CHAPTER08_DECISION MAKING [ 7 EXERCISES]

8-1 [EXERCISE 14-1 Identifying Relevant Costs]

A number of costs are listed below that may be relevant in decisions faced by the management of
Svahn, AB, a Swedish manufacturer of sailing yachts:

Item Case 1 Case 2

Relevant Not Relevant Relevant Not Relevant
a.Sales revenue
b.Direct materials
c.Direct labor
d.Variable manufacturing overhead
e.Depreciation–Model B100 machine
f.Book value–Model B100 machine
g.Disposal value–Model B100 machine
h.Market value–Model B300 machine(cost)
i.Fixed manufacturing overhead(general)
j.Variable selling expense
k.Fixed selling expense.
l.General administrative overhead

Required:

Copy the information above onto your answer sheet and place an X in the appropriate column to
indicate whether each item is relevant or not relevant in the following situations. Requirement 1
relates to Cash 1 above, and requirement 2 relates to Case 2.

1. The company chronically has no idle capacity and the old Model B100 machine is the
company’s constraint. Management is considering purchasing a Model B300 machine to use
in addition to the company’s present Model B100 machine. The old Model B100 machine
will continue to be used to capacity as before, with the new Model B300 machine being used
to expand production. This will increase the company’s production and sales. The increase in
column will be large enough to require increases in fixed selling expenses and in general
administrative overhead, but not in the fixed manufacturing overhead.
2. The old Model B100 machine is not the company’s constraint, but management is
considering replacing it with a new Model B300 machine because of the potential savings in
direct materials with the new machine. The Model B100 machine would be sold. This change
will have no effect on production or sales, other than some savings in direct materials costs
due to less waste.

8-2 [EXERCISE 14-2 Dropping or Retaining a Segment]

The Regal Cycle Company manufactures three types of bicycles – a dirt bike, a mountain bike, and a
racing bike. Data on sales and expenses for the past quarter follow:

Total Dirt Bikes Mountain Bikes Racing Bikes

Sales $300,000 $90,000 $150,000 $60,000
Variable manufacturing and 120,000 27,000 60,000 33,000
selling expenses
Contribution margin 180,000 63,000 90,000 27,000
Fixed expenses
Advertising, traceable 30,000 10,000 14,000 6,000
Depreciation of special equipment 23,000 6,000 9,000 8,000
Salaries of product-line managers 35,000 12,000 13,000 10,000
Allocated common fixed expenses 60,000 18,000 30,000 12,000
Total fixed expenses 148,000 46,000 66,000 36,000
Net operating income (loss) 32,000 17,000 24,000 $(9,000)

* Allocate on the basis of sales dollars.

Management is concerned about the continued losses shown by the racing bikes and wants a
recommendation as to whether or not the line should be discontinued. The special equipment used
to produce racing bikes has no resale value and does not wear out.

Required:

1. Should production and sale of the racing bikes be discontinued? Explain. Show computations
to support your answer.
2. Recast the above date in a format that would be more usable to management in assessing
the long-run profitability of the various product lines.

ANSWER: 1: No

8-3 [EXERCISE 14-3 Make or Buy a Component ]

Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment. The company has
always produced all of the necessary parts for its engines, including all of the carburetors. An outside
supplier has offered to sell one type of carburetor to Troy Engines, Ltd., for a cost of $35 per unit. To
evaluate this offer, Troy Engines, Ltd., has gathered the following information relating to its own cost
of producing the carburetor internally:

Per Unit 15,000 Units per Year

Direct materials $14 $210,000
Direct labor 10 150,000
Variable manufacturing overhead 3 45,000
Fixed manufacturing overhead, traceable 6* 90,000
Fixed manufacturing overhead, allocated 9 135,000
Total cost $42 $630,000

* One-third supervisory salaries; two-third depreciation of special equipment (no resale value).
Required:
 1. Assuming that the company has no alternative use for the facilities that are now being used
to produce the carburetors, should the outside supplier’s offer be accepted? Show all
computations.

