Balakrishnan/Managerial Accounting, 2eDecision Making in the Short TermCHAPTER 6DECISION MAKING IN THE SHORT TERM

TRUE/FALSE

1. A temporary gap between the demand and supply of available capacity results because, in the short term, businesses have a fixed supply of capacity but confront changing demand.LO1 True

2. An example of a decision that deals with excess supply is altering the product mix to focus on the most profitable ones.LO1 FalseAn example of a decision that deals with excess demand is altering the product mix to focus on the most profitable ones.

3. The decision of how much capacity to put in place is a long-term decision.LO1 True

4. In the short term, businesses can alter capacity that they have when dealing with fluctuations in demand.LO1 FalseIn the short term, businesses must do the best with the capacity that they have when dealing with fluctuations in demand.

5. With proper planning, businesses can match supply and demand exactly all the time.LO1 FalseDespite adjustments, businesses can rarely match supply and demand exactly all the time.

6. One reason it might be profitable for a caterer to accept a catering job for Wednesday but reject it for Saturday is because the caterer has excess capacity on Wednesdays.LO2 True

7. When picking the best decision option from among a set of available options, we could consider controllable costs and benefits or relevant costs and benefits.LO2 True

8. Relevant cost analysis involves focusing on only those costs and revenues that differ from a benchmark option.LO2 True

9. An approach that includes controllable and non-controllable costs and benefits to construct a contribution margin statement for each decision option is referred to as an incremental product approach.LO2 FalseAn approach that includes controllable and non-controllable costs and benefits to construct a contribution margin statement for each decision option is referred to as a totals (gross) approach.10. 6-206-111. In general, analysis that considers only controllable or relevant costs is less efficient when decision options differ only with respect to a few benefit and cost items.LO2 FalseIn general, analysis that considers only controllable or relevant costs is more efficient when decision options differ only with respect to a few benefit and cost items.

12. Price gouging occurs when a firm exploits temporary excess demand to raise prices to unreasonable levels.LO3 True

13. Our ultimate decision will differ when we use incremental analysis versus construct a contribution margin statement for each option.LO3 FalseWe get the same answer with both approaches.

14. Using the gross approach to choose the best decision option is preferable to the incremental method when the decision option involves many costs and benefits.LO3 True.

15. A sunk cost is a relevant cost in decision making under the gross approach.LO3 FalseA sunk cost is not a relevant cost in decision making under the gross approach.

16. A differential approach is an approach for framing and solving decisions that involves expressing the benefits and costs of the various decision options relative to one of the options.LO3 True

17. When demand is high and a scarce resource is in short supply, a company should decide how much of each product to produce by ranking products by the contribution margin per unit of the product.LO4 FalseWhen demand is high and a resource is in short supply, a company should decide how much of each product to produce by ranking products by the contribution margin per unit of the resource.

18. For a resource in short supply, the opportunity cost of the resource is positive.LO4 True

19. To maximize profit when capacity is in short supply, minimize the contribution margin per unit of capacity.LO4 FalseTo maximize profit when capacity is in short supply, maximize the contribution margin per unit of capacity.

20. When faced with a situation where supply is limited for multiple resources managers use linear and integer programming to evaluate decision options. LO4 True

21. When demand is high and a resource is in short supply, the contribution margin per unit of the resource from its best possible use should exceed that forgone by putting it to the next best use.LO4 True

22. Because potential longer-term effects could vary across short-term decision options, they might be relevant.LO5 True

23. Quantifying the longer-term implications of short-term actions is relatively simple.LO5 FalseQuantifying the longer-term implications of short-term actions is difficult.

24. Because quantitative analysis of different decision options is extremely important, it should be the only input into final decision.LO5 FalseQuantitative analysis of different decision options is extremely important, yet it constitutes just one input into decision making.

25. It is important for effective managers to consider the longer-term implications of short-term decisions because of potential tradeoffs between short-term and long-term interests.LO5 True

26. Managers often use the term real options to denote the flexibility associated with different options and use advanced mathematical techniques to value the real options.LO5 True

27. Products that are produced in a joint process where it is not possible to produce one product without producing the others as well are called joint products.Appendix A True

28. Split-off point is the step in a joint process after which the products are completely processed.Appendix A FalseSplit-off point is the step in a joint process after which we can identify and process the joint products separately.

29. Joint costs are incurred after the split-off point.Appendix A FalseCosts incurred before the split-off point are joint costs that we cannot trace to individual products.

30. Joint cost is not relevant for product-related decisions beyond the split-off point.Appendix A True.

31. Usually, firms do not process individual products further beyond the split-off point.Appendix A FalseUsually firms process individual products further beyond the split-off point.

32. Managers should not rely on income statements that allocate common costs to product lines or sections to evaluate the effect on short-term profit because such statements mingle controllable and non-controllable costs.Appendix B True

33. Avoidable fixed costs are costs that need not be incurred if an option is not chosen.Appendix B True

34. Avoidable fixed costs are also referred to as non-controllable fixed costs.Appendix B FalseAvoidable fixed costs are also referred to as controllable fixed costs.35. The segmented income statement offers a convenient way to evaluate short-term profit effects.Appendix B True

36. An example of a an avoidable cost over the short term is the lease payments for a buildingAppendix B FalseLease payment for the building is not avoidable or controllable over the short term.

MULTIPLE CHOICE37. Most short-term decisions deal with temporary gaps between:A. A flexible supply of capacity and a fixed demand.B. The inability to change selling price and the ability to estimate controllable costs.C. The amount of fixed costs that can be avoided and the contribution margin.D. The demand of and the supply of available capacity.E. Company goals and employee goals.LO1 D

38. Capacity is the maximum volume of activity that a company can sustain with available:A. Resources.B. Discretionary orders.C. Inventory.D. Employees.E. None of the above.LO1 A

39. Which of the following is an example of utilizing capacity effectively?A. Building a plant large enough so that production can be increased as demand increases.B. Hiring extra temporary employees to work extended hours during Christmas season at a retail store. C. Having all employees of a donut shop work a regular 8-hour shift every day.D. A caterer having a limited number of chefs working during the week and on weekends.E. An airline selling 20% more tickets for a flight than their airplane has available seats.LO1 B

40. One way businesses may manage demand is:A. Building a plant large enough so that production can be increased as demand increases.B. Rent additional office space.C. Decreasing variable costs.D. Raising prices during periods of high demands.E. None of the above.LO1 D

