Chapter 11 - Measuring relevant costs and revenues for decision-making

MULTIPLE CHOICE

1. Tactical decision-making relies

a. only on relevant cost information.
b. on qualitative factors.
c. on relevant costs as well as other qualitative factors.
d. on neither relevant costs or qualitative decisions.
ANS: C PTS: 1

2. An important qualitative factor to consider regarding a special order is the

a. variable costs associated with the special order.
b. avoidable fixed costs associated with the special order.
c. effect the sale of special-order units will have on the sale of regularly priced units.
d. incremental revenue from the special order.
ANS: C PTS: 1

3. Qualitative factors that should be considered when evaluating a make-or-buy decision are
a. the quality of the outside supplier's product.
b. whether the outside supplier can provide the needed quantities.
c. whether the outside supplier can provide the product when it is needed.
d. all of the above.
ANS: D PTS: 1

4. Future costs that differ across alternatives describe

a. relevant costs.
b. target cost.
c. full costs.
d. activity-based costs.
ANS: A PTS: 1

5. Relevant costs are

a. past costs.
b. future costs.
c. full costs.
d. cost drivers.
ANS: B PTS: 1

6. Sunk costs are

a. future costs that have no benefit.
b. relevant costs that have only short-run benefits.
c. target costs.
d. cannot be avoided.
ANS: D PTS: 1

7. Which item is not an example of a sunk cost?

a. materials needed for production
 b. purchase cost of machinery
c. depreciation
d. All are sunk costs.
ANS: A PTS: 1

8. The Titanic hit an iceberg and sank. In deciding whether or not to salvage the ship, its book value is
a(n)
a. relevant cost.
b. sunk cost.
c. opportunity cost.
d. discretionary cost.
ANS: B PTS: 1

9. A purchasing agent has two potential firms from which to buy materials for production. If both firms
charge the same price, the material cost is a(n)
a. irrelevant cost.
b. relevant cost.
c. sunk cost.
d. opportunity cost.
ANS: A PTS: 1

10. Which of the following BEST describes relevant costs?

a. present costs with similar decision alternatives
b. future costs that differ between competing decision alternatives
c. past costs that correspond solely on competing decision alternatives
d. present costs that differ between competing decision alternatives
ANS: B PTS: 1

11. If a cost is identical under each alternative under consideration within a given decision context, the
cost is considered:
a. an alternative cost.
b. a discounted cost.
c. an irrelevant cost.
d. a procedural cost.
ANS: C PTS: 1

12. Which of the following statements is true when making a decision between two alternatives?
a. Variable costs may not be relevant when the decision alternatives have the same activity
levels.
b. Variable costs are not relevant when the decision alternatives have different activity levels.
c. Sunk costs are always relevant.
d. Fixed costs are never relevant.
ANS: A PTS: 1

13. Which of the following costs is NOT relevant to a special-order decision?

a. the direct labour costs to manufacture the special-order units
b. the variable manufacturing overhead incurred to manufacture the special-order units
c. the portion of the cost of leasing the factory that is allocated to the special order
d. All of the above costs are relevant.
 ANS: C PTS: 1

14. Which of the following costs is NOT relevant to a make-or-buy decision?

a. £10,000 of direct labour used to manufacture the parts
b. £30,000 of depreciation on the plant used to manufacture the parts
c. the supervisor's salary of £25,000 that will be avoided if the part is purchased from an
outside supplier
d. £15,000 in rent from leasing the production space to another company if the part is
purchased from an outside supplier
ANS: B PTS: 1

15. ____ are future costs that differ across alternatives.

a. Relevant costs
b. Irrelevant costs
c. Sunk costs
d. Past costs
ANS: A PTS: 1

16. Which of the following costs is NOT relevant for special decisions?
a. incremental costs
b. sunk costs
c. avoidable costs
d. All of the above costs are relevant for special decisions.
ANS: B PTS: 1

17. Which of the following costs is relevant to a make-or-buy decision?

a. original cost of the production equipment
b. annual depreciation of the equipment
c. the amount that would be received if the production equipment were sold
d. the cost of direct materials purchased last month and used to manufacture the component
ANS: C PTS: 1

18. A decision to make a component internally versus through a supplier is a

a. special-order decision.
b. keep-or-drop a product-line decision.
c. make-or-buy decision.
d. Both a and c are correct.
ANS: C PTS: 1

Figure 1

Foster Industries manufactures 20,000 components per year. The manufacturing cost of the
components was determined as follows:

Direct materials £150,000

Direct labour 240,000
Variable manufacturing overhead 90,000
Fixed manufacturing overhead _120,000
Total £600,000
 An outside supplier has offered to sell the component for £25.50.

19. Refer to Figure 1. What is the effect on income if Foster Industries purchases the component from the
outside supplier?
a. £30,000 decrease
b. £30,000 increase
c. £90,000 decrease
d. £90,000 increase
ANS: A
SUPPORTING CALCULATIONS:

Make:
Direct materials £(150,000)
Direct labour (240,000)
Variable overhead __(90,000)
Total £(480,000)

Buy:
Purchase price (20,000  £25.50) £(510,000)

£510,000 - £480,000 = £30,000 decrease in income

PTS: 1

20. Refer to Figure 1. What is the effect on income if Foster purchases the component from the outside
supplier?
a. £45,000 increase
b. £15,000 increase
c. £75,000 decrease
d. £105,000 increase
ANS: B
SUPPORTING CALCULATIONS:

Make:
Direct materials £(150,000)
Direct labour (240,000)
Variable overhead __(90,000)
Total £(480,000)

Buy:
Purchase price (20,000  £25.50) £(510,000)
Rental income ___45,000
Total £(465,000)

£480,000 - £465,000 = £15,000 increase in income

PTS: 1

Figure 2

Vest Industries manufactures 40,000 components per year. The manufacturing cost of the components
was determined as follows:
 Direct materials £ 75,000
Direct labour 120,000
Variable manufacturing overhead 45,000
Fixed manufacturing overhead __60,000
Total £300,000

An outside supplier has offered to sell the component for £12.75.

