Chapter 10

Relevant Information for Decision Making

Questions

1. Relevance means that a factor should be considered in making a decision. A relevant cost is a cost that is applicable, pertinent, or logically related to making a decision. In business, managers use the concept of relevant costs in the allocation of resources.

2. Time is correlated with relevance. For costs to be relevant they must reside in the future; historical costs are never relevant.

Further, the more distant in the future a cost resides, the more likely it is to be relevant. For example, in the long run, certain fixed costs are likely to be relevant; however, in the short run, most fixed costs are not relevant.

3. Opportunity costs are benefits that are sacrificed to pursue one decision alternative over another. These costs are difficult to identify because they do not appear as “costs” in accounting records. For example, in allocating scarce resources, managers may decide to produce Product A rather than Product B. An opportunity cost of this decision is the lost contribution margin on Product B. The lost contribution margin does not appear in the accounting records as an expense.

4. Sunk costs are costs that have already been incurred; i.e., they are historical costs. Sunk costs are never relevant to decisions because one a cost has been incurred, it cannot be “unincurred.”

5. Outsourcing occurs when a firm chooses to acquire necessary service functions or materials from a supplier rather than produce them in-house. The movement favoring outsourcing is controversial because it often involves loss of jobs to the organization electing to outsource. In the U.S., the outsourcing controversy is even tenser because vendors selected in outsourcing decisions often are foreign

companies. Thus, it can be argued that outsourcing leads to the movement of jobs from the U.S. to other countries.

6. A scarce resource is any input that constrains production capacity. In the short run, any constraint can be binding and the tightest constraint changes over time. For example, in a labor strike, direct labor may be the most constrained resource. If a machine breaks down, the conversion operation performed by that machine may be the most binding constraint on capacity, and if a supplier becomes bankrupt, certain materials may become the most binding constraint.

7. The object of managing the sales mix is to increase the contribution margin (or total profit) realized on the sale of a portfolio of products. The major factors that can be manipulated to change product mix are product prices, focus of advertising and promotion, and the manner in which sales personnel are compensated.

8. A special order decision involves the analysis of a nonrecurring sale of products. The typical circumstance involves the opportunity to sell products outside of the normal marketing area or to a one-time customer. The usual analysis involves a consideration of incremental costs and incremental revenues as well as the effect of the proposed sale on existing business.

9. Segment margin is sales less variable costs and avoidable fixed costs. Segment margin is used in decisions about whether to keep or eliminate a product line. The costs deducted in arriving at segment margin include only relevant costs (total direct variable expenses and avoidable fixed expenses). The costs presented below the level of segment margin to derive product line operating results are irrelevant costs (sunk direct fixed costs) because such costs could not be avoided or eliminated should the product line be discontinued.

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10. Linear programming is used as an aid in complex decisions that involve a single, identifiable objective function and multiple decision constraints.

Exercises

11. a. The relevant factors include the difference between the starting salaries for B.A.s and M.A.s, time until retirement, time to complete the M.A., and the out-of-pocket costs to obtain the M.A.

b. The opportunity cost associated with earning the master's degree is two years’ income that could have been earned with the B.A. degree ($40,400 x 2 = $80,800).

c. The out-of-pocket cost would include the cost of tuition, books, lab fees, and other direct educational costs. It would not include room and board or other living expenses that would be incurred irrespective of whether the student works (with the B.A. degree) or attends school.

d. The other factors to be considered would be the qualitative factors, e.g., the relative satisfaction, prestige, and happiness obtained from jobs that can be secured with each degree, and each alternative's effect on retirement plans, free time, and travel opportunities.

12. a. The only sunk cost is the purchase cost of the lettuce, $0.60 per head; or $0.60 × 49,500 = $29,700

b. The unspoken alternative is to do nothing. Doing nothing might simply mean throwing the heads of lettuce in a dumpster.

c. Do Sell to Sell to Nothing Wholesaler Restaurant

Incremental revenue $ 0 $15,750 $21,600Incremental costs 0 0 10,000Incremental profit $ 0 $15,750 $11,600

Based on a comparison of the incremental profits associated with each alternative, the company should sell the lettuce to the wholesaler.