41. Most short-term decisions can be classified as decisions that:A. Deal with excess supply.B. Deal with excess demand.C. Deal with limited capacity.D. Both A and B.E. A, B and C.F. None of the above.LO1 D

42. The Owens Company budgeted sales of 20,000 printers at $90 per unit last year. Variable manufacturing costs were budgeted at $46 per unit, and fixed manufacturing costs at $12 per unit. A special order for 1,000 printers at $72 each was received by Owens in April. There is enough plant capacity to meet these additional units without incurring any additional fixed manufacturing costs; however, the production would have to be done on an overtime basis at an estimated additional cost of $5 per printer. Acceptance of the special order would not affect Owens normal sales and no selling expenses would be incurred. What would be increase to net operating income if the special order were accepted? A. $21,000B. $9,000 C. $14,000 D. $10,000 LO1 Self-test A

43. When making a decision regarding a special order management must consider:A. Whether there is enough capacity to meet the order.B. Additional costs associated with the order.C. Whether the selling price of the special order covers the variable costs of making the product.D. All of the above.LO1 Self-test D

44. Warner Company has some material that originally cost $41,500. The material has a scrap value of $21,600 as is, but if reworked at a cost of $4,600, it could be sold for $29,100. What would be the incremental effect on the company's overall profit if it is reworked? a. $17,000 decrease.b. $38,600 decrease.c. $2,900 increase.d. $24,500 increase.LO1 Self-test C

45. When management must decide whether to offer special promotions in order to reduce excess inventory, which of the following is not relevant?A. The cost of offering the promotion.B. The selling price of the product during the promotion.C. The unit product cost of the inventory being sold.D. The regular selling price of the product when not on promotion.LO1 Self-test D

46. The Huffman Tire Company has 3,000 tires in its inventory which are considered obsolete. Each unit originally cost the company $35. Management is considering options to reduce these inventory levels. Units can be sold directly to car dealerships for $30 per tire as opposed to the normal selling price of $45 per tire. The other option is to offer their current customers a $10 per tire rebate on their purchase. In addition to the $10 rebate, the program would cost the company approximately $24,000 to manage. They predict that either option will rid them completely of their excess inventory. The decision to sell directly to the car dealerships over offering the rebate will result in: A. A $21,000 increase in profits. B. A $9,000 increase in profits.C. A $15,000 decrease in profits.D. A $24,000 decrease in profits.LO1 Self-test B

47. Which of the following short-term decisions deal with excess capacity?a. Special order.b. Product mix.c. Make or buy. d. Increasing prices.LO1 Post-test A

48. Beach Surf Boards is making a decision on whether to add long boards as a new product line to complement its short boards. A recent analysis determined that the average long board can be sold for $300.00 with unit variable costs of $225. Fixed costs are currently $51,000 per month but would be increased to $69,000 if long boards are added. How much is incremental profit or (loss) if long boards are added and its sales volume is expected to be 250?a. $750b. $18,750c. ($32,250)d. ($50,250)LO1 Post-test A

49. Which of the following options might a consultant choose when making a decision to accept or reject a new client when capacity is limited? (That is, the consultant already has all the clients her present circumstances can handle.)A. Refer the client to a competitor, but charge a referral fee to the competitor.B. Reject the client.C. Accept the client knowing that the consulting job cannot be completed.D. A and B only.E. A, B and C.LO2 D

50. The excess supply/excess demand classification is a helpful way for us to evaluate which of the following decision problems?A. Whether to accept a special order.B. Whether to make or buy an item.C. What product mix to adopt.D. B and C only.E. A, B and C.LO2 E

51. If selling price is $25, unit contribution margin equals $15 and fixed costs are $12,000, then breakeven volume is:A. 300 units.B. 1,200 units.C. 800 units.D. 2,500 units.E. 1,500 units.LO2 C

52. Consider the following decision option data:Option #1Option #2

Number of units150200

Revenue per unit$25$25

Variable cost per unit$12$12

Lost revenue from choosing option($500)($4,000)

Cost savings from choosing option$0$1,000

Avoidable fixed cost$0$0

What is the incremental profit for Option #2?a. $5,600b. ($2,400)c. $2,600d. ($400)e. $1,400LO2 D

53. Consider the following decision option data:Option #1Option #2

Number of units150200

Revenue per unit$25$25

Cost per unit$12$12

Lost Revenue from choosing option($500)($4,000)

Cost savings from choosing option$0$1,000

Avoidable Fixed Cost$0$0

What is the best choice?a. Option #1b. Option #2c. Option #1 and Options #2 are equally good choices.d. Neither Option #1 nor Option #2 should be chosenLO2 A

54. Brand X Computers makes and sells computers. Each computer sells for $400. The following cost data per computer are based on a full capacity of 10,000 computers each period:Direct materials$150

Direct labor$100

Variable manufacturing overhead $38

Unavoidable fixed overhead$12

Brand X is considering a special order for a sale of 2,500 computers to an overseas customer. The only selling costs that would be incurred for the order would be shipping charges of $15 per computer. Brand X is currently selling 7,500 computers through its regular orders. What should be the minimum selling price per computer in negotiating a price for the special order?a. $303b. $250c. $300d. $265e. $315LO3 A

55. In a make-or-buy decision relevant costs would include all of the following except:A. Depreciation expense on the plant equipment currently used to make the partB. Direct labor costs of the employees in that department which makes the partC. Direct material costs of the partD. The cost of buying the part from an outside companyLO1 Self-test A

56. Which of the following would be relevant in a make-or-buy decision?Variable

costs assignedCost to buy

to the item when made

A.NoYes

B.YesNo

C.YesYes

D.NoNo

LO3 Self-test C

57. Gecko Company is evaluating the use of a supplier versus making the wheels for its skateboards internally. The currently manufactured wheels have a variable unit cost of $2. Fixed costs are $16,000 per month, however, 25% can be eliminated if wheels are no longer produced. A supplier has offered to produce this part for $3 per wheel and can produce the 3,200 wheels for the 800 skateboards needed monthly. Should Gecko outsource wheels or make them internally? a. Outsource because the incremental cost savings is $12,800.b. Make the product because the incremental cost savings is $3,200.c. Outsource because the incremental cost savings is $800. d. Outsource because the incremental cost savings is $8,800. LO3 Post-test C 58. Which of the following is not a short-term decision that is a reaction to excess capacity?a. Management makes the decision to emphasize sales in a particular market to boost poor sales.b. Management makes the decision to issue a rebate, offering customers a rebate of $0.50 for every widget sold, because inventory is too large.c. Management makes the decision to close a plant because of increased competition.d. Management accepts a special order at a reduced selling price since the orders relevant costs will be less than the special orders sales price.e. All of the above are short-term decisions that are reactions to excess capacity.LO3 C