21. Refer to Figure 2. What is the effect on income if Vest Industries purchases the component from the
outside supplier?
a. £270,000 decrease
b. £270,000 increase
c. £30,000 decrease
d. £30,000 increase
ANS: A
SUPPORTING CALCULATIONS:

Make:
Direct materials £ (75,000)
Direct labour (120,000)
Variable overhead __(45,000)
Total £(240,000)

Buy:
Purchase price (40,000  £12.75) £(510,000)

£510,000 - £240,000 = £270,000 decrease in income

PTS: 1

22. Refer to Figure 2. What is the effect on income if Vest purchases the component from the outside
supplier?
a. £225,000 increase
b. £195,000 increase
c. £165,000 decrease
d. £135,000 increase
ANS: A
SUPPORTING CALCULATIONS:

Make:
Direct materials £ (75,000)
Direct labour (120,000)
Variable overhead __(45,000)
Total £(240,000)

Buy:
Purchase price (40,000  £12.75) £(510,000)
Rental income ___45,000
Total £(465,000)

£465,000 - £240,000 = £225,000 increase in income

 PTS: 1

Figure 3

Miller Company produces speakers for home stereo units. The speakers are sold to retail stores for
£30. Manufacturing and other costs are as follows:

Variable costs per unit: Fixed costs per month:

Direct materials £ 9.00 Factory overhead £120,000
Direct labour 4.50 Selling and admin. __60,000
Factory overhead 3.00 Total £180,000
Distribution __1.50
Total £18.00

The variable distribution costs are for transportation to the retail stores. The current production and
sales volume is 20,000 per year. Capacity is 25,000 units per year.

23. Refer to Figure 3. A Tennessee manufacturing firm has offered a one-year contract to supply speaker
parts at a cost of £6.00 per unit. If Miller Company accepts the offer, it will be able to reduce variable
costs by 30 percent and rent unused space to an outside firm for £18,000 per year. All other
information remains the same as the original data. What is the effect on profits if Miller Company buys
from the Tennessee firm?
a. decrease of £19,000
b. increase of £19,000
c. increase of £13,000
d. decrease of £6,000
ANS: D
SUPPORTING CALCULATIONS:

Cost to buy (£6  20,000) £120,000

Cost to make:
Variable costs [(£18.00  0.30)  20,000] £108,000
Opportunity costs __18,000 _126,000
Profit will decrease by £ 6,000

PTS: 1

24. Refer to Figure 3. A San Diego wholesaler has proposed to place a special one-time order of 10,000
units at a reduced price of £24 per unit. The wholesaler would pay all distribution costs, but there
would be additional fixed selling and administrative costs of £3,000. All other information remains the
same as the original data. What is the effect on profits if the special order is accepted?
a. increase of £75,000
b. increase of £57,000
c. decrease of £168,000
d. increase of £12,000
ANS: D
SUPPORTING CALCULATIONS:

Additional revenues (10,000  £24) £240,000

Additional costs:
Variable (10,000  £16.50) £165,000
 Fixed 3,000
Opportunity cost (5,000  £12) __60,000 _228,000
Profits increase by £ 12,000

PTS: 1

25. Refer to Figure 3. An Atlanta wholesaler has proposed to place a special one-time order for 7,000 units
at a special price of £25.20 per unit. The wholesaler would pay all distribution costs, but there would
be additional fixed selling and administrative costs of £6,000. In addition, assume that overtime
production is not possible and that all other information remains the same as the original data. What is
the effect on profits if the special order is accepted?
a. increase of £54,900
b. increase of £30,900
c. increase of £36,900
d. increase of £176,400
ANS: B
SUPPORTING CALCULATIONS:

Additional revenues (7,000  £25.20) £176,400

Additional costs:
Variable (7,000  £16.50) £115,500
Fixed 6,000
Opportunity cost (2,000  £12) __24,000 _145,500
Profits increase by £ 30,900

PTS: 1

26. Refer to Figure 3. The speakers are currently unpackaged. Packaging them individually would increase
costs by £1.20 per unit. However, the units could then be sold for £33.00. All other information
remains the same as the original data. What is the effect on profits if Miller Company packages the
speakers?
a. decrease of £36,000
b. decrease of £24,000
c. increase of £36,000
d. no change
ANS: C
SUPPORTING CALCULATIONS:
£1.80  20,000 = £36,000

PTS: 1

27. Harris Company uses 5,000 units of part AA1 each year. The cost of manufacturing one unit of part
AA1 at this volume is as follows:

Direct materials £10.00

Direct labour 14.00
Variable overhead 6.00
Fixed overhead __4.00
Total £34.00
 An outside supplier has offered to sell Harris Company unlimited quantities of part AA1 at a unit cost
of £31.00. If Harris Company accepts this offer, it can eliminate 50 percent of the fixed costs assigned
to part AA1. Furthermore, the space devoted to the manufacture of part AA1 would be rented to
another company for £24,000 per year. If Harris Company accepts the offer of the outside supplier,
annual profits will
a. increase by £29,000.
b. increase by £14,500.
c. increase by £22,000.
d. increase by £2,500.
ANS: A
SUPPORTING CALCULATIONS:

Cost to buy (5,000  £31) + (£2.00  5,000) £165,000

Cost to make (5,000  £34) + £24,000 _194,000
Profits increase by £ 29,000

PTS: 1

28. Houston Ltd. manufacturers a part for its production cycle. The costs per unit for 5,000 units of this
part are as follows:

Direct materials £ 32
Direct labour 40
Variable overhead 16
Fixed overhead __32
Total £120

Johnson Company has offered to sell Houston Ltd. 5,000 units of the part for £112 per unit. If Houston
Ltd. accepts Johnson Company's offer, total fixed costs will be reduced to £60,000. What alternative is
more desirable and by what amount is it more desirable?

Alternative Amount
a. Make £20,000
b. Make £120,000
c. Buy £40,000
d. Buy £100,000
e. Buy £140,000
ANS: A
SUPPORTING CALCULATIONS:

Make (£120  5,000) £600,000

Buy [(£112  5,000) + £60,000] _620,000
Make increases profits by £ 20,000

PTS: 1

29. A decision to make or eliminate an unprofitable product is a

a. special-order decision.
b. keep-or-drop a product-line decision.
c. make-or-buy decision.
d. Both b and c are correct.
 ANS: B PTS: 1

30. The operations of Smits Ltd. are divided into the Childs Division and the Jackson Division. Projections
for the next year are as follows:

Childs Jackson
Division Division Total
Sales £250,000 £180,000 £430,000
Variable costs __90,000 _100,000 _190,000
Contribution margin £160,000 £ 80,000 £240,000
Direct fixed costs __75,000 __62,500 _137,500
Segment margin £ 85,000 £_17,500 £102,500
Allocated common costs __35,000 __27,500 __62,500
Operating income (loss) £ 50,000 £(10,000) £ 40,000

Operating income for Smits Ltd. as a whole if the Jackson Division were dropped would be
a. £22,500.
b. £40,000.
c. £50,000.
d. £60,000.
ANS: A
SUPPORTING CALCULATIONS:
£85,000 - £62,500 = £22,500