13. a. You would explain to Sara that the purchase cost of $70 is not relevant to any decision she can now make regarding the phone. No matter what action she takes now, the $70 is not a recoverable cost. In deciding which action to take, Sara should consider only those costs that can be avoided by taking one action rather than another. Any cost that is the same across all decision alternatives can be ignored; such a cost is not relevant. Ignoring qualitative factors, Sara should select the alternative that minimizes total relevant costs.

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b. Her logical choices are (1) repair the phone at an estimated cost of $55 and (2) purchase a new phone. Accordingly, the decision would logically be made by comparing the purchase cost of a new phone to the repair cost of the old phone. However, Sara may want to consider differences in features between the existing phone and replacement phones as well. She may be willing to pay more than $55 for a new machine if it has additional features. This would be a qualitative consideration.

14. a. The sunk cost is the original cost of the old equipment, $75,000.

b. Irrelevant future costs include $4,000 of cash operating costs and the (nondifferential) salvage values in five years.

c. The relevant costs include the cost of the new equipment, $99,000, the current salvage value of the old equipment, $22,000, and $13,000 of annual cash operating savings.

d. The opportunity costs associated with keeping the old equipment include the potential $13,000 savings in cash operating costs, and the current $22,000 salvage value of the old equipment.

e. The incremental cost to purchase the new equipment is the difference between the purchase cost of the new machine and the current salvage value of the old machine, $99,000 - $22,000 = $77,000

f. Some qualitative factors to be considered would include how the new machine would affect the quality of production relative to the old machine, effects on employee morale if purchasing the new machine would require layoffs, and whether current employees have the skills to operate the new machine.

15. Incremental savings: $28,000 x 10 = $280,000Incremental cost of software: $270,000 - $48,000 = (222,000)Incremental profit $ 58,000

From a quantitative perspective, the new software should be purchased because it will result in increased profits of $58,000 over the life of the system.

16. a. Relevant cost to manufacture = $1.20 Relevant cost to buy = $1.00Advantage of buying: 120,000 x ($1.20 - $1.00) = $24,000

b. Relevant cost to buy: $ 1.00Avoidable variable costs (0.92)Minimum avoidable fixed costs $ 0.08 per unit

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17. The relevant costs to make the bumpers include only the variable costs:Direct material $42 (incl. purchased mounting hardware at $16)

Direct labor 14Overhead ($36 × 1/3) 12

Total $68

Incremental profit per bumper = $120 - $68 = $52

Increased profit from released facilities: ($52 x 4,800) $ 249,600Increased cost of production on first 150,000 units:

($16 - $12) x 150,000 (600,000)Net profit effect of purchasing mounting hardware $ (350,400)

18. a. Cost to make: $23,000 + ($2.75 x 25,000) = $ 91,750Cost to buy: 25,000 x $3.60 = (90,000)Advantage of purchasing $ 1,750

b. Cost to make: $23,000 + ($2.75 x 60,000) = $188,000

Cost to buy: 60,000 x $3.60 = 216,000Advantage of making $ (28,000)

c. Point of indifference occurs at the volume level that equates the cost to make with the cost to buy:

$23,000 + $2.75X = $3.6X X = approximately 27,059 units

19. a. MP3 Players PDAs

Contribution margin $ 6 $10Divide by labor time per unit ÷1 ÷2CM per unit of labor time $ 6 $ 5

Because the company can sell as many of either product as it can make, it should make only MP3 Players.

The company should make 120,000 MP3 Players.

b. The company should consider the need to provide a market assortment of goods and the possibility of customer preferences permanently changing to PDAs not made by Elkhorn Digital. This is acknowledging the possible long-term consequences to a short-term problem solution.

20. a. Individual Estate CorporateSales price $350 $1,200 $750 Variable costs (50) (200) (150)Contribution margin $300 $1,000 $600

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Contribution margin per hour of professional time:Individual: $300 ÷ 2 = $150 Estate: $1,000 ÷ 8 = $125 Corporate: $600 ÷ 5 = $120

According to the CM generated per hour of professional time, Ms. Jones would prefer to satisfy demand for services in the following order: individual taxation, estate taxation, and corporate taxation. Because all of Ms. Jones’ time could be consumed in providing individual income tax services, all of her time should be dedicated to providing that service.

b. Contribution margin: 2,500 x $150 $375,000Fixed costs (50,000)Pretax income $325,000

c. Ms. Jones should carefully consider the relationship between the three services she offers. For example, much of the demand for individual and estate tax services may be generated by the services she provides corporate clients. It may be because of the quality of her corporate tax services that demand is generated to provide individual income and estate tax services. Accordingly, there may be long-term negative consequences to providing only individual income tax services.

d. Ms. Jones could overcome the time constraint in one of two generic ways. First, she could employ accountants in her firm to do work in all service lines. Secondly, she could engage in a joint venture or partnership with other firms to provide the full array of services to clients.