59. Which of the following is a short-term decision that is a reaction to excess demand?a. Management makes the decision to emphasize sales in a certain market to boost poor sales.b. Management makes the decision to close a plant because of increased competition.c. Management makes the decision to buy parts rather than make them after calculating a positive opportunity cost for capacity.d. Management makes the decision to make parts rather than buy them after calculating a positive opportunity cost for capacity.e. All of the above a short-term decisions that are reactions to excess demand.LO3 C

60. Hobbs Electronics makes and sells portable DVD players. Each DVD player has a selling price of $100. The following cost data per DVD player is based on a capacity of 5,000 DVD players per period.Direct Material$30Direct Labor$20Manufacturing Overhead(70% variable; 30% fixed)$10Hobbs receives a special order for 100 DVD players. The only additional costs Hobbs will incur are $2 shipping charges per item. Hobbs has sufficient idle capacity to produce the additional DVD players. What is the minimum price Hobbs should charge per DVD player for the special order?a. $60b. $59c. $57d. $55e. $62LO3 B

61. Spikes Company manufactures 5,000 high-end racing bicycles each period. Spikes has been making all the components for the bikes, but a supplier has approached Spikes with an offer to sell her bicycle seats at a price of $40. The cost per unit of manufacturing one bicycle seat is computed as follows:Direct Material $10Direct Labor$18Manufacturing overhead(100% fixed)$10

If the bicycle seats are purchased from the outside supplier, $1 per unit of the fixed manufacturing overhead costs can be avoided. If Spikes purchases the seats, the facility used to manufacture the seats would be rented for $20,000 per period. If Spikes chooses to purchase the bicycle seats, then the change in annual net operating income is an:a. $35,000 decrease.b. $35,000 increase.c. $5,000 decrease.d. $5,000 increase.e. $10,000 increase.LO3 A

62. The Pleasantville Company makes 20,000 units per year of a part used in production. The unit product cost is as follows:Direct materials$ 6.20Direct labor 2.30Variable Manufacturing Overhead 1.20Fixed Manufacturing Overhead .80Unit product cost$10.50An outside supplier has offered to sell the company the same part at a cost of $9.00 per unit. If the company purchases the part only half of the fixed overhead would be avoided. How much of the unit product cost is relevant in making this decision?A. $9.70B. $10.50C. $2.30D. $10.10LO3 Self-test D

63. Augusta Company manufactures stereo components. One of its most popular products is the LoudBoom Speaker. Data concerning this product are given below:

Normal Selling Price$50.00Direct materials$12.20Direct labor$3.60Variable Manufacturing Overhead$1.80Fixed Manufacturing Overhead$2.00Variable Selling Expense$1.90Fixed Selling & Administrative Expense$.80The above per unit data are based on annual production of 3,000 units of the component. The company has received a special, one-time-only order for 200 units of the speaker. There would be no selling expenses on this special order and the total fixed manufacturing overhead and fixed selling and administrative expenses of the company would not be affected by the order. Assuming that Augusta Company has excess capacity and can fill the order without any production disruptions, what is the minimum price per unit on the special order the company should charge? A. $50.00B. $19.60C. $17.60D. $22.30LO3 Self-test C

64. Shickman Company makes the widgets it uses in one of its products at a cost of $8 per unit. This cost includes $2 of fixed overhead. The company needs 10,000 of these plugs annually, and Orlando Company has offered to sell them at $5 per unit. If Shickman Company purchases the plugs, the company would: a. Increase profits by $30,000.b. Decrease profits by $10,000.c. Increase profits by $10,000.d. Decrease profits by $30,000.LO3 Self-test C

65. Little Toy Company makes and sells miniature doll houses. Little produces two kinds of houses: Standard and Deluxe. The demand for doll houses is highest in November and December. Expecting this trend to continue Little is interested in how to best utilize available capacity. Given the following information, what combination of doll houses should Little produce?StandardDeluxe

Demand 8,0003,000

Unit Price$60$80

Unit variable cost$25$35

Unit contribution margin$35$45

Production rate (units per hour)21

Available production hours 5,000 hrs

Total fixed costs$40,000

a. 8,000 Standard; 3,000 Deluxe.b. 8,000 Standard; 1,000 Deluxe.c. 5,000 Standard; 3,000 Deluxe.d. 3,636 Standard; 7,364 Deluxe.e. 3,636 Standard; 1,363 Deluxe.LO4 B

66. The general rule to apply to maximize profit when capacity is in short supply is:a. Minimize the contribution margin per unit of capacity.b. Maximize the margin of safety per unit of capacity.c. Maximize the contribution margin per unit of capacity.d. Minimize the margin of safety per unit of capacity.e. Maximize the unit contribution margin.LO4 C

67. Handi-Tool Company manufactures and sells lawn and garden tools. Handi manufactures three kinds of pruning shears: Snip-It, Deluxe Clipper, and Limb-Away. The demand for the pruning shears is highest in April. Expecting this trend to continue, Handi is interested in how to best utilize available capacity. Given the following information, what combination of pruning shears should Handi-Tool produce?Snip-ItDeluxe ClipperLimb-Away

Demand 200,000100,00060,000

Unit Price$20$30$50

Unit variable cost$10$15$20

Unit contribution margin$10$15$30

Production rate (units per hour)502515

Available production hours 8,000 hrs

Total fixed costs$400,000

a. 200,000 Snip-It; 100,000 Deluxe Clipper, 0 Limb-Away.b. 200,000 Snip-It; 60,000 Limb-Away; 0 Deluxe Clipper.c. 100,000 Deluxe Clipper; 60,000 Limb-Away; 0 Snip-It.d. 200,000 Snip-It; 100,000 Deluxe Clipper; 60,000 Limb-Away.e. 150,000 Snip-It; 75,000 Deluxe Clipper; 45,000 Limb-Away.LO4 B

68. When capacity is limited, which of the following are alternative courses of action to consider?a. Produce the items with the largest contribution margin per unit of capacity.b. Purchase some components from outside suppliers.c. Produce the items with the largest selling price to maximize revenue.d. A and B only.e. A, B and C.LO4 D

