be eliminated if the parts are purchased. The other two-thirds of the traceable fixed manufacturing
costs consist of depreciation of special equipment that has no resale value. The decision to buy the
parts from the outside supplier would have no effect on the common fixed costs of the company,
and the space being used to produce the parts would otherwise be idle.

Required:
Prepare computations showing how much profits would increase or decrease if the parts are
purchased from the outside supplier rather than produced inside the company.

1
 3. (5 pts)

Charter Sports Equipment has 3 product lines and manufactures round, rectangular and octagonal
trampolines. Sales and expense data for the past month are as follows (in EUR):

TOTAL Round Rectangula Octagona

r l
sales 100000 140000 500000 360000
0
variable costs 410000 60000 200000 150000
fixed costs:
advertising - specific to product 216000 41000 110000 65000
line
depreciation of special equipment 95000 20000 40000 35000
line supervisors' salaries 19000 6000 7000 6000
general factory overhead 200000 28000 100000 72000
total fixed costs 530000 95000 257000 178000
net operating income 60000 -15000 43000 32000

Management is concerned about the continued losses shown by the round trampolines and wants a
recommendation as to whether or not the line should be discontinued. The special equipment used
to produce the trampolines has no resale value. If the round trampoline model is dropped, the two
line supervisors assigned to the model would be laid off. The general factory overhead is a common
fixed cost that is allocated on the basis of dollar sales.

Question: Should production and sale of the round trampolines be discontinued? The company has
no other use for the capacity now being used to produce the round trampolines. Show
computations to support your answer and motivate your answer.

4. (6 points)

Your grandfather put some money in an account for you on the day you were born. You are 18
years old and are allowed to withdraw the money for the first time. The account currently has
$3996 in it and pays an interest of 8% interest rate.
How much money would be in the account if you left the money there until your 25th birthday?
How much money did your grandfather originally put in the account?

Suppose you retire at age 70. You expect to live 10 more years and to spend $40000 a year during
your retirement. How much do you need to save by age 70 to support this consumption plan?
Assume an interest rate of 4% per annum.

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 5. (8 points)

The product development department of Dolly plc is contemplating renting a plant through a four-
year lease from 1 January 20X1 and using it to produce a new product, code named GS7.

Since there appears to be no possibility of the plant continuing to be economically viable beyond a
four-year life, it has been decided to assess the new product over a four-year manufacturing and
sales life.

Under the lease, the business will pay £100.000 annually in advance on 1 January.

The new machines are expected to cost £600.000. These will be bought and paid for on 1 January
20X1 and are expected to be scrapped (zero proceeds) on 31 December 20X4. The business will
depreciate these machines, in its financial statements, on a straight-line basis (25% each year).

Each unit of GS7 is estimated to give rise to a total variable cost of £300. GS7 manufacture will be
charged with an annual share of the business’s administrative costs, totaling £150.000 each year.
Manufacture and sales of GS7 are expected to increase total administrative costs by £90.000 each
year.

Manufacture and sales of GS7s are expected to be as follows:

Year ending 31 December Year Units of GS7

20X1 400
20X2 600
20X3 500
20X4 200

These will be sold for an estimated £1.400 each. It has been decided to use a discount rate of
15% a year.

Required:

(i) Identify the annual net relevant cash flows and use this information to assess the
project on a net present value basis at 1 January 20X1.
(ii) What is the net present value of the above project?