Decision Making With Relevant

7/27/2019 Decision Making With Relevant

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

CHAPTER 9: DECISION MAKING WITH RELEVANTCOSTS AND A STRATEGIC EMPHASIS

QUESTIONS

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

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

9-3 Decisions where relevant cost analysis might be used effectively include:1. The special order decision2. Make, lease, or buy3. Outsourcing4. Sale before or after additional processing5. Keep or drop products or services6. Profitability analysis: evaluating programs

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

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

9-6 Strategic factors include:1. The level of capacity usage of the plant2. The time value of money3. Quality4. Functionality5. Timeliness of delivery6. Reliability in shipping7. Service after the sale


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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 makingbecause they are committed and therefore there is no longer any discretionregarding these costs. Examples include the purchase price of equipmentalready owned and all related costs of installing the equipment.

9-8 Variable costs are usually more relevant in decision making than fixed costsbecause 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 beenpurchased 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 moretechnologically advanced and therefore more expensive machine will likely havelower 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 bereduced by replacing equipment with labor, to become a more labor-intensiveoperation.

9-11 A well-known problem in business today is the tendency of managers to focus onshort-term goals and neglect the longer-term strategic goals, because theircompensation is based upon short-term accounting measures such as netincome. This issue has been raised by many critics of relevant cost analysis. Asnoted throughout the chapter, it is critical that the relevant cost analysis besupplemented by a careful consideration of the long-term, strategic concerns of

the firm. Without strategic considerations, management could improperly userelevant cost analysis to achieve a short-term benefit and potentially suffer asignificant long-term loss. For example, a firm might choose to accept a specialorder because of a positive relevant cost analysis, without properly consideringthat the nature of the special order will have a significant negative impact on thefirm's image in the marketplace, and perhaps a negative effect on sales of theother products. The important message for managers is to keep the strategicconcerns in mind, and to start with the strategic objectives in any decisionsituation.

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 theimportant strategic factors (see Question 9-6)3. Managers tendency to include irrelevant costs, such as sunk costs, in thedecision making4. Tendency to focus on a single product or department in isolation of others,and then to perhaps not find the strategically correct analysis


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

9-14 Some of the behavioral, implementation, and legal issues in using relevant costanalysis include:1. The tendency of managers to focus on short term goals, and to not attendsatisfactorily to longer-term strategic goals of the firm. The techniques describedin relevant cost analysis can have the effect of encouraging this bias, unlessspecific steps are taken, such as to use the balanced scorecard in managementevaluation (see chapter 18).

2. If variable costs are given too much focus, as suggested in relevant costanalysis, managers can tend to ignore fixed costs. Moreover, some managersmight replace variable costs with fixed costs where possible, to improve theevaluation 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 useirrelevant factors such as sunk costs in decision making. Thus, the proper use ofrelevant cost analysis requires the management accountant to carefully explainthe techniques and to carefully present the relevant cost reports to management.4. Predatory pricing, the lowering of prices to where the effect may be tosubstantially damage the competition in an industry is unlawful under theprovisions of the Robinson Patman Act.

9-15 When there is only one production constraint and excess demand it is generallybest to produce only one of products to maximize income, and that is the productwith the highest contribution per unit of scarce resource. When the productionprocess requires two or more production activities, the choice of sales mixinvolves a more complex analysis, and in contrast to the case of one productionconstraint, the solution can include both products. The determination of bestproduct 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 allSituation Customer-related Factors

Short-term Focus Long-term Focus


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

9-16 Relevant cost analysis and cost-volume-profit analysis (Chapter 7) are similar inthat 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 theanalysis. Both cost-volume-profit analysis and relevant cost analysis focus onthe relationship of profit to volume, and therefore on the unit contribution marginfor the product or service.

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


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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 = $6Both products should be processed further, but Y should go first as it has thehigher 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 thespecial 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

= $5,000Fixed Costs:Repair Cost = $1,000Total 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


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9-23 Buying Costs:= $20 x 500= $10,000Manufacturing Costs:

Batch Cost = $1,000

Variable Cost = $10 x 500= $5,000Total Cost = $6,000

Ford should manufacture the shirts; the manufacturing cost of $6,000is less than the purchase cost of $10,000

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

Jamison should keep the division.