PTS: 1

31. The operations of Knickers Ltd. are divided into the Pacers Division and the Bulls Division.
Projections for the next year are as follows:

Pacers Bulls
Division Division Total
Sales £420,000 £252,000 £672,000
Variable costs _147,000 _115,500 _262,500
Contribution margin £273,000 £136,500 £409,500
Direct fixed costs _126,000 _105,000 _231,000
Segment margin £147,000 £ 31,500 £178,500
Allocated common costs __63,000 __47,250 _110,250
Operating income (loss) £ 84,000 £(15,750) £ 68,250

Operating income for Knickers Ltd. as a whole if the Bulls Division were dropped would be
a. £99,750.
b. £84,000.
c. £68,250.
d. £36,750.
ANS: D
SUPPORTING CALCULATIONS:
£147,000 - £110,250 = £36,750

PTS: 1

Figure 4
 The following information pertains to Ewing Company's three products:

D E F
Unit sales per month 900 1,400 800

Selling price per unit £6.00 £11.25 £ 7.50

Variable costs per unit _3.00 __9.00 __7.80
Unit contribution margin £3.00 £ 2.25 £(0.30)

32. Refer to Figure 4. Assume that product F is discontinued and the space used to produce product F is
rented for £600 per month. Monthly profits will
a. increase by £360.
b. decrease by £5,400.
c. increase by £600.
d. increase by £840.
ANS: D
SUPPORTING CALCULATIONS:
(800  £0.30) + £600 = £840

PTS: 1

33. Refer to Figure 4. Assume that product F is discontinued and the space is used to produce E. Product
E's production is increased to 2,200 units per month, but E's selling price of all units of E is reduced to
£10.20. Monthly profits will
a. decrease by £2,070.
b. increase by £1,200.
c. decrease by £270.
d. increase by £2,640.
ANS: C
SUPPORTING CALCULATIONS:
[2,200  (£10.20 - £9.00)] + (800  £0.30) - (1,400  £2.25) = £270 decrease

PTS: 1

34. Refer to Figure 4. Assume that the selling price of product F is increased to £8.25 with a reduction in
monthly sales to 400 units. Monthly profits will
a. increase by £2,070.
b. increase by £420.
c. increase by £180.
d. decrease by £60.
ANS: B
SUPPORTING CALCULATIONS:
[400  (£8.25 - £7.80)] + (800  £0.30) = £420 increase

PTS: 1

35. The following information pertains to Dodge Company's three products:

A B C
Unit sales per year 250 400 250
 Selling price per unit £9.00 £12.00 £ 9.00
Variable costs per unit _3.60 __9.00 __9.90
Unit contribution margin £5.40 £ 3.00 £(0.90)
Contribution margin ratio 60% 25% (10)%

Assume that product C is discontinued and the extra space is rented for £300 per month. All other
information remains the same as the original data. Annual profits will
a. increase by £75.
b. decrease by £75.
c. increase by £525.
d. remain the same.
ANS: C
SUPPORTING CALCULATIONS:
(250  £0.90) + £300 = £525

PTS: 1

36. Firms may be asked to accept a special order of their product for a reduced price if
a. it can be concealed from the government.
b. excess capacity exists.
c. the order is small.
d. the plant is producing at maximum capacity.
ANS: B PTS: 1

37. A decision that focuses on whether a specially priced order should be accepted or rejected is a
a. special-order decision.
b. keep-or-drop a product-line decision.
c. make-or-buy decision.
d. Both a and c are correct.
ANS: A PTS: 1

Figure 5

Reggie Ltd. manufactures a single product with the following unit costs for 1,000 units:

Direct materials £2,400

Direct labour 960
Factory overhead (30% variable) 1,800
Selling expenses (50% variable) 900
Administrative expenses (10% variable) ____840
Total per unit £6,900

Recently, a company approached Reggie Ltd. about buying 100 units for £5,100 each. Currently, the
models are sold to dealers for £7,800. Reggie Ltd.'s capacity is sufficient to produce the extra 100
units. No additional selling expenses would be incurred on the special order.

38. Refer to Figure 5. What is the profit earned by Reggie Ltd. on the original 1,000 units?
a. £6,900,000
b. £8,400,000
c. £900,000
d. £2,640,000
 ANS: C
SUPPORTING CALCULATIONS:
1,000  (£7,800 - £6,900) = £900,000

PTS: 1

39. Refer to Figure 5. How much will income change if the special order is accepted?
a. increase by £398,400
b. decrease by £180,000
c. increase by £111,600
d. no change
ANS: C
SUPPORTING CALCULATIONS:
100  (£5,100 - £2,400 - £960 - (£1,800  0.30) - (£840  0.10)) = £111,600

PTS: 1

40. Refer to Figure 5. If Reggie Ltd. wants to increase its profit by £18,000 on the special order, what is
the minimum price it should charge per unit?
a. £4,014
b. £4,164
c. £5,100
d. £6,900
ANS: B
SUPPORTING CALCULATIONS:
£2,400 + £960 + £540 + £84 + (18,000/100) = £4,164

PTS: 1

Figure 6

The following information relates to a product produced by Creamer Company:

Direct materials £24

Direct labour 15
Variable overhead 30
Fixed overhead _18
Unit cost £87

Fixed selling costs are £500,000 per year, and variable selling costs are £12 per unit sold. Although
production capacity is 600,000 units per year, the company expects to produce only 400,000 units next
year. The product normally sells for £120 each. A customer has offered to buy 60,000 units for £90
each.

41. Refer to Figure 6. The incremental cost per unit associated with the special order is
a. £84.
b. £81.
c. £69.
d. £64.
ANS: B
SUPPORTING CALCULATIONS:
 Direct materials £24
Direct labour 15
Variable overhead 30
Variable selling and administrative _12
£81

PTS: 1

42. Refer to Figure 6. If the firm produces the special order, the effect on income would be a
a. £360,000 increase.
b. £360,000 decrease.
c. £540,000 increase.
d. £540,000 decrease.
ANS: C
SUPPORTING CALCULATIONS:

Incremental revenue (60,000  £90) £5,400,000

Less: Incremental costs (60,000  £81) _4,860,000
Incremental profit £ 540,000

PTS: 1

Figure 7

Meco Company produces a product that has a regular selling price of £360 per unit. At a typical
monthly production volume of 2,000 units, the product's average unit cost of goods sold amounts to
£270. Included in this average is £120,000 of fixed manufacturing costs. All selling and administrative
costs are fixed and amount to £30,000 per month.