Differential approach

Relevant costs and Reject the offer/make Accept the offer/buy Differential costs and
benefits (1) (2) benefits
(2)-(1)

Direct materials ($210,000) O 210.000$

Direct labor (150,000) 0 150.000
Variable manufacturing (45.000) 0 45.000
overhead
Fixed manufacturing (90.000) (2/3*90.000) 30.000
overhead, traceable
Purchased costs 0 (35$*15.000u) (525.000)
Net (90.000)

From the results, the company should make the components.

2. Suppose that if the carburetors were purchased, Troy Engines, Ltd., could use the freed
capacity to launch a new product. The segment margin of the new product would be
$150,000 per year. Should Troy Engines, Ltd., accept the offer to buy the carburetors for $35
per unit? Show all computations.

Relevant costs and Reject the offer/make Accept the offer/buy Differential costs and
benefits (1) (2) benefits
(2)-(1)

Direct materials ($210,000) O 210.000$

Direct labor (150,000) 0 150.000
Variable manufacturing (45.000) 0 45.000
overhead
Fixed manufacturing (90.000) (2/3*90.000) 30.000
overhead, traceable
Purchased costs 0 (35$*15.000u) (525.000)
The segment margin 0 150.000$ 150.000
Net 60.000

From the result, The company should accept the offer because the profit will increase by 60.000$

ANSWER: 1. Reject; 2. Accept the offer.

8-4 [EXERCISE 14-4 Evaluating a Special Order]

Imperial Jewelers is considering a special order for 20 handcrafted gold bracelets to be given as gifts
to members of a wedding party. The normal selling price of a gold bracelet is $189.95 and its unit
product cost is $149.00 as shown below:
 Direct materials $ 84.00
Direct labor 45.00
Manufacturing overhead 20.00
Unit product cost $149.00

Most of the manufacturing overhead is fixed and unaffected by variations in how much jewelry is
produced in any given period. However, $4.00 of the overhead is variable with respect to the
number of bracelets produced. The customer who is interested in the special bracelet order would
like special filigree applied to the bracelets. This filigree would require additional materials costing
$2.00 per bracelet and would also require acquisition of a special tool costing $250 that would have
no other use once the special order is completed. This order would have no effect on the company’s
regular sales and the order could be fulfilled using the company’s existing capacity without affecting
any other order.[ no opportunity cost]

Required:

What effect would accepting this order have on the company’s net operating income if a special
price of $169.95 per bracelet is offered for this order? Should the special order be accepted at this
price?

If the company accepts the order:

Sales of the oder : 20 units* 169.95$/u

=3.399$

Costs incurred to make the order :

- Direct materials: (84$ + 2$)*20 units = 1.720

- Labor costs: 45$*20 units =900
- Variable manufacturing overhead: 4$*20 units = 80
- Tool cost 250$
Total costs =2.950
Profit of the order

Special order – incremental costs/

449$

Reject Accept the order Differential costs and

benefit
Sales 0 3.399 3.399
Direct materials: 0 (1.720) (1720)
Labor costs 0 (900) (900)
Variable 0 (80) (80)
manufacturing
overhead
Tool cost 0 (250) (250)
Net 449$
ANSWER: $  449.00, accepted.

8-5 [EXERCISE 14-5 Utilization of a Constrained Resource]

Barlow Company manufactures three products: A, B and C. The selling price, variable costs, and
contribution margin for one unit of each product follow:

Option 1/;

Product
A B C
Selling price $180 $270 $240
Variable expenses:
Direct materials 24 72 32
Other variable expenses 102 90 148
Total variable expenses 126 162 180
Contribution margin 54 108 60
Contribution margin ratio 30% 40% 25%
Materials needed per unit 3 pound 9 pound 4 pound
demand 2.000 unit 1000 unti 1000 unit

The same raw material is used in all three products. Barlow Company has only 5,000 pounds of raw
material on hand and will not be able to obtain any more of it for several weeks due to a strike in its
supplier’s plant. Management is trying to decide which product(s) to concentrate on next week in
filling its backlog of orders. The material cost $8 per pound.

