Exercises for Decision Making (Part I)

Exercise (1):
Olson Company has three departments. Data for the most recent year is presented
below:

Dept. C Dept. A Dept. T

Sales $4,000 $1,920 $2,240
Variable expenses 3,280 1,420 520
Unavoidable fixed expenses 480 180 440
Avoidable fixed expenses 555 265 360
Operating income(loss) $(315) $55 $920

Olson Company is considering eliminating Dept. C because it is operating at a loss.

Required:
A) Compute the change in operating income if Olson Company eliminates Dept. C
and does not replace it.
B) Compute the change in operating income if Olson Company eliminates Dept. C
and doubles the sales of Dept. T without increasing fixed costs.

Exercise (2):
Aloa Company has three product lines: A, B and C. The following annual
information is available:
Product A Product B Product C
Sales $100,000 $90,000 $44,000
Variable costs 76,000 48,000 35,000
Contribution margin 24,000 42,000 9,000
Avoidable fixed costs 9,000 18,000 3,000
Unavoidable fixed costs 6,000 9,000 7,700
Operating income(loss) $9,000 $15,000 $(1,700)

Assume Aloa Company drops Product C. Aloa Company then doubles the
production and sales of Product B without increasing fixed costs. What will happen
to operating income?
A) increase $15,000
B) increase $24,000
C) increase $36,000
D) increase $42,000
Exercise (3):
Garcia Company produces a part that is used in the manufacture of one of its
products. The annual costs associated with the production of 5,000 units of this part
are as follows:

Direct materials $108,000

Direct labor 156,000
Variable factory overhead 72,000
Fixed factory overhead 168,000
Total costs $504,000

Of the fixed factory overhead costs, $72,000 are avoidable. Another company has
offered to sell 5,000 units of the same part to Garcia for $105.60 per unit. The
facilities currently used to make the part can be rented out to another manufacturer
for $72,000 per year. What should Garcia Company do?
A) Make the part to save $48,000.
B) Make the part to save $96,000.
C) Buy the part to save $24,000.
D) Buy the part to save $72,000.

Exercise (4):
Dally Company produces a part that is used in the manufacture of one of its products.
The costs associated with the production of 5,000 units of this part are as follows:
Direct materials $108,000
Direct labor 156,000
Variable factory overhead 72,000
Fixed factory overhead 168,000
Total costs $504,000

Of the fixed factory overhead costs, $72,000 are avoidable. Assuming there is no
other use for the facilities. What is the highest price Dally Company should be
willing to pay for 5,000 units of the part?
A) $288,000
B) $336,000
C) $408,000
D) $504,000
Exercise (5):
Match Company produces a part that is used in the manufacture of one of its
products. The costs associated with the production of 5,000 units of this part are as
follows:
Direct materials $108,000
Direct labor 156,000
Variable factory overhead 72,000
Fixed factory overhead 168,000
Total costs $504,000

Of the fixed factory overhead costs, $72,000 are avoidable. Today Company has
offered to sell 5,000 units of the same part to Match for $86.40 per unit. Assuming
there is no other use for the facilities, Match Company should ________.
A) make the part to save $24,000
B) make the part to save $72,000
C) buy the part to save $24,000
D) buy the part to save $72,000

Exercise (6):
Hitch Company currently produces 10,000 units of a key part at a total cost of
$512,000 annually. Annual variable costs are $300,000. Of the annual fixed costs,
$140,000 relate specifically to this part. The remaining fixed costs are unavoidable.
Another manufacturer has offered to supply the part for $48 per unit. The facilities
currently used to manufacture the part could be used to manufacture a new product
with an expected contribution margin of $55,000 annually. Alternatively, the
facilities could be rented out at $68,000 annually. If Hitch Company makes the part,
what is the annual opportunity cost of the facilities?
A) $13,000
B) $28,000
C) $55,000
D) $68,000
Exercise (7):
Deuce Company currently produces 10,000 units of a key part at a total cost of
$512,000 annually. Variable costs are $300,000 annually. Of the annual fixed costs,
$140,000 relate specifically to this part. The remaining fixed costs are unavoidable.