Meco Company has just received a special order for 1,000 units at £240 per unit. The buyer will pay
transportation, and the regular selling price will not be affected if Meco accepts the order.

43. Refer to Figure 7. Assuming Meco Company has excess capacity, the effect on profits of accepting the
order would be
a. a £60,000 increase.
b. a £60,000 decrease.
c. a £30,000 increase.
d. a £30,000 decrease.
e. no change in profits.
ANS: C
SUPPORTING CALCULATIONS:
1,000  [£240 - (£270 - £120,000/2,000)] = £30,000 increase

PTS: 1

44. Refer to Figure 7. Assuming Meco Company is operating at capacity and accepting the order would
require an offsetting reduction in regular sales, the effect on profits of accepting the order would be a
a. £240,000 decrease.
b. £30,000 increase.
c. £120,000 decrease.
d. £150,000 decrease.
 ANS: C
SUPPORTING CALCULATIONS:
£30,000 - [(£360 - £210)  1,000] = £120,000 decrease

PTS: 1

45. If there is excess capacity, the minimum acceptable price for a special order must cover
a. variable costs associated with the special order.
b. variable and fixed manufacturing costs associated with the special order.
c. variable and incremental fixed costs associated with the special order.
d. variable costs and incremental fixed costs associated with the special order plus the
contribution margin usually earned on regular units.
ANS: C PTS: 1

46. If a firm is at full capacity, the minimum special order price must cover
a. variable costs associated with the special order.
b. variable and fixed manufacturing costs associated with the special order.
c. variable and incremental fixed costs associated with the special order.
d. variable costs and incremental fixed costs associated with the special order plus foregone
contribution margin on regular units not produced.
ANS: D PTS: 1

47. Gundy Company manufactures a product with the following costs per unit at the expected production
of 30,000 units:

Direct materials £4
Direct labour 12
Variable manufacturing overhead 6
Fixed manufacturing overhead 8

The company has the capacity to produce 40,000 units. The product regularly sells for £40. A
wholesaler has offered to pay £32 a unit for 2,000 units.

If the firm is at capacity and the special order is accepted, the effect on operating income would be
a. a £20,000 increase.
b. a £16,000 decrease.
c. a £4,000 increase.
d. £-0-.
ANS: B
SUPPORTING CALCULATIONS:
2,000  (£40 - £32) = £16,000 decrease

PTS: 1

Figure 8

Walton Company manufactures a product with the following costs per unit at the expected production
level of 84,000 units:

Direct materials £12

Direct labour 36
 Variable manufacturing overhead 18
Fixed manufacturing overhead 24

The company has the capacity to produce 90,000 units. The product regularly sells for £120.

48. Refer to Figure 8. A wholesaler has offered to pay £110 a unit for 7,500 units.

If the special order is accepted, the effect on operating income would be a

a. £75,000 decrease.
b. £429,000 increase.
c. £495,000 increase.
d. £249,000 increase.
ANS: D
SUPPORTING CALCULATIONS:

Incremental revenue (7,500  £110) £ 825,000

Lost revenue from regular sales (1,500  £120) (180,000)
Incremental costs:
Direct materials (6,000  £12) £ 72,000
Direct labour (6,000  £36) 216,000
Variable overhead (6,000  £18) _108,000 _(396,000)
Incremental profit £ 249,000

PTS: 1

49. Refer to Figure 8. If a wholesaler offered to buy 4,500 units for £100 each, the effect of the special
order on income would be a
a. £153,000 increase.
b. £45,000 increase.
c. £450,000 increase.
d. £90,000 decrease.
ANS: A
SUPPORTING CALCULATIONS:

Incremental revenue (4,500  £100) £ 450,000

Incremental costs:
Direct materials (4,500  £12) £ 54,000
Direct labour (4,500  £36) 162,000
Variable overhead (4,500  £18) __81,000 _(297,000)
Incremental profit £ 153,000

PTS: 1

50. Rose Manufacturing Company had the following unit costs:

Direct materials £24

Direct labour 8
Variable factory overhead 10
Fixed factory overhead (allocated) 18
 A one-time customer has offered to buy 2,000 units at a special price of £48 per unit. Assuming that
sufficient unused production capacity exists to produce the order and no regular customers will be
affected by the order, how much additional profit (loss) will be generated by accepting the special
order?
a. £12,000 profit
b. £96,000 profit
c. £84,000 loss
d. £24,000 loss
ANS: A
SUPPORTING CALCULATIONS:
2,000  (£48 - £42) = £12,000

PTS: 1

Figure 9

Boone Products had the following unit costs:

Direct materials £24

Direct labour 10
Variable factory overhead 8
Fixed factory overhead (allocated) 18

51. Refer to Figure 9. A one-time customer has offered to buy 1,000 units at a special price of £48 per unit.
Assuming that sufficient unused production capacity exists to produce the order and no regular
customers will be affected by the order, how much additional profit (loss) will be generated from the
special order?
a. £12,000 loss
b. £14,000 profit
c. £48,000 profit
d. £6,000 profit
ANS: D
SUPPORTING CALCULATIONS:
1,000  (£48 - £42) = £6,000

PTS: 1

52. Refer to Figure 9. A one-time customer has offered to buy 2,000 units at a special price of £48 per unit.
Because of capacity constraints, 1,000 units will need to be produced during overtime. Overtime
premium is £8 per unit. How much additional profit (loss) will be generated by accepting the special
order?
a. £30,000 loss
b. £4,000 loss
c. £24,000 loss
d. £4,000 profit
ANS: D
SUPPORTING CALCULATIONS:

1,000  (£48 - £42) = £6,000

1,000  (£48 - £50) = (2,000)
£4,000
 PTS: 1

53. Reggie Ltd. manufactures a single product with the following unit costs for 1,000 units:

Direct materials £2,400

Direct labour 960
Factory overhead (30% variable) 1,800
Selling expenses (50% variable) 900
Administrative expenses (10% variable) ___840
Total per unit £6,900

Recently, a company approached Reggie Ltd. about buying 100 units for £5,100 each. Currently, the
models are sold to dealers for £7,800.