9-25 Machine Cost = $500,000 + $0.10 x # of barsCurrent Cost = $1 x # of barsBreak 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 AAAand 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 = $250,000Cost without machine: $20 x 10,000 = $200,000

Jackson would recover the cost in 1 and 1/3 years$200,000 + $5Q = $20 QQ = 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 doesnot offer many customer services, might very low or near zero per passenger.The variable costs in this case would be those costs associated with ticketingand gate operations which are variable per passenger.


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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 coverfixed 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 onlycosts that are relevant are the variable costs, in this case housekeeping. If aroom goes unoccupied, the only cost that is saved is that of housekeeping.


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EXERCISES

9-32 Special Order Analysis (10 min)

Since there are no marketing costs for the special order, the onlyrelevant 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.


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9-33 Special Order (15 min)1. Current Special OrderRevenue per unit $ 45 $ 35Variable costs per unit:

Direct materials $ 9 $ 9Direct labor $ 8 $ 8Variable factory overhead $ 4 $ 4Variable nonmanufacturing costs $ 8 29 $ 4 25Contribution margin per unit $ 16 $ 10

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

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

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

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

2. The minimum price would be $28.20.At 16,000 units of output, Alton does not have enough capacity toproduce the entire order for SHC. Further, the contribution onregular 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 toget an order for 4,000 units. Then the special order could be donewithout a loss of regular sales. If SHC insists on the full order of5,000 units, then Alton must figure the costs of lost sales ($16 x1,000 = $16,000). This loss is less than the contribution of the

special order ($30,000), so the special order would still be acceptedat the $35 price. The minimum price would be the total variable costper unit ($25) plus the per unit cost of lost sales ($3.20 =$16,000/5,000): $25 + $3.20 = $28.20.


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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 tocompare the cost of purchasing machine X versus the cost of purchasingfrom the outside vendor. The analysis was as follows, showing that Calistashould purchase machine X if volume is expected to exceed 100,000units.:

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 sunkcost, and thus, the unit cost of $ 0.65 is always preferred to the outsideprice 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 7-28was 197,143 units, but now it is much higher 582,857 units. Thethreshold to moving up to machine Y is now much higher because thepurchase 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


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9-35 Special Order (15 min)

1. The costs fall from $11 to $10 because of the fixed overhead costswhich 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 priceabove $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, willthere be other costs in addition to the variable manufacturing costs inorder to complete the order, that is, special tooling or set up costs, etc.Also, are there alternative uses of the capacity which will produce agreater contribution?


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9-36 Profitability Analysis (15 min)

1. T-1Last year's contribution = $200,000 - $70,000 - $20,000 = $ 110,000

Last year's contribution margin ratio = $110,000/$200,000 = 55%

T-2Last year's contribution = $260,000 - $130,000 - $50,000 = $80,000Last 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 bethe effect on the firms image if T-2 is dropped? Will this result in anunfavorable reaction from key customers of T-1 and of other productlines? Can the production capacity released by T-2 be used for new

products?


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

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

Costs Per Unit:Direct Materials $ 28Direct Labor 18Var. Overhead 16Total $ 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 orderMr. Walters may opt for the alternative which will allow him to deliverthe product as quickly as possible. Quality, reliability, and capacityutilization are other considerations.

b. Disposal of AssetsRemachine Scrap

Future Revenues $30,000 $2,500Deduct future costs 25,000Margin $ 5,000 $2,500

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

c. Replacement of AssetReplace Rebuild

New boat $92,000 -

Deduct current disposal price $ 9,000Rebuild of existing boat $75,000Margin $83,000 $75,000

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


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Exercise 9-37(continued)

d. Profit from Processing FurtherA B C

Addtl costs of further process $28,000 20,000 12,000Increase in sales 40,000 20,000 10,000Differential benefit (loss) $12,000 $0 ($2,000)

Deaton Corp. Is indifferent about the further processing for B sincethe net benefit is zero. There would be a positive benefit for furtherprocessing 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 thatamount could be avoided by buying the part from McMillan. Allvariable costs are relevant ($75=$35+$16+$24). The relevant costper unit is $85 ($75+$10). Eggers should make the part. When youcompare the cost to make of $85 to the cost to buy, $90; there is a$5 per unit savings.

f. Selection of most Profitable ProductFLASH CLASH

Selling price per unit $250.00 $140.00Variable cost per unit 200.00 100.00Contribution margin per unit $ 50.00 $ 40.00Relative 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 aconstraint, and since CLASHs relative contribution per labor hour isgreater, as much production as possible should be devoted toCLASH. Note that the products have the same per unit profit, butFLASH has the higher contribution, and CLASH has the highercontribution per labor hour. Thus, FLASH would be the mostprofitable product without a labor constraint, while CLASH is the mostprofitable product with the labor constraint. The measure, operatingprofit, is not used because it includes the sunk fixed costs.