Another manufacturer has offered to supply the part for $48 per unit. The facilities
currently used to manufacture the part could be used to manufacture a new product
with an expected contribution margin of $30,000 per year. Alternatively, the
facilities could be rented out at $60,000 per year. Given all of these alternatives,
what is Deuce Company's lowest net relevant cost per unit for the part?
A) $30
B) $42
C) $44
D) $48

Exercise (8):
Copter Company currently produces a key part at a total cost of $210,000. Annual
variable costs are $170,000. Of the annual fixed costs, $10,000 relate specifically
to this part. The remaining fixed costs are unavoidable.

Another manufacturer has offered to supply the part annually for $190,000. The
facilities currently used to manufacture the part could be used to manufacture a new
product with an expected contribution margin of $30,000 per year. Alternatively,
the facilities could be rented out at $60,000 per year. Given all of these alternatives,
what is Copter Company's lowest net relevant cost for the part?
A) $130,000
B) $170,000
C) $180,000
D) $190,000

Exercise (9):
Goldwater Company manufactures a part for its production cycle. The annual costs
per unit for 10,000 units of the part are as follows:

Direct materials $20.00

Direct labor 15.00
Variable factory overhead 16.00
Fixed factory overhead 10.00
Total costs $61.00
The fixed factory overhead costs are unavoidable. Olson Company has offered to
sell 10,000 units of the same part to Goldwater Company for $60 per unit. The
facilities currently used to make the part could be used to make 10,000 units per year
of a new product that has a contribution margin of $20 per unit. No additional fixed
costs would be incurred with the new product. Goldwater Company should
________.
A) make the part to save $10,000
B) make the part to save $90,000
C) make the new product and buy the part to save $90,000
D) make the new product and buy the part to save $110,000

Exercise (10):
Konrade’s Engine Company manufactures part TE456 used in several of its engine
models. Monthly production costs for 1,000 units are as follows:

Direct materials $ 40,000

Direct labor 10,000
Variable overhead costs 30,000
Fixed overhead costs 20,000
Total costs $100,000

It is estimated that 10% of the fixed overhead costs assigned to TE456 will no longer
be incurred if the company purchases TE456 from the outside supplier. Konrade’s
Engine Company has the option of purchasing the part from an outside supplier at
$85 per unit.

1. If Konrade’s Engine Company accepts the offer from the outside supplier, the
monthly avoidable costs (costs will no longer be incurred) total
a. $ 82,000.
b. $ 98,000.
c. $ 50,000.
d. $100,000.

2. If Konrade’s Engine Company purchases 1,000 TE456 parts from the outside
supplier per month, then its monthly operating income will
a. increase by $2,000.
b. increase by $80,000.
c. decrease by $3,000.
d. decrease by $85,000.
3. The maximum price that Konrade’s Engine Company should be willing to pay
the outside supplier is
a. $80 per TE456 part.
b. $82 per TE456 part.
c. $98 per TE456 part.
d. $100 per TE456 part.

Exercise (11):
Schmidt Corporation produces a part that is used in the manufacture of one of its
products. The costs associated with the production of 10,000 units of this part are
as follows:

Direct materials $ 45,000

Direct labor 65,000
Variable factory overhead 30,000
Fixed factory overhead 70,000
Total costs $210,000
Of the fixed factory overhead costs, $30,000 is avoidable.

1. Phil Company has offered to sell 10,000 units of the same part to Schmidt
Corporation for $18 per unit. Assuming there is no other use for the facilities,
Schmidt should
a. make the part as this would save $3 per unit.
b. buy the part as this would save $3 per unit.
c. buy the part as this would save the company $30,000.
d. make the part as this would save $1 per unit.