21. a. Only the variable production costs are relevant to this decision:$440 + $60 + $50 = $550.

b. Incremental revenue: $580 x 200 $116,000Incremental costs: $550 x 200 (110,000)Incremental profit $ 6,000

Profits would increase by $6,000 if this special order was accepted

22. a. The relevant costs include the lost contribution margin associated with the 20 units of regular production that would be sacrificed to accept the special order, and the variable production costs for the three special stands:Normal sales price (20 x $275) $ 5,500Variable costs (20 x $145) (2,900)Lost contribution margin $ 2,600Production costs (3 x $860) 2,580Total costs $ 5,180

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b. Additional sales $ 3,600Less total relevant costs (5,180)Incremental loss $(1,580)

23. a. Grooming Training TotalRevenue $600,000 $800,000 $1,400,000Labor costs (160,000) (288,000) (448,000)Material costs (80,000) (96,000) (176,000)CM $360,000 $416,000 $ 776,000Fixed costs (200,000) (180,000) (380,000)Income before taxes $160,000 $236,000 $ 396,000

b. Contribution margin $360,000 $416,000Divide by sales 600,000 800,000Contribution margin % 60% 52%

If $1 spent on advertising could increase revenue by either service by $20, it should be spent on Grooming because it has a higher contribution margin percent.

c. Grooming TrainingRevenue per hr. $30 $50Variable costs per hr. (12) (24) CM per hr. $18 $26

Because $1 will yield $26 in CM if spent on training, but yield only $18 in CM if spent on grooming, the $1 should be spent advertising the company’s training services.

24. a. Sales 90,000 x $50 $4,500,000Variable costs ($9 + $7) x 90,000 (1,440,000)Contribution margin $3,060,000Fixed costs (300,000)Projected profit $2,760,000

b. New sales (90,000 x 1.20) x ($50 x 0.90) $ 4,860,000New variable costs (90,000 x 1.20) x $16 (1,728,000)New contribution margin $ 3,132,000Old contribution margin (3,060,000)Change in profit $ 72,000

c. Change in CM $3,060,000 x 0.25 $765,000

Change in fixed costs (220,000)Change in profit $545,000

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25. a. If the U. S. Division had been eliminated, Tanner Oil’s income statementwould have appeared as follows:

Sales $ 3,600,000Variable costs (2,088,000)Contribution margin $ 1,512,000Fixed costs:

Direct $ 480,000Corporate 2,700,000 (3,180,000)

Operating income (loss) $(1,668,000)

b. United States Mexico Total Sales $7,200,000 $3,600,000 $10,800,000Variable costs (4,740,000) (2,088,000) (6,828,000)Direct fixed costs (900,000) (480,000) (1,380,000)Segment margin $1,560,000 $1,032,000 $ 2,592,000Corporate costs (2,700,000)Operating income (loss) $ (108,000)

If the U. S. Division is eliminated, corporate income would decline by the $1,560,000 of segment margin currently being generated by that division. The common corporate costs of $2,700,000 would then need to be covered in total by the Mexico Division, which it cannot do.

26. a. Gross margin GL Services $ 600,000Avoidable fixed and variable operating costs (725,000)Segment margin $(125,000)

Yes, the company should strongly consider dropping the GL service line because it generates a negative segment margin of $125,000.

b. The pretax profit of the company would rise by $125,000 (the amount of the negative segment margin of the GL service line) if the GL area was dropped.