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Exercise 9-37 (continued)

g. Special Order PricingThe 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 forlong 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 abovevariable cost of $2.00. Thus, the tour operators deal is a good onefor Barry. As long as there is space for the additional meals, andsince daily fixed costs are unaffected by the additional patrons, anyprice above $2.00 should be acceptable.

The idea of agreeing to serve 200 patrons on any given daypresents a problem with limited capacity. In this case, 100 of the

regular customers would have to look elsewhere for lunch on thesedays, at a loss of $3.00 ($5.00-$2.00 variable cost) per meal or atotal of $300 per day. The additional new patrons at $3.00 eachwould bring in a contribution of only $1.00 ($3.00-2.00) per meal or atotal of $200. It turns out the single bus load is a better deal.


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9-38 Make or Buy (15 min)

Relevant Cost to Make (per unit):Direct Materials $ 35

Direct Labor 50Variable Overhead 10Fixed Overhead Avoidable 5

$100

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

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


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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 purchaseits bread and pastries or make them? The same would be true fordesserts.

3. The process further decision; does Baileys want to enhance anmenu 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 canbe compared in this way. Also, Baileys could review the possibilityof opening for a late-night crowd to project the revenues and costsof that plan, and to assess the expected profitability. In this situation,the rent costs would be irrelevant, but the additional cost of wait staffwould be incremental; the cost of utilities might or might not change.


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PROBLEMS


1.Price of special order $100Relevant 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 considerationsa. 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 variablemanufacturing costs in order to complete the order, that is, special toolingor set up costs, etc

d. See part 3. below

3. Obviously the controller, LePenn has a conflict of interest in thesourcing of raw materials for the firm. Cathy has the ethical responsibilityunder the IMA code to bring this matter to the attention of the appropriateperson in the firm. Since LePenn is the controller, the appropriate personfor Cathy to contact is likely to be the Vice President of Finance, ChiefFinancial Officer, a member of top management, or the audit committee ifAward Plus has one.


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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 variablecosts 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 thesale of the special order would require Jordan to lose some amountof current sales. For a good in-class assignment, ask the class toanswer the question again, assuming Jordan is at full capacity. We

now assume that a total of 10,000 units will be produced (fullcapacity). The variable marketing costs will be relevant for regularsales.

Contribution of special order2,000 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 Jordansmooth the seasonal and cyclical changes in the business. If specialorders such as this can be planned and scheduled carefully, theproduction rate at Jordans plant can be smoothed to improvescheduling and lower overall costs. Lower overall costs can helpJordan to become more cost competitive. This is especiallyimportant, since price competition is an important aspect of thisindustry. 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 bydeveloping new customers and helping the firm to learn new markets,perhaps for other interior finish items for cars and trucks. Specialorders such as the one to JepCo can lead to additional orders forexisting and new products.


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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 batchrelated 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 = $100,000Facilities related fixed costs = $15 x 10,000 150,000

Total Fixed costs = $25 x 10,000 $ 250,000 ]

Relevant costs for the special orderVariable manufacturing $21

Batch related costs $10,000/2,000 5Total 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, soJordan should accept the JepCo offer since there is availablecapacity. 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 inProblem 9-41 because we are taking into account the batch relatedcosts.

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


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Problem 9-42 (continued)

Relevant costs for the special orderVariable manufacturing $21

Batch related costs $10,000/1,000 10Total 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 becausethe unit cost ($31) is greater than the special order price ($28).


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9-43 Make or Buy

1. Since the contribution for manufactured fans is higher then forpurchased 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 HarrisProducts.

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 shouldcontinue to manufacture the fans.

Total Relevant Costs Relevant Costs Relevant CostsCost 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 5.50Other parts 8.00 $8.00 7.00Direct labor ($15.00/hr.) 15.00 $15.00 7.50Manufacturing overhead 15.00 * 5.00 3.00Selling 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 variableOf the total per unit selling and administrative cost, $6 is given as fixed, and the remaining $14 is variable.