69. The Southeast Company makes three products in one manufacturing facility. Data regarding these products are as follows:ABCDirect Materials$5.70$6.20$8.90Direct Labor2.051.902.20Variable Overhead.70.80.90Fixed Overhead1.101.401.60Unit Product Cost$9.55$10.30 $13.60

Machine Hours Per Unit.51.25Selling Price per Unit$16.00 $18.00 $20.00Demand (units) 1,2001,400800How many machine hours would be required to meet the demand for all products?A. 3,400B. 2,200C. 1,700D. 850LO4 Self-test B

70. The Southeast Company makes three products in one manufacturing facility. Data regarding these products are as follows:ABCDirect Materials$5.70$6.20$8.90Direct Labor2.051.902.20Variable Overhead.70.80.90Fixed Overhead1.101.401.60Unit Product Cost$9.55$10.30 $13.60

Machine Hours Per Unit.51.25Selling Price per Unit$16.00 $18.00 $20.00Demand (units) 1,2001,400800If there are only 2,000 machine hours available, which is the MOST profitable product?A. Product AB. Product BC. Product CD. Cannot be determinedLO4 Self-test C

71. The Southeast Company makes three products in one manufacturing facility. Data regarding these products are as follows:ABCDirect Materials$5.70$6.20$8.90Direct Labor2.051.902.20Variable Overhead.70.80.90Fixed Overhead1.101.401.60Unit Product Cost$9.55$10.30 $13.60

Machine Hours Per Unit .51.25Selling Price per Unit$16.00 $18.00 $20.00Demand (units) 1,2001,400800If there are only 2,000 machine hours available, how much is the profit per machine hour for product A?A. $12.90B. $6.45C. $7.70D. $6.40LO4 Self-test A

72. When there is a production constraint, the company should first produce the product with:A. The highest contribution margin per unitB. The highest contribution margin ratioC. The highest revenue per unitD. The highest contribution margin per unit of the constrained resourceLO4 Self-test D

73. The Jackson Company produces 2 different products, each of which has unlimited demand. If there are 4,000 total available labor hours, and the company desires to maximize its contribution margin, how many units of each product should be produced?Product

XZ

Selling price per unit$8$16

Variable cost per unit$4$9

Labor hours per unit24

A. 2,000 units of Product X and 0 units of Product ZB. 0 units of Product X and 1,000 units of Product ZC. 0 units of Product X and 4,000 units of Product ZD. 2,000 units of Product X and 4,000 units of Product ZLO4 Self-test A

74. The production of two products has the same selling prices per unit. If total fixed costs will be $5,000 for product A and $4,500 for product B, what factors are relevant in determining which of the two products to produce and sell?a. Selling and variable costs per unit, and the fixed cost savings.b. Variable costs per unit and total fixed costs.c. Total variable and fixed costs and total sales revenued. .Variable costs per unit and the fixed cost savingsLO4 Post-test D

75. Which of the following is in the context of a short-term decision?a. Special order.b. Product promotion.c. Product mix.d. A and B only.e. A, B and C.LO4 E

76. Which of the following statements is not true?a. Quantifying longer-term implications of short-term actions is relatively simple.b. It is important to consider longer-term implications of short term decisions because of potential tradeoffs between short-term and long-term interests.c. Many managers follow a peel the onion approach to assessing decision effects, first by estimating the short-term effects, and then expanding the range of considered factors.d. For longer-term actions, in many cases, qualitative assessments are the only ones possible, and large estimations errors accompany such assessments.e. All of the above statements are true.LO5 A

77. Quantifying the longer-term implications of short-term actions is difficult. Consequently:a. It is impossible to make an informed decision.b. Frequently, only qualitative assessments are possible.c. Long-term implications should be ignored in the decision-making process.d. A and B only.e. A, B, and C are consequences.LO5 B

78. Which consideration is most relevant for a startup manufacturing company?a. Short-term decisions regarding production.b. Implications that arise from people outside the firm such as customers, suppliers, and suppliers.c. Qualitative aspects of decisions.d. Decisions that cause profit to be highest in the short-run LO5 Post-test B

79. A cost that is common to two or more products is a:a. Split-off cost.b. Incremental cost.c. Joint cost.d. Opportunity cost.e. Fixed cost.Appendix A C

80. Which of the following is not an example of a joint product?a. Mined zinc and lead from the same ore.b. Kerosene and aviation fuel from crude oil.c. Goats milk and cows milk.d. Pine bark and pine cones from a pine tree.Appendix A C

81. Which of the following statements is true?a. Joint costs occur after the split-off point.b. Joint costs occur before the split-off point.c. Joint costs can be traced to specific outputs.d. Joint costs are considered relevant costs beyond the split-off point.e. None of the above statements are true.Appendix A B 82. A joint product costs $20 (including $8 allocated joint cost) and sells for $15. Which of the following statements is true?a. The production of the product should be discontinued since it creates a loss of $5.b. The product should be processed further so the joint cost can be allocated to additional products.c. The product should be analyzed further to determine its profitability since the joint cost will be incurred whether or not the product is discontinued.d. Profit will be increased if the product is discontinued.e. Both A and D are true statements.Appendix A C

83. Which of the following is not relevant to make a decision to process further or sell as is?a. Selling price if processed further.b. Cost incurred to produce the product after the split-off point.c. Joint costs.d. Costs incurred to process further.Appendix A Post-test C

84. Which of the following statements is not true?a. Common costs are not relevant in determining whether to drop a product line.b. If a segment of a company has been losing money for several periods because a competitor has opened in the area, the segment should be dropped.c. Neither of the above statements if true.d. Both of the above statements are true.Appendix B B

Problems

1. Robin offers Christmas tree decorating services six days per week during late November and December. She charges $50 per live tree regardless of the size of the tree. Robins clients provide all the decorations. Her variable cost, solution to keep the tree fresh, is $10 per tree and the fixed costs per month total $100. Robin has had more calls by the end of October than she had expected and is considering hiring a helper. She will pay the helper $8 per hour. Robin estimates that she can decorate 8 trees in a 10-hour day (before hiring a helper) during the holiday season (25 days.)

Required:a. Does Robins decision deal with excess supply or excess demand?

b. If Robin decides not to hire a helper, list three alternatives she should consider.

c. List three long-term effects of Robins decision alternative courses of action.