27. Objective function, MAX CM: 9.50X1 + 5.00X2 + 1.50X3

28. Objective function, MIN VC: 0.65X1 + 0.93X2 + 1.39X3 + 0.72X4

29. Objective function, MAX CM: 3.25X1 + 2.05X2 + 2.60X3

Subject to: 2.5X1 + 1.0X2 + 2.5X3 < 800 2.5X1 + 2.0X2 + 1.0X3 < 4,000

Where: X1 = the number of pairs of pants X2 = the number of pairs of shorts

X3 = the number of shirts

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30. Minimize Cost: 3.99X1 + 1.29X2 + 0.93X3 + 2.12X4 + 3.42X5

Subject to: 38X1 + 1X2 + 35X3 + 23X4 + 42X5 > 50 10X1 + 13X2 + 7X3 + 3X4 + 8X5 > 10 0X1 + 0X2 + 120X3 + 110X4 + 100X5 > 100 500X1 + 60X2 + 190X3 + 110X4 + 210X5 > 2,000

Where: X1 = pizza X2 = tuna fish

X3 = cereal X4 = macaroni & cheese X5 = spaghetti

Problems

31. a. Cost of new machine $ (700,000)Sales value of old machine 100,000Incremental cost of new machine $ (600,000)Operating cost savings ($130,000 x 5) 650,000 Net advantage of buying new machine $ 50,000

b. The qualitative factors that should be considered include any quality differences between the output generated by the two machines, whether the company’s employees have the knowledge to operate the new machine, how acquisition of the machine would affect safety considerations, and the capacity levels of the two machines.

32. a. The relevant costs include the cost to purchase the new turbine, the current market value of the old turbine, and the difference in annual operating costs between the old and new turbines.

b. Incremental cost of new turbine: $2,000,000 - $400,000 $(1,600,000)Incremental cost savings of new turbine:

($480,000 - $180,000) x 8 2,400,000Incremental profit from buying new turbine $ 800,000

c. The maximum amount that the company could pay:Total annual operating savings $2,400,000Cash value of old machine 400,000Total $2,800,000

d. Some of the factors to consider would include the reliability of the technologies, the difference in lives of the technologies, the environmental impacts of the technologies, and relative risks of using the two technologies.

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33. a. Relevant costs include:Variable production costs: ($0.04 + $0.03 + $0.02) or $0.09 per unitAnnual salary of manager who can be replaced: $50,000Vendor’s offering price: $0.13 per unit

b. Production costs saved ($0.9 x 4,000,000) $ 360,000Salary savings 50,000Purchase cost of part ($0.13 x 4,000,000) (520,000)Disadvantage of outsourcing the part $(110,000)

c. Other considerations include the relative quality of the part acquired from the vendor and the part produced internally, the ability of the vendor to deliver in a timely manner, the existence of competitors of the vendor, the likelihood that future volume levels will differ from present volume levels.

34. a. Cost to make:Direct materials $139.00Direct labor ($66 x .75) 49.50Variable overhead ($43 x .75) 32.25Fixed overhead:

Rental value of production space ($114,000 ÷ 50,000) 2.28 Depreciation on new machine ($5,000,000 ÷ 5) ÷ 50,000 20.00Total unit cost $243.03Cost to buy: $240.00

b. If 60,000 subassemblies were required annually, the "cost to make" would change because of the lower fixed costs on a per-unit basis. The depreciation would be ($5,000,000 ÷ 5) ÷ 60,000 = $16.67, and the rental value opportunity cost would decline to: $114,000 ÷ 60,000 = $1.90. This would change the overall cost to make to $139.00 + $49.50 + $32.25 + $16.67 + $1.90 = $239.32. At this volume level, the advantage is slightly in favor of making.

c. If 75,000 subassemblies were required annually, the "cost to make" would again change due to the lower fixed costs on a per-unit basis. The depreciation would be ($5,000,000 ÷ 5) ÷ 75,000 = $13.33, and the rental value opportunity cost would decline to $114,000 ÷ 75,000 = $1.52. This would change the overall cost to make to $139.00 + $49.50 + $32.25 + $13.33 + $1.52 = $235.60. At this volume level, the advantage is significantly in favor of making.

d. Qualitative considerations:

Quality control systems in place by potential supplier Reliability of the supplier Risk of future price increases by supplier Lead time to receive orders Number of competing suppliers

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Labor relations in supplier's plants

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35. a. Maximize the contribution per unit of the scarce resource (direct labor hours):

Racing Touring BasicSales per unit $1,800 $1,360 $480VC per unit (1,440) (1,140) (372) CM per unit $ 360 $ 220 $108Hours per bike ÷24 ÷22 ÷ 6 CM per hour $15 $10.00 $18.00

Since Basic cycles yield the greatest contribution margin per direct labor hour, the company should devote all of its capacity to their production in the absence of market or other restrictions. Profit can be determined as follows:Production of Basic cycles = 34,000 ÷ 6 = 5,667 (rounded)

Contribution margin 5,667 x $108 $612,036Fixed costs (450,000)Pretax income $162,036

b. In part (a), it was determined that Basic cycles are the most profitable product, so the company will devote 50 percent of its time to that product. Touring cycles yield the lowest contribution margin per hour, so 20 percent of the time should be devoted to them. This would leave 30 percent of the time to manufacture Racing cycles.