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3 Some of the possible strategic factors to consider are:Re: The pumps:

Will the sale of pumps introduce Jabbour to new markets and newcustomers 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 forJabbour?

How reliable are the estimates used to develop the predictions forrevenues and costs for the pumps? How reliable is the market researchthat predicted growth in pump sales?

Will the sale of pumps affect Jabbours image in either a positive ornegative fashion? For example, will Jabbours current customers viewJabbour 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?


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1. Relevant Cost Data (per sheet):Direct Materials $ 1.20

Direct Labor .20Variable Overhead .40$ 1.80

There are 4 sets in each sheet (132 /33) and 25,000 sets beingordered. 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 keepingcosts down. Also, a critical success factor is the firms ability to

negotiate licensing agreements with the major leagues and theplayers. The special order with Pennock Cereal Inc is a competitivelyimportant decision because it will help BallCards to have its productdistributed widely among its key customers. Promotion of the brandname is a key success factor for BallCards, and this special order isone important way to accomplish that.


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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 costsare not charged for the special order. Other relevant costs includethe delivery cost of $2,000 and the cost of lost sales (since the 5,000unit order would exceed GGIs capacity. Currently, GGI has only2,000 units of available capacity, and APAC requires the order to befilled 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 costsVariable manufacturing costs $ 75,000Delivery costs 2,000Cost of lost sales 63,000

Total relevant costs $140,000

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

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

3. These are both ethical and strategic issues for GGI. From astrategic view, GGI would suffer severe damage to its reputation ifAPAC were to have any problems with the purity of the special order.

One of the reasons APAC has requested the special order from GGIis because of its reputation for quality. It is clear that GGI competeson differentiation, with quality being a critical success factor.

Also, there is an ethical issue. The use of a competitorsmaterials would deceive APAC who is expecting the highest qualityproduct from GGI.


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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 theorder from competitors stock. GGI might request that the shipmentbe delayed until it can provide all of the product from its own stock.Or alternatively, it might offer to reduce the price, or to performcareful tests of its own on the competitors materials.


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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 $5,000each, 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 $100,000Costs that do not vary with number of batches 60,000

Facilities related fixed costs = $4 x 20,000 80,000Total Fixed costs $240,000 ]

Relevant costs for the special orderVariable manufacturing ($15 x 5,000) $75,000Batch related costs 10,000Delivery costs 2,000Cost 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) $114,000Less: Variable Costs ($15 + $2) x 3,000 51,000Less: 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 priceof $125,000, so GGI should not accept.

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


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

1. Compare the relevant cost to make a truss ($10,000/200 = $50 pertruss) 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 theadditional beams vs. the truss production.

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

Trusses Special order beamsSales 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 netbenefit of $6,000. The firm should also consider the impact ofdropping the trusses; the company may lose customers that need tobuy 2 or 3 different components, one being trusses. These

customers may like the convenience of one-stop shopping.


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

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

per unit.

No Frills Standard SuperModel Model Model

Selling Price $30.00 $35.00 $50.00

Direct Materials 9.00 11.00 11.00Direct Labor ($10/hour) 5.00 10.00 15.00Variable overhead 3.00 6.00 9.00Total 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 bemanufactured since it has the highest contribution margin per directlabor hour. See below.

No Frills Standard SuperModel Model Model

Contribution Margin $ 13 $8 $15Labor Hours Required .5 1 1.5Contribution Margin/hr. $26.00 $8.00 $10


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Problem 9-48(continued)

Note: As an additional in-class assignment, the class can be askedto determine the best product mix when machine time rather than

labor is the limited resource. Since fixed overhead is applied on thebasis of machine hours, and fixed overhead per unit is given, it ispossible to determine the relative proportion of machine time in eachproduct. Since the fixed overhead in No Frills is $3 and in theStandard model is $6, we can infer that there is twice the amount ofmachine time in Standard as in No Frills. Similarly, there is twice theamount of machine time in the Super model relative to No Frills. Thecontribution per (relative) machine hour is again greatest for the NoFrills model, as follows:

Contribution Relative Machine Hours Contribution/ Rel. HourNo Frills $13.00 1 $13.00Standard 8.00 2 4.00Super 15.00 2 7.50


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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 scenariocan be determined as follows, where total traffic paint = 380,000 x .9 =342,000 gallons, the remainder, 380,000 342,000 = 38,000 gallons, iscommercial paint. The loss of Virginia would reduce the traffic paint to342,000 88,000 = 254,000 gallons. A doubling of commercial paint usingthe promotion would mean 38,000 x 2 = 76,000 gallons.