Assume there is additional capacity for 60 more units and the firm has to reduce regular customer sales
by 40 units in order to contract the special order. There are selling expenses on only the sales to the
regular customers. What is the net income if the special order of 100 units is accepted?
a. £831,960
b. £876,960
c. £1,011,600
d. £900,000
ANS: B
SUPPORTING CALCULATIONS:

Sales (960  £7,800) £7,488,000

(100  £5,100) ___510,000 £7,998,000
Costs:
Variable costs-Regular (960  £4,434*) £4,256,640
Variable costs-Special (100  £3,984**) 398,400
Fixed costs [1,000  (£1,260 + £450 + £756] _2,466,000 _7,121,040
Net income £ 876,960

*£2,400 + [£960 + (£1,800  0.30) + (£900  0.50) + (£840  0.10)] = £4,434

**£2,400 + [£960 + (£1,800  0.30) + (£840  0.10)] = £3,984

PTS: 1

54. For a cost or revenue to be relevant to a particular decision, the cost or revenue must
a. differ between the alternatives being considered.
b. be a past cost.
c. be a future cost.
d. Both a and c above are correct.
ANS: D PTS: 1

55. Which of the following costs is NOT relevant to a make-or-buy decision?

a. £10,000 of direct labour used to manufacture the parts
b. £30,000 of depreciation on the equipment used to manufacture the parts
c. the supervisor's salary of £25,000, which would be avoided if the part is purchased from an
outside supplier
 d. £15,000 in rent from leasing the production space to another company if the part is
purchased from an outside supplier
ANS: B PTS: 1

56. Which of the following is a qualitative factor that should be considered when evaluating a make-or-
buy decision?
a. the quality of the outside supplier's product
b. whether the outside supplier can provide the needed quantities
c. whether the outside supplier can provide the product WHEN it is needed
d. all of the above
ANS: D PTS: 1

57. If there is excess capacity, the minimum acceptable price for a special order must cover
a. only variable costs associated with the special order.
b. variable and fixed manufacturing costs associated with the special order.
c. variable and incremental fixed costs associated with the special order.
d. variable costs and incremental fixed costs associated with the special order, plus the
contribution margin usually earned on regular units.
ANS: C PTS: 1

58. If the firm is at full capacity, the minimum special-order price must cover
a. variable costs associated with the special order.
b. variable and fixed manufacturing costs associated with the special order.
c. variable and incremental fixed costs associated with the special order.
d. variable costs and incremental fixed costs associated with the special order, plus foregone
contribution margin on regular units not produced.
ANS: D PTS: 1

59. When there is one scarce resource, the product that should be produced first is the product with the
highest
a. contribution margin per unit of the scarce resource.
b. sales price per unit of the scarce resource.
c. demand.
d. contribution margin per unit.
ANS: A PTS: 1

60. Zandy Beverage Company plans to eliminate a branch that has a contribution margin of £50,000 and
fixed costs of £75,000. Of the fixed costs, £55,000 cannot be eliminated. The effect of eliminating this
branch on net income would be a(n)
a. decrease of £25,000.
b. increase of £25,000.
c. decrease of £30,000.
d. increase of £30,000.
ANS: C
SUPPORTING CALCULATIONS:

Contribution Margin £50,000

Avoidable fixed costs (£75,000 - £55,000) _20,000
Segment margin £30,000
 PTS: 1

61. Salish Industries manufactures a product with the following costs per unit at the expected production
of 60,000 units:

Direct materials £8
Direct labour 15
Variable manufacturing overhead 10
Fixed manufacturing overhead 12

The company has the capacity to produce 70,000 units. The product regularly sells for £60. A
wholesaler has offered to pay £55 each for 5,000 units.

If the special order is accepted, the effect on operating income would be a

a. £42,000 decrease.
b. £67,000 increase.
c. £110,000 increase.
d. £182,000 decrease.
ANS: C
SUPPORTING CALCULATIONS:

Incremental revenue (5,000 units  £55) £275,000

Incremental costs:
Direct materials (5,000 units £8) £40,000
Direct labour (5,000 units  £15) 75,000
Variable overhead (5,000 units  £10) _50,000 _165,000
Incremental profit £110,000

PTS: 1

62. Bridge Industries manufactures a product with the following costs per unit at the expected production
of 78,000 units:

Direct materials £15

Direct labour 22
Variable manufacturing overhead 12
Fixed manufacturing overhead 19

The company has the capacity to produce 80,000 units. The product regularly sells for £90. A
wholesaler has offered to pay £75 each for 2,000 units.

If Bridge's special order is accepted, the effect on operating income would be a

a. £20,000 decrease.
b. £52,000 increase.
c. £14,000 increase.
d. none of the above.
ANS: B
SUPPORTING CALCULATIONS:

Incremental revenue (2,000 units  £75) £150,000

Less: Incremental costs
 [2,000 units  (£15 + £22 + £12)] __98,000
Incremental profit £ 52,000

PTS: 1

63. The Dot Company manufactures two products: X and Y. The contribution margin per unit is
determined as follows:

X Y
Sales £130 £80
Variable costs __70 _38
Contribution margin £ 60 £42

Total demand for Product X is 16,000 units and for Product Y is 8,000 units. Machine hours is a scarce
resource. During the year, 42,000 machine hours are available. Product X requires 6 machine hours per
unit, while Product Y requires 3 machine hours per unit.

How many units of Products X and Y should Dot Company produce?

Product X Product Y
a. 16,000 -0-
b. 8,000 4,000
c. 7,000 -0-
d. 3,000 8,000
ANS: D
SUPPORTING CALCULATIONS:
Product X: £60/6 machine hours = £10 contribution margin per machine hour
Product Y: £42/3 machine hours = £14 contribution margin per machine hour

Product Y: 8,000 units  3 machine hours = 24,000 machine hours

Product X: 3,000 units  6 machine hours = 18,000 machine hours
Total 42,000 machine hours

PTS: 1

64. Caddo Ltd. produces two products using the same manufacturing equipment. Information about the
two products is as follows:

Alpha Beta
Sales £15 £35
Variable costs £5 £10
Machine hours required 0.5 2.0
Demand (units) 30,000 10,000
Demand (machine hours) 15,000 20,000

If Caddo can produce only one of the products in the next period, which product should be produced?
a. Alpha should be produced because it requires less machine hours.
b. Beta should be produced because it generates more revenue.
c. Beta should be produced because it generates more contribution margin per unit.
d. none of the above
ANS: D
SUPPORTING CALCULATIONS:
 Alpha should be produced because it produces more contribution
margin per unit of scarce resource.