2. Trisha Hardin owns Ice Flavors, a small business selling fruit-flavored slush drinks. Each drink sells for $2.50. Trisha derived her price as follows:

Drink mixture and crushed ice$0.60

Labor per drink ($8 per hour 20 drinks per hour)$0.40

Variable overhead per drink (cups, etc)$0.35

Fixed overhead per drink$0.40

Total cost per drink$1.75

Trisha is considering a special order for a sale of 100 drinks for a local birthday party. The hostess is willing to pay $1.50 per drink. The party will be in the evening, which is not during Trishas regular business hours. Trisha will provide the drink mixture, ice and labor. Her only additional expense will be one employee for two hours ($8 per hour), travel to and from the party location (estimated to be $15). Since the party is not at Trishas business, her fixed overhead will not change. The party hostess will furnish all cups, napkins and other variable cost items.

Required:a. What is the incremental cost associated with accepting the special order?

b. List the costs that are not relevant to the decision.

c. Should Trisha accept the special order? Why?

3. Outdoor Flames manufactures 5,000 outdoor gas fireplaces each period. The company has been manufacturing the ignition system for the fireplaces. The unit cost of each ignition is as follows:

Direct Material$12

Direct Labor5

Variable manufacturing overhead2

Fixed manufacturing overhead14

Unit product cost$33

A local supplier has offered to sell the company the ignition system for $30 each. If the ignition systems are purchased from the outside supplier, the facilities now being used to make them can be used to make other units of a product that is in high demand. The additional contribution margin on the other unit would be $42,000 per year. If the ignition systems are purchased from an outside supplier, all the direct labor would be avoided, but $8 of the fixed cost would continue and be applied to the remaining products even if the part is purchased.

Required:a. How much of the unit product cost of $33 is relevant to the decision to make or buy the ignition systems?

b. What is the net total dollar advantage or disadvantage of purchasing the ignition systems rather than making them?

c. List three qualitative characteristics that the owner of Outdoor Flames should consider in looking at the long-term effect of purchasing the ignition systems.

4. The Gant Company produces three items in its manufacturing plant. The plant has a total capacity of 9,600 minutes per month for production. The following information is provided for the products:Products

XYZ

Direct material$16$10$14

Direct labor (all variable)151415

Variable overhead234

Fixed overhead202330

Unit cost$53$50$63

Minutes required per unit546

Selling price per unit$70$65$80

Variable selling expense per unit$5$4$2

Monthly demand in units2,2001,000800

Required:a. How many minutes would be required to meet the demand for all three products?

b. How many units of each product should Gant product to maximize profit? Show your calculations.

5. Hermitage Farms produces two products, X and Y, in a joint process. The products may each be sold at the split-off point or processed further. The selling price $1.10 for X and $0.80 for Y if the products are sold without further processing. Data for the two products, if processed further, is presented below:

Product XProduct YTotal

Sales volume28,000 units16,000 units

Revenues$42,000$18,400$60,400

Traceable processing cost12,0005,00017,000

Segment Margin$30,000$13,400$43,400

Joint costs$35,000

Profit before Taxes$6,000

Required: What is the monetary advantage (disadvantage) of further processing the products? Show calculations.

6. Creative Lawn Ornaments sells three categories of lawn structures: Fountains, Bird and Butterfly Houses, and Obelisks. For the current year, Creative reported the following results:

FountainsHousesObelisksTotal

Revenue$175,000$145,000$95,000$415,000

Variable costs 85,000 43,000 45,000 173,000

Contribution margin$ 90,000$102,000$50,000$242,000

Traceable fixed costs30,00033,00030,00093,000

Common fixed costs 35,000 35,000 35,000 105,000

Profit$ 25,000$ 34,000($15,000)$ 44,000

Creatives owner is pleased with the overall profit, but is concerned about the loss on the Obelisks line and is considering eliminating it. The owner believes that if the Obelisk sales are discontinued he will be able to display more Fountains and increase the revenues by 5% without increasing any fixed costs. If the Obelisk line is discontinued, all of its traceable fixed costs will be avoided, but its common fixed costs will be allocated to the Fountains.

Required:Evaluate whether Creative Lawn Ornaments should discontinue its line of Obelisk structures. Show all calculations.

Solutions to Problems1. Short-term decision (LO1)a. Robins decision deals with excess demand.

b. Answers may vary. Some alternative courses of action include: Instead of hiring a helper, work longer hours. Instead of hiring a helper, extend business from six days to seven days per week. Increase the price per tree, and thereby, reduce the number of clients. Limit the size of tree, thereby being able to complete more trees in the same amount of time. Instead of hiring a helper paid per hour, outsource some work for a fixed fee per tree. Begin decorating a few days earlier in November.

c. Answers may vary. Some long-term effects include: If Robin increases the price per tree, in the long-run she may lose clients. By hiring a helper and accepting additional clients, in the long run Robin may have to consider hiring additional employees. If Robin increases business and hires helpers, in the long-run she may wish to offer additional services such as decorating mantels, doorways, dining rooms, etc. With increased business, Robin should consider the long-term effect on her health. With increased business, Robin should consider the long-term effect on her personal and family obligations.

2. Special Order (LO2)a. Incremental cost associated with accepting the order:Accept OrderReject Order

Revenue$150$0

Drink mix and ice$ 60$0

Labor ($8 per hr x 2 hrs)$ 16$0

Transportation$ 15$0

Total Incremental costs: $60 + $16 + $15 = $91

b. Non-relevant costs:Fixed overhead $0.40 per drinkVariable overhead$0.35 per drink

c. Trisha should accept the order:Incremental Revenue$150

Incremental Costs$ 91

Incremental profit$ 59

Because Trishas incremental revenue exceeds her incremental costs and she has the capacity to accept the order (it does not interfere with regular business), it would be profitable to accept the special order.

3. Make or buy decision (LO2, LO3, LO5))

a. Relevant unit product cost:$12 + $5 + $2 + $6 = $25

b. Net total dollar advantage (disadvantage) of purchasing:

Relevant cost$125,000

Additional contribution margin42,000

Cost of purchasing(150,000)

Net advantage$17,000

c. Qualitative considerations: Will the supplier continue to sell the ignition systems at the $30 price? Over the long run, will the company be able to absorb all the employees from the ignition system into other areas of the company? What are the alternatives if the purchased ignition systems turn out to be a lower quality than expected? Does the high-demand item expected to use the space formerly used for making the ignition systems have a long-range high demand?