2. Assuming no other use of their facilities, the highest price that Schmidt should
be willing to pay for 10,000 units of the part is
a. $210,000.
b. $140,000.
c. $170,000.
d. $180,000.

3. Relevant costs in a make-or-buy decision of a part include

a. setup overhead for the manufacture of the product using the outsourced
part.
b. currently used manufacturing capacity that has alternative uses.
c. annual plant insurance costs that will remain the same.
d. corporate office costs that will be allocated differently.
4. If Horsley Corporation doesn't use one of its limited resources in the best
possible way, the lost contribution to income could be called
a. a variable cost.
b. a fixed cost.
c. an opportunity cost.
d. a sunk cost.

Exercise (12):
Stephans Corporation currently manufactures a subassembly for its main product.
The costs per unit are as follows:
Direct materials $ 1.00
Direct labor 10.00
Variable overhead 5.00
Fixed overhead 8.00
Total $24.00

Bill Company has contacted Stephans with an offer to sell them 5,000 of the
subassemblies for $22.00 each. Stephans will eliminate $25,000 of fixed
overhead if it accepts the proposal.
1. What are the relevant costs for Stephans?
a. $140,000
b. $125,000
c. $105,000
d. $80,000
2. Should Stephans make or buy the subassemblies? What is the difference
between the two alternatives?
a. Buy; savings = $20,000
b. Buy; savings = $50,000
c. Make; savings = $60,000
d. Make; savings = $5,000
3. A recent college graduate has the choice of buying a new auto for $20,000 or
investing the money for four years with a 6% expected rate of return. If the
graduate decides to purchase the auto, the BEST estimate of the opportunity
cost of that decision is
a. $1,200.
b. $4,800.
c. $20,000.
d. zero since there is no opportunity cost for this decision.
4. A supplier offers to make Part A for $70. Jansen Company has relevant costs
of $80 a unit to manufacture Part A. If there is excess capacity, the opportunity
cost of buying Part A from the supplier
a. is zero.
b. is $10,000.
c. is $70,000.
d. cannot be determined using the above information.

Exercise (13):
Braun’s Brakes manufactures three different product lines, Model X, Model Y, and
Model Z. Considerable market demand exists for all models. The following per unit
data apply:

Model X Model Y Model Z

Selling price $50 $60 $70
Direct materials 6 6 6
Direct labor ($12 per hour) 12 12 24
Variable support costs ($4 per machine-hour)4 8 8
Fixed support costs 10 10 10

1. Which model has the greatest contribution margin per unit?

a. Model X
b. Model Y
c. Model Z
d. Both Models X and Y

2. Which model, has the greatest contribution margin per machine-hour?

a. Model X
b. Model Y
c. Model Z
d. Both Models Y and Z

3. If there is excess capacity, which model is the most profitable to produce?

a. Model X
b. Model Y
c. Model Z
d. Both Models X and Y
4. If there is a machine breakdown, which model is the most profitable to
produce?
a. Model X
b. Model Y
c. Model Z
d. Both Models Y and Z

5. How can Lisa Braun encourage her salespeople to promote the more
profitable model?
a. Put all sales persons on salary
b. Provide higher sales commissions for higher priced items
c. Provide higher sales commissions for items with the greatest contribution
margin per constrained resource
d. Both (b) and (c)

Exercise (14):
Helmer’s Rockers manufactures two models, Standard and Premium. Weekly
demand is estimated to be 100 units of the Standard Model and 70 units of the
Premium Model. The following per unit data apply:

Standard Premium
Contribution margin per unit $18 $20
Number of machine-hours required 3 4

1. The contribution per machine-hour is

a. $18 for Standard, $20 for Premium.
b. $54 for Standard, $80 for Premium.
c. $15 for Standard, $16 for Premium.
d. $6 for Standard, $5 for Premium.