Alpha: (£15 - £5)/0.5 hour = £20 per hour

Beta: (£35 - £10)/2.0 hours = £12.50 per hour

PTS: 1

65. WJE Company has only 4,000 machine hours available each month. The following information on the
company's three products is available:

Product Product Product

AA BB CC
Contribution margin per unit £10 £13 £5
Machine hours per unit 2 1.5 0.5

If demand exceeds the available capacity, in what sequence should orders be filled to maximize the
company's profits?
a. Product AA first, Product BB second, and Product CC third
b. Product BB first, Product AA second, and Product CC third
c. Product CC first, Product BB second, and Product AA third
d. Product CC first, Product AA second, and Product BB third
ANS: C
SUPPORTING CALCULATIONS:
Contribution margin per machine hour:
Product AA: £10/2 hours = £5 per machine hour
Product BB: £13/1.5 hours = £8.67 per machine hour
Product CC: £5/0.5 hour = £10 per machine hour

PTS: 1

PROBLEM

1. Junior Company currently buys 30,000 units of a part used to manufacture its product at £40 per unit.
Recently the supplier informed Junior Company that a 20 percent increase will take effect next year.
Junior has some additional space and could produce the units for the following per-unit costs (based on
30,000 units):

Direct materials £16

Direct labour 12
Variable overhead 12
Fixed overhead _10
Total £50

If the units are purchased from the supplier, £200,000 of fixed costs will continue to be incurred. In
addition, the plant can be rented out for £20,000 per year if the parts are purchased externally.

Required:

Should Junior Company buy the part externally or make it internally?

ANS:
 Produce internally; it saves £120,000. (£1,620,000 - £1,500,000)

If purchased externally:
Purchase price (30,000  £40  1.20) £1,440,000
Fixed costs 200,000
Rent received ___(20,000)
Net cost to purchase £1,620,000

If produced internally:
Cost to produce (30,000  £50) £1,500,000

PTS: 1

2. Rippey Ltd. manufactures a single product with the following unit costs for 5,000 units:

Direct materials £ 60
Direct labour 30
Factory overhead (40% variable) 90
Selling expenses (60% variable) 30
Administrative expenses (20% variable) __15
Total per unit £225

Recently, a company approached Rippey Ltd. about buying 1,000 units for £225. Currently, the models
are sold to dealers for £412.50. Rippey's capacity is sufficient to produce the extra 1,000 units. No
additional selling expenses would be incurred on the special order.

Required:

a. What is the profit earned by Rippey Ltd. on the original 5,000 units?
b. Should Rippey accept the special order if its goal is to maximize short-run profits? How much
will income be affected?
c. Determine the minimum price Rippey would want to receive in order to increase profits by
£7,500 on the special order.
d. When making a special order decision, what nonquantitative aspects of the decision should
Rippey Ltd. consider?

ANS:
a. Sales (5,000  £412.50) £2,062,500
Less: costs (5,000  £225) _1,125,000
Net income £ 937,500

b. Yes, profit will increase by:

Increase in sales (1,000  £225) £225,000

Less:
Increase in direct materials (1,000  £60) (60,000)
Increase in direct labour (1,000  £30) (30,000)
Increase in var. overhead (1,000  £90  0.40) (36,000)
Increase in var. selling (1,000  £30  0.60) (18,000)
Increase in var. adm. (1,000  £15  0.20) __(3,000)
Increase in profits £ 78,000
 c. £60 + £30 + (£90  0.40) + (£30  0.60) + (£15  0.20) + (£7,500/1,000) = £154.50 per unit

d. What is the impact on regular customers?

Will regular customers demand a similar price?
Do we have the capacity to produce the extra units?
Will we lose some regular customers?
Will we be penetrating new markets?
Will we be violating the Robinson-Patman Act?

PTS: 1

3. The operations of Grant Ltd. are divided into the Fix Division and the Roach Division. Projections for
the next year are as follows:

Fix Roach
Division Division Total
Sales £60,000 £ 40,000 £100,000
Variable costs _20,000 __15,000 __35,000
Contribution margin £40,000 £ 25,000 £ 65,000
Direct fixed costs _12,500 __30,000 __42,500
Segment margin £27,500 £ (5,000) £ 22,500
Allocated common costs _10,000 ___7,500 __17,500
Operating income (loss) £17,500 £(12,500) £ 5,000

Required:

a. Determine operating income for Grant Ltd. as a whole if the Roach Division is dropped.
b. Should the Roach Division be eliminated?

ANS:
a. Sales £60,000
Variable costs _20,000
Contribution margin £40,000
Direct fixed costs _12,500
Segment margin £27,500
Allocated common costs:
(£10,000 + £7,500) _17,500
Operating income £10,000

b. Yes. The Roach division should be dropped, since it has a negative segment margin of
£5,000. Dropping the Roach Division increases the firm's income by £5,000.

PTS: 1

4. Barron Company's 2012 income statement is as follows:

Sales (5,000 units  £15) £75,000

Less variable expenses:
Cost of goods sold:
Direct materials £15,000
Direct labour 10,000
Variable factory overhead 10,000
Selling and administrative __2,500 _37,500
 Contribution margin £37,500
Less fixed expenses:
Factory overhead £10,000
Selling and administrative _15,000 _25,000
Net income (loss) £12,500

In an attempt to improve the company's profit performance, management is considering a number of

alternative actions.

Required:

Determine the effect of each of the following on monthly profit. Each situation is to be evaluated
independently of all the others.

a. Purchasing automated assembly equipment. This action should reduce direct labour costs by 40
percent. It also will increase variable overhead costs by 10 percent and fixed factory overhead
by £2,500.
b. Reducing the unit selling price by £2 per unit. This should increase the monthly sales by 5,000
units. Fixed factory overhead will increase by £1,500.
c. Increase fixed selling and administrative expenses by £1,000 for advertising costs. The number
of units sold will increase to 8,000 units.

ANS:
a. Increase in variable overhead (£10,000  0.10) £ 1,000
Increase in fixed costs 2,500
Decrease in direct labour cost (£10,000  0.40) _(4,000)
Net decrease in costs (increase in profits) £ 500

b. Increase in sales [(£13  10,000) - £75,000] £55,000

Less:
Increase in variable expenses
[5,000  (£37,500/5,000)] £37,500
Increase in fixed overhead __1,500 _39,000
Increase in net income £16,000

c. Increase in sales (3,000  £15) £45,000

Less:
Increase in variable expenses
[3,000  (£37,500/5,000)] £22,500
Increase in fixed S & A expenses __1,000 _23,500
Net income £21,500

PTS: 1

5. The management of James Industries has been evaluating whether the company should continue
manufacturing a component or buy it from an outside supplier. A £200 cost per component was
determined as follows:

Direct materials £ 15
Direct labour 40
Variable manufacturing overhead 10
Fixed manufacturing overhead __35
Total £100
 James Industries uses 4,000 components per year. After Light, SA., submitted a bid of £80 per
component, some members of management felt they could reduce costs by buying from outside and
discontinuing production of the component. If the component is obtained from Light, SA., James's
unused production facilities could be leased to another company for £50,000 per year.