4. Best use of resources in short supply( LO4)

a. Total minutes required to meet demand:(2,200 units x 5 minutes) + (1,000 x 4 minutes) + (800 x 6 minutes) = 16,600 minutes

b. Production to maximize profit:Products

XYZ

Selling price per unit

$70$65$80

Direct material$16$10$14

Direct labor (all variable)151415

Variable overhead234

Variable selling expense per unit 5 4 2

Total variable cost$38$31$35

Contribution margin per unit$32$34$45

Minutes required per unit546

Contribution margin per minute$160$136$270

Gant should produce the following units to maximize profit:Optimal UnitsMinutes UsedAvailable Minutes

9,600

Product Z 800 units @ 6 minutes 4,8004,800

Product X 1,000 units @4 minutes 4,000 800

Product Y 160units @ 5 minutes 800 -0-

5. Joint costs (Appendix A)

Product XProduct YTotal

Process Further:

Sales volume28,000 units16,000 units

Revenues$42,000$18,400$60,400

Traceable processing cost 12,000 5,000 17,000

Segment Margin$30,000$13,400$43,400

Sell at Split-Off

Revenue$30,800$12,800$43,600

Traceable processing costs 0 0 0

Segment Margin$30,800$12,800$43,600

a. The disadvantage of processing Product X further is $800.($30,000 - $30,800)

b. The advantage of processing Product Y further is $600.($13,400 - $12,800)

6. Dropping product line (Appendix B

FountainsHousesObelisksTotal

Revenue$175,000$145,000$95,000$415,000

Variable costs 85,000 43,000 45,000 173,000

Contribution margin$90,000$102,000$50,000$242,000

Traceable fixed costs 30,000 33,000 30,000 93,000

Segment Profit$ 60,000$ 69,000$20,000$149,000

Increased revenue if Obelisk

ContinueDiscontinue

FountainObeliskTotalFountainObeliskTotal

Revenue$175,000$95,000$270,000$183,7500$183,750

Variable costs85,00045,000130,00089,250089,250

Traceable fixed costs30,00030,00060,00030,000030,000

Common fixed costs 35,00035,000 70,00070,0000 70,000

Net Income$ 25,000($15,000)$ 10,000($5,500)0($5,500)

Creatives owner should not discontinue its Obelisk line of products. The increase in revenue from the additional fountain sales does not offset the portion of common fixed costs that the Obelisk absorbs.

End of Chapter ContentShort Answer1. What do short-term decisions deal with in most business environments?

2. What does the term capacity mean?

3. Why is the decision of how much capacity to put in place a long-term decision?

4. What are the two broad classifications of short-term decisions? List two examples of each.

5. Briefly describe the incremental or differential method approach to making short-term decisions.

6. Briefly describe the totals or the gross approach to making short-term decisions.

7. Which approach, incremental or totals, requires more computations? Why?

8. When might the gross approach be preferable to the incremental approach for making short-term decisions?

9. Are sales promotion decisions typically responses to an excess supply situation or an excess demand situation?

10. What is a make-or-buy decision?

11. When does it make sense to compute the contribution margin per unit of a particular resource in making short-term decisions?

12. What is the general rule for allocating a scarce resource to making multiple products?

13. How might managers deal with the possible long-term implications that may arise from short-run decisions?

Solutions to Short Answer1. (LO1)The temporary gaps between the demand and supply of available capacity.

2. (LO-1)The maximum volume of activity that a company can sustain with available resources.

3. (LO-1)Because organizations make capacity decisions based on the expected volume of operations over a horizon spanning many years. They build plants, buy equipment, rent office space, and hire salaried personnel in anticipation of the demand for their products and services.

4. (LO-1)(1) Decisions that deal with excess supply. Examples include reducing prices to stimulate demand, running special promotions, processing special orders, and using extra capacity to make production inputs in-house; (2) Decisions that deal with excess demand. Examples include increasing prices to take advantage of favorable demand conditions, meeting additional demand by outsourcing production, and altering the product mix to focus on the most profitable ones.

5. (LO-2)This method focuses only on those costs and revenues that differ from the benchmark option.

6. (LO-2)This method considers the gross revenues and costs associated with each option, rather than the incremental amounts relative to the benchmark option.

7. (LO-2)The totals approach requires more computations because it includes some noncontrollable benefits and costs.

8. (LO-2)In decisions involving many costs and benefits it helps us ensure that we do not forget to include a relevant cost or benefit.

9. (LO-3)Excess supply usually, the firm cuts prices to stimulate demand.

10. (LO-3)In a make or buy decision, the firm is deciding whether to make a product, or piece thereof, internally or outsource and buy them from a supplier.

11. (LO-4)When demand is high and a resource is in short supply.

12. (LO-4)To maximize profit when capacity is in short supply, maximize the contribution margin per unit of capacity.

13. (LO-5)Typically on a qualitative basis by considering how customers, suppliers, and competitors might respond to the decision being made.

Short Essay1. The definition of short-term depends on the business context. What would General Motors consider as short-term? Is this period longer than what a bakery would consider as short-term? Why?

2. Automobile dealers frequently advertise sales because their lots are overflowing. The ads suggest a shortage of storage capacity but the price-cutting action indicates a demand shortfall. How can you reconcile these seemingly contradictory inferences?

3. Identify the one resource whose daily supply is fixed for each person. How could we improve the effectiveness with which we consume this resource?

4. Some people argue that the gross method is also, at some level, incremental. Evaluate this argument.

5. When faced with a sudden spurt in demand, why does it sometimes make sense for a company to increase prices? For example, why do airlines raise fares during peak travel periods? Why might it not be a good idea for consulting companies?

6. In periods of excess capacity, does it make sense for a manufacturing company to produce some products to stock (i.e., build up inventory) for sale in future periods of high demand? Give two examples of industries where this might be a good idea. Give two examples where it might be a bad idea.

7. How does holding inventory help reduce the expected gap between available capacity and uncertain demand?

8. Inventory is one mechanism that a firm could use to protect itself from the impact of fluctuating demand. What are other long-term strategies a company could adopt to insulate itself against uncertain demand?

9. Often, the capacity of the most expensive machine defines a plants capacity. That is, firms will deliberately install excess capacity in cheap resources. Why might this practice be optimal?

10. The general allocation procedure in the text assumes few constraints on how we could use resources. Why might this general rule not hold when individual uses require a minimum amount of the resource? (For example, if we are allocating space, each use might need a minimum of 10 units of space.) How might we modify our approach to incorporate lumpy uses of capacity?

11. How does the notion of maximizing the contribution per unit of the scarce resource apply when some products have minimum production quantities?