Traffic CommercialSelling price per gallon $9.00 $11.00Direct materials costs:

Latex 6.075 4.3875Camelcarb 0.38 0.54

Silica 0.37 0.52Pigment 0.12 0.38Other ingredients 0.06 0.03

Direct labor cost 0.46 0.85Freight 0.78 0.43Total variable cost 8.245 7.1375Contribution margin $0.7550 $3.8625


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2. The proposed promotional campaign, scenario C, has the greatestcontribution, as shown in the calculations above. Strategic issues for the

decision between scenario B and scenario C include the reliability of theprojected sales increase in commercial paint and assumption that thevolume of commercial paint can be doubled without increasing unit variablecosts for fixed costs, other than the cost of the promotion. A strategicopportunity, on the other hand, is that Wellesley can move from a relativelylow contribution product line (traffic paint) to a relatively high contributionproduct 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 15,000Total 470,320$

Scenario A Scenario B Scenaraio C


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

To begin the analysis, the New Life CFO should recognize thatthe $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 $1.00relevant cost) per unit sold. Moreover, sales to SuperValue wouldutilize New Lifes available capacity. If these sales to were tocontinue for the long term, then average fixed costs would bereduced and New Lifes profitability would be improved in the longterm as well.

However, the sales to SuperValue could be a potentiallyserious strategic mistake for New Life. New Lifes reputation is built

upon quality and product excellence, features which give it a cleardifferentiation in the market. To sell its products in a supermarket,even under another brand name, would cheapen the image of allNew Life products, and cause it to lose market share in its usualdistribution channels, the pharmacies and department stores. This isespecially true given that SuperValue has the limited right to marketthe 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.


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

1. The relevant cost analysis follows:

First contest: Gliders Second contest:Chair and StoolPer Unit Total Per Unit Total

Number of units(note 1)

1,250 900

Sales $ 80.00 $100,000 $ 61.00 $ 54,900Direct material 16.00 20,000 11.00 9,900Direct labor (note 2) 22.50 28,125 30.88 27,792Sales commission 15.00 18,750 10.00 9,000

Contribution margin $26.50 $33,125 $9.12 $8,208Cost of Prize $8,800 $4,685Excess of CM over cost $24,325 $3,523

Notes:1. 1,250 = 4,000 2,750; 900 = 8,000 7,1002. $22.50 = 2.5 x $9.00; $30.88 = 3.25 x $9.50

Both contests have a substantially higher contribution relative to thecost of the prize: $24,325 and $3,523 net contribution for the first

and second contests, respectively. Thus, the contests appear to bedesirable.

However, some additional strategic factors should also beconsidered:

a. The contest appears to reward an increase of sales in units.However, the average sales price for each product has already fallenbelow budgeted levels. If the contest provides an expected incentiveto reduce price in order to increase sales, then the result could be

lower contributions than expected. Moreover, the price cutting couldhave adverse long term effects. Clear Lake should carefully considerits short and long term pricing strategy to make sure it is consistentwith the firms overall strategy. While it appears that the firmsoverall strategy is cost leadership, so that lower prices arecompetitively advantageous, the pricing should be based on a long-term strategy with established profit targets.


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b. Clear Lake should evaluate the effectiveness of itsadvertising and promotional efforts. Are the targeted customers

being reached?c. Since the products have a seasonal demand, are the lowersales the result of failure to meet sales delivery dates or to badforecasts of the timing of demand?

d. An unintended effect of the sales contests is that certainretail customers might buy unusually large orders, at the urging ofsales people, and that some portion of these order might eventuallybe 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 salescontest exclude the table? Perhaps this is one of Clear Lakes most

in-demand products, and overall profits would be improved throughincentives on this product.

f. Are Clear Lakes products competitive? Have newcompetitors developed superior products, at lower prices? Perhapsthis is time for a careful market research and competitive analysis forClear Lake.


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1. GianAuto is in a high-growth, highly competitive industry. Automakers are increasingly outsourcing the manufacture of parts and

entire brake or seating systems to low-cost producers throughout theworld. In North America, many of these plants are located in Mexicoand throughout Latin America. To be competitive in this business,Gian must continue to be cost competitive and to also provide thecustomer service and reliability that is expected by the auto makers.Gian can also look for additional ways to be competitive by assistingthe auto makers in improving the design of the parts, developingmodular manufacturing systems, and improving the quality of theparts.