Required:

a. Determine the maximum amount per unit James should pay an outside supplier.
b. Indicate if the company should make or buy the component and the total monetary difference
in favor of that alternative.
c. Assume the company could eliminate production supervisors with salaries totaling £30,000 if
the component is purchased from an outside supplier. Indicate if the company should make or
buy the component and the total monetary difference in favor of that alternative.

ANS:
a. £77.50 [£15 + £40 + £10 + (£50,000/4,000)]

b. £10,000 difference in favor of making the component

Buy Make
Outside supplier's price
(£80  4,000) £(320,000)
Direct materials
(£15  4,000) £ (60,000)
Direct labour
(£40  4,000) (160,000)
Variable manufacturing overhead
(£10  4,000) (40,000)
Fixed manufacturing overhead
(£35  4,000) (140,000) (140,000)
Rental revenue ___50,000 _________
Totals £(410,000) £(400,000)

The make or buy alternatives also could be analyzed as follows excluding the fixed
manufacturing overhead:

Buy Make
Outside supplier's price £(320,000)
Direct materials £ (60,000)
Direct labour (160,000)
Variable manufacturing overhead (40,000)
Rental revenue ___50,000 _________
Totals £(270,000) £(260,000)

c. £20,000 difference in favor of buying the component from the outside supplier

Buy Make
Outside supplier's price
(£80  4,000) £(320,000)
Direct materials
(£15  4,000) £ (60,000)
Direct labour
 (£40  4,000) (160,000)
Variable manufacturing overhead
(£10  4,000) (40,000)
Fixed manufacturing overhead
(£35  4,000) (140,000)
(£140,000 - £30,000) (110,000)
Rental revenue ___50,000 _________
Totals £(380,000) £(400,000)

The analysis could be done including only avoidable fixed costs:

Buy Make
Outside supplier's price
(£80  4,000) £(320,000)
Direct materials
(£15  4,000) £ (60,000)
Direct labour
(£40  4,000) (160,000)
Variable manufacturing overhead
(£10  4,000) (40,000)
Avoidable fixed manufacturing overhead (30,000)
Rental revenue ___50,000 _________
Totals £(270,000) £(290,000)

PTS: 1

6. Scott Company has an annual capacity of 18,000 units. Budgeted operating results for 2012 are as
follows:

Revenues (16,000 units @ £60) £960,000

Variable costs:
Manufacturing £384,000
Selling _128,000 _512,000
Contribution margin £448,000

Fixed costs:
Manufacturing £160,000
Selling and administrative _120,000 _280,000
Operating income £168,000

A foreign wholesaler wants to buy 1,000 units at a price of £40 per unit. All fixed costs would remain
within the relevant range. Variable selling costs on the special order would be the same as variable
selling costs for regular orders.

Required:

a. Determine the effect on operating income if the company produces the special order.
b. Should the company produce the special order?
c. Determine operating income if the customer had wanted a special order of 3,000 units and the
company produced the special order.
d. Should the company produce the 3,000-unit special order?
e. Discuss any nonquantitative factors the company might want to consider when making the
decision.
 ANS:
a. £8,000 increase

Incremental revenue (£40  1,000) £ 40,000

Incremental costs:
Variable manufacturing (£24  1,000) (24,000)
Variable selling (£8  1,000) __(8,000)
Incremental contribution margin £ 8,000

Since the company would still be operating within the relevant range, fixed costs would
remain the same.

b. Yes, the company should produce the special order.

c. £164,000

Without With
Special Order Special Order
Revenues:
(16,000  £60) £ 960,000
(15,000  £60) £900,000
(3,000  £40) 120,000
Variable costs:
Manufacturing:
(16,000  £24) (384,000)
(18,000  £24) (432,000)
Selling:
(16,000  £8) (128,000)
(18,000  £8) ________ _(144,000)
Contribution margin £448,000 £ 444,000
Fixed costs:
Manufacturing (160,000) (160,000)
Selling and administrative (120,000) _(120,000)
Operating income £168,000 £ 164,000

d. No. If the decision is based on quantitative factors, the company should not produce the
special order.

e. Nonquantitative considerations might include:

•The possibility of repeat business with the special-order customer.

•Increasing the selling price on subsequent special orders.
•The reliability of regular customer repeat business.
•If the special order is produced, the reaction of regular customers to the reduced price on the
special order.

PTS: 1

7. Bonilla Ltd., which produces one product, had the following income statement for a recent month:

Bonilla Ltd.
 Income Statement
For the Month of April 2012

Sales £30,000
Cost of goods sold _27,000
Gross profit £ 3,000
Selling and administrative __2,500
Net income £ 500

There were no beginning or ending inventories of work-in-process or finished goods. Bonilla's

manufacturing costs were as follows:

Direct materials (1,200 units  £5) £ 6,000

Direct labour (1,200 units  £8) 9,600
Variable overhead (1,200 units  £4.50) 5,400
Fixed overhead __6,000
Total £27,000

Average cost per unit £ 22.50

Selling and administrative expenses are all fixed.

Bonilla has just received a special order from a firm in Canada to purchase 800 units at £20 each. The
order will not affect the selling price to regular customers.

Required:

a. Prepare a differential analysis of the relevant costs and revenues associated with the decision to
accept or reject the special order, assuming Bonilla has excess capacity.
b. Determine the net advantage or disadvantage (profit increase or decrease) of accepting the
order, assuming Bonilla does not have excess capacity.

ANS:
a. Increase in revenues (800  £20) £16,000
Increase in costs:
Direct materials (800  £5) £4,000
Direct labour (800  £8) 6,400
Variable overhead (800  4.50) _3,600 _14,000
Increase in profits £ 2,000

b. Contribution margin of special order £ 2,000

Opportunity cost:
Regular selling price £25.00
Variable costs (£5 + £8 + £4.50) _17.50
Regular unit contribution margin £ 7.50
Lost sales ___800 __6,000
Net disadvantage £ 4,000

PTS: 1
 8. Vance Company manufactures a product that has the following unit costs: direct materials, £15; direct
labour, £12; variable overhead, £8; and fixed overhead, £12. Fixed selling costs are £1,500,000 per
year. Variable selling costs of £4 per unit cover the transportation cost. Although production capacity is
800,000 units per year, the company expects to produce only 650,000 units next year. The product
normally sells for £70 each. A customer has offered to buy 50,000 units for £45 each. The customer
will pay the transportation charge on the units purchased.

Required:

a. What is the incremental cost to Vance Company for the special order?
b. What is the effect on Vance's income if the special order is accepted?