Production levels: Basic (34,000 x .50) ÷ 6 2,833 (rounded) Racing (34,000 x .30) ÷ 24 425 Touring (34,000 x .20) ÷ 22 309 (rounded)

Contribution margin: Basic (2,833 x $108) $305,964 Racing (425 x $360) 153,000 Touring (309 x $220) 67,980Total $526,944Less Fixed costs (450,000)Pretax income $ 76,944

c. Yes. The demand in this market is likely fragmented, with particular consumers preferring a cycle suited for a particular purpose. However, there is likely enough demand for the Basic cycle to absorb the entire production capacity of the company.

d. The company’s tax rate is irrelevant because it does not change across the choices under consideration in this decision.

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36. a. Plan 1:New commission on belts = 0.11($40 - $22) = $1.98

New commission on key fobs = 0.11($10 - $5) = $0.55

New CM on belts: ($40 - $1.98 - $22 - $4) 95,000 = $1,141,900

New CM on key fobs: ($10 - $0.55 - $5 - $0.50)115,000 = $454,250

Income from belts: ($1,141,900 - $580,000) $561,900Income from key fobs: ($454,250 - $180,000) 274,250Total Plan 1 income: $836,150

Plan 2:New FC for belts: $580,000 + $25,000 = $605,000

New sales for belts: 119,000 units CM: ($12 x 119,000) = $1,428,000

New sales for key fobs: 91,000 unitsCM: (91,000 x $4) = $364,000

Income from belts: ($1,428,000 - $605,000) $ 823,000Income from key fobs: ($364,000 - $180,000) 184,000Total Plan 2 income: $1,007,000

Plan 3New sales for belts: 94,000 unitsCM: ($17 x 94,000) = $1,598,000

New sales for key fobs: 90,000 unitsCM: $7 x 90,000 = $630,000

Income from belts: ($1,598,000 - $580,000) $ 1,018,000Income from key fobs: ($630,000 - $180,000) 450,000Total Plan 3 income: $1,468,000

b. Plan 3 should be adopted because it maximizes total income relative to the existing price and cost structure and Plans 1 and 2.

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37. a. Ice Cream Steaks TotalSales $8,000,000 $3,600,000 $11,600,000Variable costs

Merchandise sold (4,800,000) (2,600,000) (7,400,000) Commissions (800,000) (300,000) (1,100,000) Delivery costs (1,200,000) (210,000) (1,410,000)CM $1,200,000 $ 490,000 $ 1,690,000Avoidable fixed costsAllocated corporate (30,000) (30,000)Manager's salary (160,000) (150,000) (310,000)Segment margin $1,040,000 $ 310,000 $ 1,350,000Unavoidable direct fixed costs Delivery costs (30,000) (30,000) Depreciation (400,000) (200,000) (600,000)Product line results $ 640,000 $ 80,000 $ 720,000Common costs (200,000) (170,000) (370,000)Net income (loss) $ 440,000 $ (90,000) $ 350,000

b. Based on segment margin, the Steaks Division generates $310,000 of income above its avoidable expenses. Additional computations are necessary to determine whether the steaks product line should be kept:

Steaks segment margin $310,000Opportunity cost, rent (17,000)Net advantage to keeping steaks line $293,000

c. To the extent the two product lines cross-fertilize each other’s sales, the company should be concerned. Some customers who prefer to purchase both ice cream and steaks from the same vendor may seek another vendor that has a broader product offering.

d. Layoffs could adversely affect morale and trust between employees and managers. If cordial relations existed between managers and workers prior to the layoffs, the culture could be destroyed by the layoffs. The consequence might be a loss of key employees, a drop in profits, and a decline in customer service.