Continuing to obtain covers from its own Denver Cover Plant wouldallow GianAuto to maintain its current level of control over the qualityof the covers and the timing of their delivery. Keeping the DenverCover Plant open also allows GianAuto more flexibility than purchasingthe coverings from outside suppliers. GianAuto could more easily alterthe coverings' design and change the quantities produced, especially iflong term contracts are required with outside suppliers. GianAutoshould also consider the economic impact that closing Denver Coverwill have on the community and how this might affect GianAuto's other

operations in the region.

Other items that should be considered by GianAuto beforemaking 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, depreciationand 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.


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

Materials $32,000LaborDirect $23,000Supervisor 3,000Indirect 4,000 30,000

Differential pensionexpenses ($4,000 - 3,000) 1,000

Termination charges on cancelledmaterial orders($32,000 x .15) $4,800

Employment assistance 1,000Total $68,800

The following costs are not relevant to the decision.

Depreciation-equipment $ 5,000Depreciation-building 3,000Continuing pension expense

($4,000 - 1,000) 3,000Plant manager and staff 2,000Corporate allocation 6,000

$ 19,000

The depreciation amounts are not relevant to the decisionbecause they represent portions of sunk costs that are being writtenoff during 2007. Three-fourths of the annual pension expense($3,000) is not relevant because it would continue whether or not theplant is closed. The amount for plant manager and staff is not relevant

because Vosilo and his staff would continue with GianAuto andadminister three remaining plants. Corporate allocation is not relevantbecause this represents costs incurred outside Denver Cover andassigned to the plant.


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1.Savings Cost to Buy:

Current to Buy Alternative Calculation

Materials 192$ 68.00$ $192-$68=$124Labor 75 7.50 =10% x $75 75-7.50 = 67.50Variable Overhead 150 15.00 =.1 x $150 150.00 - 15.00 = 135.00Fixed Overhead 150 0 150.00

Total Cost 567$ 90.50$

Add Cost to Buy 105.00Total 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 therelevant cost to buy is $105, so the analysis favors to make, for a$14.50 (= $105 - $90.50) advantage. This is shown also by theequivalent 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 tomake the part will best support the desired quality. Usually, bykeeping manufacturing within the firm, as in this case, the firm canbest maintain the desired quality levels. If, however, it can be shownthat the outside supplier can provide the part at significantly higherquality than RSM can provide, then strategically it makes sense toforego the $14.50 advantage and buy the part outside, in order toimprove overall quality. We put first priority on quality because of thedifferentiation strategy.

Other considerations include whether or not the firm candevelop successful cost reduction plans in other areas, and stillmaintain the desired quality.

In addition to the need to maintain differentiation based onquality, the firm should consider other means to improve profitabilityand competitiveness. Some possible ideas include:


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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 inachieving the firms goals. That way both the firm and the supplierssucceed together. Probably some long-term supply agreementswould be necessary.

b. Develop new product designs that improve quality whilereducing cost. Avoid over-emphasis on getting the best out of thecurrent technology. Look for ways to achieve the desired productdifferentiation in new ways not just quality, but perhaps also inproduct innovation.

c. Has the firm developed appropriate means to sell itsposition as a high-quality manufacturer? Is this well understood inthe market place?

d. The firm should continue to re-evaluate its strategy, as thedemand in the industry changes, and as the nature of the competitionchanges.


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

1. If the cylinders are manufactured by Henderson EquipmentCompany, 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 DirectCumulative Labor Hours Total DirectOutput Per Unit Labor Hours50 .285 14.25

100 (.8 X .285)=.228 22.80200 (.8 X .228)=.182 36.40400 (.8 X .182)=.146 58.40800 (.8 X .146)=.117 93.60

2. The total manufacturing costs for Henderson to produce theadditional 1,600 cylinders, assuming the first 800 cylinders produced(including the pilot run) required 100 direct labor hours and the 800thunit produced required .079 direct labor hours, amounts to

$12,381.94, calculated as follows:

Total units to be produced = 1,650Additional 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)


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Manufacturing costs

First 750 unitsDirect laborhours consumed = 85.75 hours (100 hours, Pilot Run 14.25 hrs)

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

$ 6,347.45

Last 850 unitsAggregate 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 shouldmanufacture the additional 1,600 cylinders as the cost tomanufacture 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) $12,000.00Manufacturing cost:

From Requirement (2). $12,381.94Less: Fixed overhead750 units (85.75 hrs. x $16.60) $1,423.45850 units (850 X .079 x $16.60) 1,114.69 2,538.14 9,843.80

Savings by manufacturing $2,156.20


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9-55 Profitability Analysis; Review Master Budget; Strategy (50 min)1. The dollar value of DimLok's present annual fixed costs iscalculated 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 profitobjectives of 20 percent return on fixed costs and $20 per unit sold.