2. If there are 496 machine-hours available per week, how many rockers of each
model should Jim Helmer produce to maximize profits?
a. 100 units of Standard and 49 units of Premium
b. 72 units of Standard and 70 units of Premium
c. 100 units of Standard and 70 units of Premium
d. 85 units of Standard and 60 units of Premium
3. If there are 600 machine-hours available per week, how many rockers of each
model should Jim Helmer produce to maximize profits?
a. 100 units of Standard and 49 units of Premium
b. 72 units of Standard and 70 units of Premium
c. 100 units of Standard and 70 units of Premium
d. 85 units of Standard and 60 units of Premium

Exercise (15):
The management accountant for Martha’s Book Store has prepared the following
income statement for the most current year.
Cookbook Travel Book Classics Total
Sales $60,000 $100,000 $40,000 $200,000
Cost of goods sold 36,000 65,000 20,000 121,000
Contribution margin 24,000 35,000 20,000 79,000
Order and delivery processing18,000 21,000 8,000 47,000
Rent (per sq. foot used) 2,000 1,000 3,000 6,000
Allocated corporate costs 7,000 7,000 7,000 21,000
Corporate profit $ (3,000) $ 6,000 $ 2,000 $ 5,000

1. If the cookbook product line had been discontinued prior to this year, the
company would have reported
a. greater corporate profits.
b. the same amount of corporate profits.
c. less corporate profits.
d. resulting profits cannot be determined.

2. If the travel book line had been discontinued, corporate profits for the current
year would have decreased by
a. $35,000.
b. $14,000.
c. $13,000.
d. $6,000.
Exercise (16):
Denly Company has three products, A, B, and C. The following information is
available:

Product A Product B Product C

Sales $60,000 $90,000
$24,000
Variable costs 36,000 48,000 15,000
Contribution margin 24,000 42,000 9,000
Fixed costs:
Avoidable 9,000 18,000 6,000
Unavoidable 6,000 9,000 5,400
Operating income $ 9,000 $15,000 $ (2,400)

1. Denly Company is thinking of dropping Product C because it is reporting a

loss. Assuming Denly drops Product C and does not replace it, operating
income will
a. increase by $2,400.
b. increase by $3,000.
c. decrease by $3,000.
d. decrease by $5,400.

2. Assuming Product C is discontinued and the space formerly used to produce

Product C is rented for $12,000 per year, operating income will
a. increase by $6,600.
b. increase by $9,000.
c. increase by $12,000.
d. increase by $14,400.
Exercise (17):
Mr. Earl Pearl, accountant for Margie Knall Co., Inc., has prepared the
following product-line income data:

The following additional information is available:

* The factory rent of $1,500 assigned to Product C is avoidable if the product were
dropped.
* The company's total depreciation would not be affected by dropping C.
* Eliminating Product C will reduce the monthly utility bill from $1,500 to $800.
* All supervisors' salaries are avoidable.
* If Product C is discontinued, the maintenance department will be able to reduce
monthly expenses from $3,000 to $2,000.
* Elimination of Product C will make it possible to cut two persons from the
administrative staff; their combined salaries total $3,000.
Required:

Prepare an analysis showing whether Product C should be eliminated.

Exercise (18):
Kramer Company makes 4,000 units per year of a part called an axial tap for
use in one of its products. Data concerning the unit production costs of the axial
tap follow:

An outside supplier has offered to sell Kramer Company all of the axial taps it
requires. If Kramer Company decided to discontinue making the axial taps, 40%
of the above fixed manufacturing overhead costs could be avoided. Assume that
direct labor is a variable cost.

Required:

a. Assume Kramer Company has no alternative use for the facilities presently
devoted to production of the axial taps. If the outside supplier offers to sell the
axial taps for $65 each, should Kramer Company accept the offer? Fully support
your answer with appropriate calculations.

b. Assume that Kramer Company could use the facilities presently devoted to
production of the axial taps to expand production of another product that would
yield an additional contribution margin of $80,000 annually. What is the
maximum price Kramer Company should be willing to pay the outside supplier
for axial taps?

***************
Mohamed Farouk, Ph.D.