12. Outsourcing is the practice of having an external party take over some business and/or manufacturing processes. How does outsourcing change a firms cost structure and, therefore, its ability to be nimble in responding to competition? What are some long-term costs and benefits of outsourcing?

13. Suppose that buying a component is estimated to save $50,000 annually over making it in-house. However, outsourcing the component means that 20 long-term employees would be laid off, adversely affecting employee morale. How might a manager trade off these two factors?

Solutions to Short Essay1. (LO-1)Yes, the definition of what is short-term and what is long-term depends on the business context. For General Motors anywhere from few weeks to a few months may be considered short-term, as pricing and promotion decisions depend on how fast different models of cars and trucks are moving from the dealers inventories. For a baker, a day or two days may be too long as baked goods do not retain their freshness for long. Thus, product characteristics often play a critical role in determining how long the short-term horizon is.

2. (LO-1)The reason why the lots are overflowing is that vehicles are not being sold at the expected rate. Unsold vehicles occupy space in the lot. Thus, it is not correct to define capacity in terms of the lot space available. Rather, capacity should be defined in terms the number of vehicles that can potentially be sold per day. When demand falls short of supply based on the anticipated number of vehicles to be sold per day, lots overflow, and price-cutting and other promotions become necessary to move the vehicles.

3. (LO-1)Most of us drive to work, and so the demand for gasoline is fairly stable. One way to economize on gasoline consumption is to car pool.

4. LO-2)Yes, it is. The gross method considers all cash inflows and cash outflows that are associated with the options being considered in the context of a particular decision, even though some of them may be non-controllable. But, it does not consider cash flows associated with many other decisions that the companies may be considering. From an overall organizational standpoint, each decision has an incremental effect, and, therefore, the gross method is also incremental when viewed in this context.

5. (LO-3, LO-5)Increasing prices is a natural way of decreasing demand. In fact, in most market settings, demand for a product decreases as its price increases. When a firm does not have enough capacity to meet a sudden spurt in demand, it can reduce the demand by increasing prices and turning away some customers to a point where the demand can be met. The airline industry is a good example. In peak times, an increase in airfare induces some travelers to seek other means of travel or postpone their travels. Only those that are able to afford the higher prices, or have rigid and noncancelable schedules, will continue to travel. Airline companies usually face no long-term adverse implications from increasing prices to deal with peak demand situations. Air travelers usually understand this behavior and plan their travel accordingly. On the other hand, consulting companies rely on longstanding relationships with their customers. Raising their rates when their business is good usually backfires because it hurts reputation and goodwill in the long-run.

6. (LO-3)Yes, it does. This is typically referred to as production smoothing and makes good business sense as long the product is storable for sale in the future period, and as long as inventory carrying costs are manageable. The toy industry and the apparels industry are good examples.

7. (LO-3)Companies can produce and stock up during periods of lean demand to be ready for peak periods whenever demand outstrips capacity. However, such use of inventory is beneficial when demand follows reasonably predictable cycles of high and low demand. On the other hand, whenever demand is low and there is considerable uncertainty as to whether demand would rise again, producing and stocking for future may backfire.8. (LO-3)One strategy is to invest less in capacity and rely more on outsourcing. By doing so, the company would embrace a cost structure with less fixed costs and more variable costs i.e., a cost structure with lower operating leverage. Another strategy to find other uses for capacity so that excess capacity can be put to profitable alternate use during periods of lean demand (such as accepting special custom jobs, turn key projects and so on).

9. (LO-4)The idea is to make the most profitable use of critical and most expensive resources. The opportunity cost of such a resource is by assumption, high. Any situation in which such a resource has to wait because some other cheaper resource is in short supply is undesirable. To avoid such situations, it makes more economic sense to install excess capacity in other resources.

10. (LO-4)When a resource is in short supply, and it is used in a lumpy manner, calculating contribution margin per unit of the resource to allocate its use to various products is at best approximate and can often lead to wrong decisions. Advanced techniques such as integer programming may have to be employed to come up with the right way to allocate scarce resources to products in such settings.

11. (LO-4)Products requiring minimum production quantities involve committing requisite amounts of capacity to these products if they are chosen production. Whenever capacity is in short supply, such products may well necessitate leaving out products with higher contribution margins per scarce capacity unit in order to meet their minimum production requirements. The alternative is to not lock up capacity by scheduling such products, but instead use the capacity to schedule products that yield lower contribution margins per unit of the scarce capacity resource. The consequent trade-off will determine whether it is profitable to make products with minimum production requirements.

12. (LO-5)Test marketing is a way to minimize risk associated with large investments. Offering a new product often involves putting in place and committing to various organizational resources. Once the product is launched it is often extremely costly to cut back should the product fail. Plants and offices have to be closed down and people have to be fired and so on. Risk of failure is an inherent part of business, and products do fail. But one way to reduce this risk is to do a small scale launch aimed at representative customers. If this test marketing effort fails, then a larger scale launch is unadvisable. Moreover, feedback from the test market is often useful in redesigning the product to reduce the risk of failure subsequently.

13. (LO-5)Employee morale is an important factor in outsourcing decisions, especially if outsourcing is a sign of things to come. Loss of morale leads to a loss in productivity which might make outsourcing even more attractive. The company may lose talented and experienced personnel, who may prefer jobs elsewhere to being fired. Managers therefore have to be clear about the impact of outsourcing on employee morale so that they can make the appropriate trade-off between immediate cost savings from outsourcing and longer-term adverse impact of a loss in morale. Certain critical activities are better done in-house for strategic reasons, while others can be outsourced. However, decision making with respect to outsourcing has to be clearly communicated to the employees to avoid disgruntlement.

Exercises1. Ajay Singh offers gift-wrapping services at the local mall. Ajay wraps each package, regardless of size, in the customers choice of wrapping paper and bow for a price of $3. Ajays variable costs total $1 per package wrapped, and his fixed costs amount to $600 per month. Due to the anticipated increase in demand over the holiday season, Ajay is considering hiring a helper, at a cost of $8.50 per hour, to help him wrap packages. With the helper, Ajay estimates that he can wrap 110 packages in a 10-hour day. Without the helper, Ajay estimates that he can wrap 60 packages in a 10-hour day. Ajay plans on operating his business for thirty 10-hour days during the holiday season.