Supporting CalculationsFirst: 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 levelof 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 profitobjectives

= (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.


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Third: In order to achieve the profit targets, DimLok must increaseplant 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:

= $180 selling price - ($80 variable cost per unit + $20 profit per unit)= $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; variablecosts are reduced by $20 per unit for production inexcess 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 perunit is determined as follows:

= $180 selling price - ($60 variable cost per unit + $20 profit per unit)= $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


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3. DimLok DivisionPro Forma Income Statement

Revenue40,000 units x $200 $8,000,00024,000 units x $180 4,320,000 $12,320,000

Variable costs60,000 units x $80 4,800,0004,000 units x $60 240,000 5,040,000

Contribution 7,280,000Fixed costs 5,000,000Operating income $ 2,280,000

The profit objectives {(20 percent of the annual fixed costs) + ($20per 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 hasdeveloped and the advertising program stresses completely newproducts each year. Given the innovative nature of the firmsproducts, this strategy seems to be a very appropriate one.

5. Critical success factors for DimLok include research anddevelopment to maintain the technological advantage of their uniqueproducts and strong advertising programs to stress the firmsdifferentiation based on innovation. Other strategic success factorsinclude quality of production and customer service to maintain

product differentiation.


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9-56 Profitability Analysis; Pricing (25 min)

The objective of this problem is to provide an opportunity for students touse 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 andadministrative costs, which are fixed costs (see note to table in text ofproblem) and should not affect the decision about pricing. Based on theconsultants advice, sales of 6,000,000 rooms are projected at a marketprice of $76. The contribution at the $76 price ($280,920,000) issomewhat higher than the present contribution ($235,280,000), or even thecontribution at the original price of $80 ($254,100,000). Since theconsultants estimate of a 50% increase in sales might be optimistic, we

also calculate the contribution for 5,500,000 rooms, a figure that fallsbetween the 5,000,000 rooms the consultant promised for reducing price,and the 6,000,000 estimate. Again, it is also a higher contribution thanunder the either the $80 or $88 price.

Total Market 50,000,000Market 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 CostsSupplies 3.30 3.30 3.30 3.30Direct Labor 15.38 15.38 15.38 15.38Room-level Overhead 10.50 10.50 10.50 10.50

Total variable cost/room 29.18$ 29.18$ 29.18$ 29.18$

ContributionUnit 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 customersperceptions about HomeSuites for the longer term. Will the price changecause the hotel chain to appear less high quality, and damage it appeal toits current customer base? Or will the price change attract new customerswho are looking for a value in business travel hotels?


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

1. An analysis of per unit and total costs for 32,000 units shows thatthe Midwest Division should purchase the parts for a saving of

$15,440 ($575,040 - $559,600).

Cost per unit Total CostCost to purchase MTR-2000 from Marley

Bid price from Marley $17.30 $553,600Equipment lease penalty [($36,000/12)x2] 6,000

Total cost to purchase $559,600

Cost for Midwest to Make MTR-2000Direct material ($195,000/30,000)x1.08 7.02 $224,640

Direct labor ($120,000/30,000)x1.05 4.20 134,400Factory space rental ($84,000/32,000) 2.625 84,000Equipment leasing costs($36,000/32,000) 1.125 36,000Variable manufacturing overhead 3.00 96,000

Total cost to make $17.97 $575,040

2. At least three strategic factors that the Midwest Division andPaibec 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 thequality of the final product might be compromised and Paibec'sreputation affected.

Marley's reliability as an on-time supplier is important, since latedeliveries could hamper Paibec's production schedule and deliverydates 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 causelabor problems or affect the company's position in the community,In addition, there may be termination costs which have not beenfactored into the analysis.

Giving up production capability risks dependence upon Marleysfuture pricing.