38. Note that in the following solutions, the fact that the total allocated fixed

costs will decline from $1,000,000 to $500,000 can be ignored because this change is not differential across the three alternatives.

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a. Georgia factory expansion: Sales $4,200,000Fixed costs:

Factory $ 672,000 Administration 242,000 $ 914,000

Variable costs $1,344,000Alloc. home office costs 350,000 1,694,000 (2,608,000)

Est. net profit from operations $1,592,000Tennessee factory – estimated: Net profit from operations 1,080,000

Home office expense allocated to Florida factory (200,000)Estimated net profit from operations $2,472,000

b. Estimated net profit from operations:Tennessee factory $1,080,000Georgia factory 820,000Estimated royalties to be received (30,000 X $8) 240,000

$2,140,000Less home office expense allocated to Florida factory (200,000)Estimated profit from operations $1,940,000

c. Estimated net profit from operations:Tennessee factory $1,080,000Georgia factory 820,000

$1,900,000Less home office expense allocated to Florida factory (200,000)Estimated profit from operations $1,700,000

(AICPA adapted)

39. a. Sales $1,100,000Variable costs (825,000)Contribution margin $ 275,000

Units sold: ($1,100,000 ÷ $10) x 100 = 11,000,000 unitsContribution margin per unit: $275,000 ÷ 11,000,000 = $.025Required unit sales: ($350,000 + $50,000) ÷ $.025 = 16,000,000 units

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b. Plan A (000 omitted) Ohio New Jersey TotalSales $1,700 $2,000 $3,700Variable costs: Direct material $ 425 $ 500 $ 925 Direct labor 510 500 1,010 Factory overhead 340 350 690

Total $1,275 $1,350 $2,625Contribution margin $ 425 $ 650 $1,075 Direct fixed costs: Overhead $ 350 $ 450 $ 800 Promotion costs 50 50 100

Total $ 400 $ 500 $ 900Segment margin $ 25 $ 150 $ 175Allocated fixed costs 71 84 155Operating income (loss) $ (46) $ 66 $ 20

Plan B Sales $3,100,000Variable costs: Direct material $775,000 Direct labor 775,000 Variable overhead 542,500 (2,092,500)Contribution margin $1,007,500Fixed costs: Factory overhead $450,000 Promotion costs 100,000 Allocated costs 155,000 (705,000)Operating income $ 302,500

Plan CSales $2,000,000Royalties 137,500 Variable costs: Direct material $500,000 Direct labor 500,000 Variable overhead 350,000 (1,350,000)Contribution margin $ 787,500Fixed costs: Factory overhead $450,000 Promotion costs 100,000 Allocated costs 155,000 (705,000)Operating income $ 82,500

40. a. For May, it would appear that store 2 is more profitable. Although store 2 had lower sales than store 1, it is clear that store 1 incurred more expense. For example, store 1 spent two-thirds of the entire district advertising

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budget; this was 10 times more than store 2 spent. Store 1 also incurred more expense for rent and would have been allocated more district level costs because of its higher sales.

b. Store 1 is generating the most revenue. This is given in the first bulleted statement.

c. The incentive for Store 1 is to generate as much revenue as possible. The bonus scheme for that store does not take into account any expenses. Consequently, the manager of the store can benefit from the advertising without bearing any advertising costs.

d. Store 1 would have more incentive. Since store 2 is evaluated on net income, any expenditure for maintenance will reduce the net income that might otherwise have been recorded. Store 1 would want to spend an adequate amount for maintenance so that no machine malfunction or downtime occurs that might interfere with sales.

e. Both bonus schemes have some problems. The bonus scheme based on sales volume is not likely to increase profits in either the short or long term because no incentive is given to the manager to be conscious of the costs that are incurred to generate revenues. The bonus based on net income is more promising. The only detrimental aspect of this performance measure is that it is short-term oriented. It encourages managers to take actions that may generate short-term profits at the expense of long-term profits. For example, a manager may forgo maintenance activities to reduce costs in the short term. However, the long-term implications of this act may be higher costs resulting from broken machinery.

41. a. Clean-N-Brite should price the regular compound at $22 per case and the heavy-duty compound at $30 per case. The contribution margin is the highest at these prices as shown below.