Required:a. Does Ajays decision deal with excess supply or excess demand?

b. Using the gross approach, determine whether Ajay should hire the helper.

c. Using controllable cost analysis, determine whether Ajay should hire the helper.

d. Assume Ajays fixed costs were $1,000 rather than $600. Would this affect Ajays decisionto hire a helper?

2. The Dj Vu Card Company offers greeting cards for every occasion at unmatched prices. The following information comes from Dj Vus accounting records for December of the most recent year: Greeting cards sold 100,000 cards Selling price $1.00 per card Fixed costs: Manufacturing $0.30 per cardMarketing & administrative $0.21 per cardVariable costs:Manufacturing $0.15 per cardMarketing & administrative $0.08 per card

Required:Dj Vu has an extra stock of 5,000 holiday greeting cards. The company is considering two options: (1) holding a 50% off sale and (2) holding an 80% off sale. Dj Vu expects to sell 1,500 cards if it holds a 50% off sale and 4,000 cards if it holds an 80% off sale. The remaining cards would be discarded. Which option should Dj Vu pursue?

3. Myers Quarry produces coarse gravel and sand in an 8:2 ratio. Joint costs for a month (volume 5 9,000 tons of rocks input) amount to $225,000. Values at the split-off point are $30 per ton for gravel and $40 per ton for sand.

Required: a. Allocate joint costs to the two products using the relative sales value at split off as the allocation basis.

b. Suppose Myers can run the sand through a sieve to remove small rocks and make fine sand used to fill sandboxes. The process will, however, reduce the yield of sand from 1,800 tons to 900 tons. This superior grade of sand (sandbox quality) retails for $160 per ton. However, Myers will incur $18,000 to process the sand into sandbox quality. Should Myers sell the coarse sand as is or process it further into sandbox quality sand?

Solutions to Exercises1. (LO1, LO2)a. Ajays decision deals with excess demand. Due to the holidays, Ajay expects a surge in gift-wrapping needs. To handle this surge, Ajay is considering hiring a helper. This is akin to a manufacturing firm outsourcing some production in periods of high demand.

b. We can construct the entire CVP model for Ajay. We then compare the profit under each option, selecting the option with the higher profit. With the information provided, we have:

Without HelperWith Helper

60 packages per day110 packages per day

Daily revenue($3 60; $3 110)$180.00$330.00

Daily variable costs($1 60; $1 110)60.00110.00

Daily pay for help(0; $8.50 10)0.0085.00

Daily contribution Row 1 rows 2 & 3$120.00$135.00

Total contribution Row 4 30 $3,600.00$4,050.00

Total fixed costs Given 600.00600.00

Profit$3,000.00$3,450.00

Ajays profit increases by $450 ($3,450 $3,000) for the season, if he hires the helper. Accordingly, if he wishes to maximize profit then Ajay should hire the helper. In constructing the income statement for each option, we could leave out the non-controllable fixed costs of $600. While the absolute profit numbers would change, the difference in profit would be preserved. Thus, the gross approach provides decision makers some flexibility in terms of what is included and excluded from the income statement. c. We compute only the incremental revenues and costs associated with a particular decision option relative to the status quo. Since operating without the helper is the status quo, we have:

Incremental revenue50 packages per day $3 $150

Incremental variable cost (packages)50 packages per day $150

Incremental cost (helper)$8.50 10 hours85

Incremental profit per day$15

Value of hiring helper $15 30days$450

Ajay increases monthly profit by $450 if he hires a helper. The difference in profit derived with controllable cost analysis exactly equals the difference in profit under the gross approach.

d. If Ajay seeks to maximize profit, the change in fixed costs will not alter his decision to hire the helper. The fixed costs are equal under each option and are not relevant for this particular problem. Even though the gross approach uses fixed costs, they wash because they are included in the total cost for both options.

2. (LO2)Similar to the Superior Cereals problem in the text, the key to this problem is to realize that the variable costs associated with manufacturing the greeting cards are sunk thus, they are not relevant to Dj Vus decision. Additionally, Dj Vus fixed costs are non-controllable for the decision, as they are not expected to change. Thus, the problem is one of revenue maximization.

At a 50% off sale, Dj Vus profit increases by $0.50 1,500 = $750.At an 80% off sale, Dj Vus profit increases by $0.20 4,000 = $800.

Thus, Dj Vu maximizes its profit by holding the 80% off sale, even though the resulting price is below the $0.23 (= $0.15+$0.08) in variable costs associated with producing and selling a card. What we need to remember is that this is the variable cost of a card yet to be produced, not a card that has already been produced.

Note: This problem links to a common business practice. Specifically, we often observe stores employing a staggered discounting strategy the store starts with, for example, a 25% discount and increases the discount rate over time (perhaps by as much as 15-25% a week). In this way, the store attempts to capture as much consumer surplus (gross revenue) as possible by grouping customer types according to their willingness to wait and run the risk of having the item selling out. Such a strategy may work quite well for Dj Vu i.e., the company could sell the first 1,500 cards at $0.50 and 4,000 1,500 = 2,500 cards at $0.20. By employing such a strategy, Dj Vu could earn:

Expected Profit = ($0.50 1,500) + ($0.20 2,500) = $1,250.This amount represents a $450 (= $1,250 - $800) increase over its best option.

3. (Appendix A)a. Let us begin by calculating relative sales values.Gravel:9,000 tons 0.8 $30 $216,000Sand:9,000 tons 0.2 $40 $72,000 Total $288,000

Thus, 75% of the joint cost (=$216,000/$288,000) would be allocated to gravel and the 25% to sand. We have the cost allocated as 0.75 $225,000 = $168,750 and 0.25 $225,000 = $56,250.

Alternatively, we can calculate the rate per sales $ at the split off as $225,000/$288,000 = $0.78125. We then allocate $216,000 $0.78125 = $168,750 to gravel and $72,000 0.78125 = $56,250 to sand.

b. We know that only incremental revenues and costs are important for this decision. Let us therefore calculate the net gain from processing the sand further.

Value of sandbox quality 900 tons $160 $144,000Lost value at split off9,000 tons 0.2 $40 $72,000Net gain in revenue$72,000Cost of additional processinggiven ($18,000)Net value $54,000Thus, Myers should process the sand at split off into sandbox quality sand because it increases profit by $126,000[footnoteRef:1] - $72,000 = $54,000. [1: ]

Note: The important point to note is that the joint cost, or how it is allocated, is not relevant for the decision in [b]. That joint cost is sunk for this decision. These allocations are usually done only for the purpose of valuing inventory.