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3. Referring to the specific standards for ethical practice by amanagement accountant, Lynn Hardt should consider the ethicalstandards of competence, integrity, and objectivity:

Competence

Prepare complete and clear reports and recommendations afterappropriate analysis of relevant and reliable information. John hasasked Lynn to adjust and falsify her report and leave out somemanufacturing overhead costs.

Integrity

Refrain from either actively or passively subverting the attainmentof the organization's legitimate and ethical objectives, Paibec hasa legitimate objective of trying to obtain the component at thelowest cost possible, regardless of whether it is manufactured byMidwest or outsourced to Marley.

Communicate unfavorable as well as favorable information andprofessional judgments. Hardt needs to communicate the properand accurate results of the analysis, regardless of whether or notit is favorable to Midwest.

Refrain from engaging in or supporting any activity that woulddiscredit the profession. Falsifying the analysis would discreditHardt and the profession.

Credibility Communicate information fairly and objectively. Hardt needs to

perform an objective make-or-buy analysis and communicate theresults objectively.

Disclose all relevant information that could reasonably be

expected to influence an intended users understanding of thereports, comments, and recommendations presented. Hardtneeds to fully disclose the analysis and the expected costincreases.


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9-58 Profitability Analysis; Excel (80 min)

1. The profit report Hal is using is not contribution based, so the first stepis to produce a contribution income statement for the three product lines,

as shown below. Note that fixed costs are not allocated to the productlines 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 Weldonline would be the loss of $15,543,000 contribution. For a longer-termperspective, Hal should expect the Weldon product to cover the fulloperating costs, including the fixed costs. Thus, there should be aconsideration of sales trends and alternative uses of the plants capacity.For example, if sales in the Weldon line are expected to fall and there areattractive alternative uses of the plants capacity, then the Weldon linemight 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, andthe analysis in part one will continue to favor keeping the line. Hal andJoan might want to consider alternate uses of the plant facilities if Weldonsales continue to fall.

Total

Per Unit Total Per Unit Total Per Unit TotalSales units 150,000 335,000 165,000Sales dollars 459.00 68,850,000 365.00 122,275,000 248.00 40,920,000 232,045,000Factory Costs

Labor 125.00 18,750,000 118.00 39,530,000 62.00 10,230,000 68,510,000Raw Materials 88.50 13,275,000 66.00 22,110,000 78.00 12,870,000 48,255,000Power 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 7,962,500Factory Equipment 21,775,000Other Costs 8,473,750Selling Expense 22,935,000Administrative Expense 10,920,000Other Admin. Expense 17,875,000Interest 4,225,000

94,166,250

Operating Profit 10,085,750

Parker Virginian Weldon


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3. The 10% sales increase has total sales of 165,000 units for Parker and368,500 units for Virginian. The analysis for dropping Weldon is as

follows. The new total profit of $3,413,650 falls short of the profit withWeldon, $10,085,750, so in the short run it would be better to retainWeldon.

4. The most convenient way to solve this problem, once you have aspreadsheet, is to use Goal Seek in Excel. Goal Seek is available underthe Tools menu. The dialog box that executes Goal Seek is illustratedbelow:

Total

Per Unit Total Per Unit Total Per Unit 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 - 9,626,100Variable 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

Factory Equipment 21,775,000

Other Costs 8,473,750

Selling Expense 22,935,000

Office Expense 10,920,000

Administrative Expense 17,875,000

Other Admin. Expense 4,225,000

94,166,250




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The result of the Goal Seek is shown below

The analysis shows that sales in the Parker line would have to increaseto 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.

TotalPer Unit Total Per Unit Total Per Unit Total

Sales units 220,014 335,000 -

Sales dollars 459.00 100,986,203 365.00 122,275,000 248.00 - 223,261,203Factory 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 - 41,581,196Power 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 7,962,500Factory Equipment 21,775,000

Other Costs 8,473,750Selling Expense 22,935,000

Office Expense 10,920,000

Office Depreciation 17,875,000Other Adm Expense 4,225,000

94,166,250




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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 thissolution is shown in Exhibit 9-59 A, and the Answer report is shownin Exhibit 9-59 C.

Exhibit 9-59 A


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Exhibit 9-59 B


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Exhibit 9-59 C


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2. Solve with the preparation time constraint removed. Theconstraint to remove is H7

Decision Making With Relevant

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