Required:

1. Compute the amount of contribution margin that will be obtained per pound of material
used in each product.= contribution margin per pound of material

Product
A B C
Selling price $180 $270 $240
Variable expenses:
Direct materials 24 72 32
Other variable expenses 102 90 148
Total variable expenses 126 162 180
Contribution margin per unit 54 108 60
Materials needed per unit 3 pound 9 pound 4 pound
Contribution margin per pound of 18$/pound 12$/pound 15$/pound
material

2. Which orders would you recommend that the company work on next week – the orders for
product A, product B, or product C? Show computations.
 Product
A B C
Selling price $180 $270 $240
Variable expenses:
Direct materials 24 72 32
Other variable expenses 102 90 148
Total variable expenses 126 162 180
Contribution margin per unit 54 108 60
Materials needed per unit 3 pound 9 pound 4 pound
Contribution margin per pound of 18$/pound 12$/pound 15$/pound
material
Prefer to produce (1_) (3) (2)

Materials used to produce product A: 2.000 units * 3 pound/unit = 6.000 pound

Number of unit of product A equal: 5.000/3 =1.666 units

The company should produce only product A

3. A foreign supplier could furnish Barlow with additional stocks of the material at a substantial
premium over the usual price. If there is unfilled demand for all three products, what is the
highest price that Barlow Company should be willing to pay for an additional pound of
materials? Explain.

Materials purchased to produce product A , B and C

Number of product A needed to be produced: 2.000 – 1666 = 334 units

Number of product c needed to be produced: 1.000

Number of product B needed to be produced: 1.000

If the company purchases materials to produce product A, the highest price is 18$/pound

18$/pound*3pound*334 unit/3p*334 =18$/pound

If the company purchases materials to produce product A and C

(18$* 3*334u+15$*4pound*1.000)/(3*334+4*1.000) =78.036/5.002 = 15.6$/pound

If the company purchases materials to produce product A, C and B

(18$* 3*334u+15$*4pound*1.000 + 12$/pound* 9pound*1.000)/(3*334+4*1.000+9*1.000)

= 186.036/14.002 =13.28$/pound
ANSWER
1. $18; $12; $15
2. Product A
3. 26$

8-6 [EXERCISE 14-6 sell or Process Furthe]r

Dorsey Company manufactures three products from a common input in a joint processing operation.
Joint processing costs up to the split-off point total $350,000 per quarter. The company allocates
these costs to the joint products on the basis of their relative sales value at the split-off point. Unit
selling prices and total output at the split-off point are as follows:

Product Selling Price Quarterly Output

A $16 per pound 15,000 pounds
B $8 per pound 20,000 pounds
C $25 per gallon 4,000 gallons

Each product can be processed further after the spilt-off point. Additional processing requires no
special facilities. The additional processing costs (per quarter) and unit selling prices after further
processing are given below:

Product Additional Processing Costs Selling Price

A $63,000 $20 per pound
B $80,000 $13 per pound
C $36,000 $32 per gallon

Required:

Which product or products should be sold at the split-off point and which product or products
should be processed further? Show computations.

ANSWER: only product B should be processed further

8-7 [EXERCISE 14-9 Dropping or Retaining a Segment]

Thalassines Kataskeves, S.A., of Greece makes marine equipment. The company has been
experiencing losses on its bilge pump product line for several years. The most recent quarterly
contribution format income statement for the bilge pump product line follows:

Thalassines Kataskeves, S.A.

Income Statement – Bilge Pump
For the Quarter Ended March 31
Sales € 850,000
Variable expenses:
Variable manufacturing expenses €330,000
Sales commissions 42,000
 Shipping 18,000
Total variable expenses 390,000
Contribution margin 460,000
Fixed expenses:
270,000
Advertising
80,000
Depreciation of equipment (no resale value) 105,000*
General factory overhead 32,000
Salary of product-line manager 8,000
Insurance on inventories 45,000+
Purchasing department
Total fixed expenses 540,000
Net operating loss . € (80,000)
* Common costs allocated on the basis of machine-hours.
+
Common costs allocated on the basis of sales dollars.

The currency in Greece is the euro, denoted above by €. Discontinuing the bilge pump product line
would not affect sales of other product lines and would have no effect on the company’s total
general factory overhead or total Purchasing Department expenses.

Required:

Would you recommend that the bilge pump product line be discontinued? Support your answer with
appropriate computations.

ANSWER: NO