Regular CompoundSelling price per case $ 18 $ 20 $ 21 $ 22 $ 23Variable cost per case 16 16 16 16 16Contribution margin/case $ 2 $ 4 $ 5 $ 6 $ 7Volume in cases

(000 omitted) 120 100 90 80 50Total contribution margin (000 omitted) $240 $400 $450 $480 $350

Heavy-Duty CompoundSelling price per case $ 25 $ 27 $ 30 $ 32 $ 35Variable cost per case 21 21 21 21 21Contribution margin/case $ 4 $ 6 $ 9 $ 11 $ 14Volume in cases (000 omitted) 175 140 100 55 35

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Total contribution margin (000 omitted) $700 $840 $900 $605 $490b. 1. Clean-N-Brite should continue to operate during the final six months

of 2006 because any shutdown would be temporary. The company clearly intends to remain in the business and expects a profitable operation in 2007. This is a short-run decision analysis problem. Therefore, the fixed costs are irrelevant to the decision because they cannot be avoided in the short run. The products do have a positive variable contribution margin so operations should continue.

Clean-N-Brite

Cincinnati PlantPro Forma Contribution Statement

for the Final Six Months of 2006($000 omitted)

Heavy Regular Duty Total

Sales $1,150 $1,225 $2,375Variable costsSelling & admin. $ 200 $ 245 $ 445Manufacturing 600 490 $1,090Total variable costs $ 800 $ 735 $1,535Contribution margin $ 350 $ 490 $ 840

2. Clean-N-Brite should consider the following qualitative factors when making the decision to keep the Cincinnati Plant open or to close it:

The effect on employee morale. The effect on market share. The disruption of production and sales due to shut-down. The effect on the local community.

(CMA adapted)

42. a. The manufacturing overhead rate is $18 per standard direct labor hour and the standard product cost includes $9 of manufacturing overhead per pressure valve. Accordingly, the standard direct labor hour per finished valve is .5 hour ($9 ÷ $18). Therefore, 30,000 units per month would require 15,000 direct labor hours.

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b. Totals for Per unit 120,000 Units Incremental revenue $19.00 $2,280,000 Incremental costs: Variable cost:

Direct material $ 5.00 $ 600,000Direct labor 6.00 720,000Variable overhead 3.00 360,000

Total variable costs $14.00 $1,680,000 Fixed overhead:

Supervisory and clerical costs(4 months × $12,000) 48,000

Total incremental costs $1,728,000 Incremental profit before tax $ 552,000

Shipping, sales commission, and fixed factory overhead (direct and allocated) are irrelevant to the incremental analysis.

c. The minimum unit price that Hydraulic Engineering could accept without reducing net income must cover variable costs plus the additional fixed costs.

Variable unit cost $14.00Additional fixed cost ($48,000 ÷ 120,000) .40Minimum unit price $14.40

d. Hydraulic Engineering should consider the following factors before accepting the Prince Industries order.

The effect of the special order on Hydraulic Engineering's sales at regular prices.

The possibility of future sales to Prince Industries and the effects of participating in the international market.

The company's relevant range of activity and whether or not the special order will cause volume to exceed this range.

The impact on local, state, and federal taxes. The effect scheduled maintenance of equipment.

(CMA adapted)

43. a. Ethical issues to consider: whether the competitor is exploiting the workers; whether the competitor is displacing the domestic workforce; whether the competitor is violating the rights of other companies to fair competition; the effects of the various stakeholders including the customers (competitor’s and Karlson’s) of using the illegal workers and on not using the illegal workers. In addition, there exists the legal issue that hiring illegal aliens is unlawful. Karlson’s Computers is considering knowingly and willfully becoming an accomplice by purchasing from this supplier.

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b. The short-run advantages are buying at a lower price to be more profitable, being able to sell at a lower price and therefore sell more computers, having a competitive advantage, and pleasing the customers who will appreciate the lower prices. The potential disadvantages are longer run: damage to the business community and to the socioeconomic balance; damage to the company’s reputation; possible fines and/or imprisonment if co-conspiracy could be proven; ill effects on workers who are exploited; and disadvantages to domestic workers who are unable to obtain jobs.

c. Ms. Karlson should investigate further the hiring practices of the supplier or allow the proper authorities to do so. If she is satisfied that the supplier is following legal practices, Ms. Karlson should perform the necessary cost analysis for a make-or-buy decision. If the supplier is found to be hiring illegal aliens, Ms. Karlson should continue to make her own keyboards.