ANS:
a. £1,750,000 50,000 units  (£15 + £12 + £8)

b. £500,000 increase

Incremental revenue (50,000 units  £45) £2,250,000

Less: Incremental costs (50,000 units  £35) _1,750,000
Incremental profit £ 500,000

PTS: 1

9. Majestic Company manufactures a product that has the following unit costs: direct materials, £5; direct
labour, £7; variable overhead, £3; and fixed overhead, £5. Fixed selling costs are £200,000 per year.
Variable selling costs of £1 per unit cover the transportation cost. Although production capacity is
80,000 units per year, the company expects to produce only 65,000 units next year. The product
normally sells for £30 each. A customer has offered to buy 10,000 units for £18 each. The customer
will pay the transportation charge on the units purchased.

Required:

a. What is the incremental cost per unit to Majestic Company for the special order?
b. What is the effect on Majestic's income if the special order is accepted?

ANS:
a. £15 (£5 + £7 + £3)

b. £30,000 increase

Incremental revenue (10,000 units  £18) £180,000

Less: Incremental costs (10,000 units  £15) _150,000
Incremental profit £ 30,000

PTS: 1

10. Solomon Company manufactures 20,000 components per year. The manufacturing cost per unit of the
components is as follows:

Direct materials £10

Direct labour 14
Variable overhead 6
Fixed overhead __8
 Total unit cost £38

Assume that the fixed overhead reflects the cost of Solomon's manufacturing facility. This facility
cannot be used for any other purpose. An outside supplier has offered to sell the component to
Solomon for £32.

Required:

a. What is the effect on income if Solomon purchases the component from the outside supplier?
b. Assume that Solomon can avoid £50,000 of the total fixed overhead costs if it purchases the
components. Now what is the effect on income if Solomon purchases the component from the
outside supplier?

ANS:
a. £40,000 decrease

Make:
Direct materials (20,000 components  £10) £200,000
Direct labour (20,000 components  £14) 280,000
Variable overhead (20,000 components  £6) _120,000
Total cost to make £600,000

Buy:
Purchase price (20,000 components  £32) £640,000

£640,000 - £600,000 = £40,000 decrease in income

b. £10,000 increase

Make:
Direct materials (20,000 components  £10) £200,000
Direct labour (20,000 components  £14) 280,000
Variable overhead (20,000 components  £6) 120,000
Avoidable fixed overhead __50,000
Total cost to make £650,000

Buy:
Purchase price (20,000 components  £32) £640,000

£640,000 - £650,000 = £10,000 increase in income

PTS: 1

11. Mills SA. manufactures 50,000 components per year. The manufacturing cost per unit of the
components is as follows:

Direct materials £12

Direct labour 13
Variable overhead 5
Fixed overhead _10
Total unit cost £40
 An outside supplier has offered to sell the component to Mills SA. for £35.

Required:

a. What is the effect on income if Mills SA. purchases the component from the outside supplier?
b. Assume that Mills SA. can avoid £700,000 of the total fixed overhead costs if it purchases the
components. Now what is the effect on income if Mills SA. purchases the component from the
outside supplier?

ANS:
a. £250,000 decrease

Make:
Direct materials (50,000 components  £12) £ 600,000
Direct labour (50,000 components  £13) 650,000
Variable overhead (50,000 components  £5) ___250,000
Total cost to make £1,500,000

Buy:
Purchase price (50,000 components  £35) £1,750,000

£1,750,000 - £1,500,000 = £250,000 decrease in income

b. £450,000 increase

Make:
Direct materials (50,000 components  £12) £ 600,000
Direct labour (50,000 components  £13) 650,000
Variable overhead (50,000 components  £5) 250,000
Avoidable fixed overhead ___700,000
Total cost to make £2,200,000

Buy:
Purchase price (50,000 components  £35) £1,750,000

£1,750,000 - £2,200,000 = £450,000 increase in income

PTS: 1

12. The Dash Company manufactures two products: A and B. Information about the products is as follows:

Product A Product B
Revenue per unit £150 £125
Variable costs per unit __80 __70
Contribution margin per unit £ 70 £ 55

Total demand 15,000 units 12,000 units

Machine hours per unit .5 MH .25 MH

There are 5,000 machine hours available during the quarter.

Required:
 a. Which of the products should Dash Company produce if it can only produce one of the products?
b. Assume that Dash Company uses half of the hours available to produce Product A and half of the
hours available to produce Product B. What is Dash's total contribution margin?
c. Assume that Dash Company produces the product mix that will maximize profit. What is Dash's
total contribution margin?

ANS:
a. Product B should be the product produced first because it has the highest contribution
margin per machine hour.

Product A: £70 per unit/.5 MH per unit = £140 per MH

Product B: £55 per unit/.25 MH per unit = £220 per MH

b. £900,000

Product A: 2,500 MH => 5,000 units

(5,000  £70) £350,000
Product B: 2,500 MH => 10,000 units
(10,000  £55) _550,000
Total contribution margin £900,000

c. £940,000

requirement a, produce Product B first.

From
12,000 units  .25 MH per unit = 3,000 MH to produce Product B

Use remaining 2,000 MH available to produce Product A.

2,000 MH/.5 MH per unit = 4,000 units of Product A

Product A (4,000 units  £70) £280,000

Product B (12,000 units  £55) _660,000
Total contribution margin £940,000

PTS: 1

13. The Bilko Company manufactures two products: widgets and gadgets. Information about the products
is as follows:

Widgets Gadgets
Revenue per unit £200 £150
Variable costs per unit _110 __90
Contribution margin per unit £ 90 £ 60

Total demand 20,000 units 20,000 units

Direct labour hours per unit 1.5 DLH 1.2 DLH

There are 40,000 direct labour hours available during the year.

Required:
 a. Which of the products should Bilko Company produce if it can only produce one of the products?
b. Assume that Bilko Company uses half of the hours available to produce widgets and half of the
hours available to produce gadgets. What is Bilko's total contribution margin?
c. Assume that Bilko Company produces the product mix that will maximize profit. What is Bilko's
total contribution margin?

ANS:
a. Widgets should be the product produced first because they have the highest contribution
margin per direct labour hour.

Widgets: £90 per unit/1.5 DLH per unit = £60 per DLH
Gadgets: £60 per unit/1.2 DLH per unit = £50 per DLH

b. £2,199,930

Widgets: 20,000 DLH => 13,333 units

(13,333  £90) £1,199,970
Gadgets: 20,000 DLH => 16,666 units
(16,666  £60) ___999,960
Total contribution margin £2,199,930

c. £2,299,980

From requirement a, produce widgets first.

20,000 units  1.5 DLH per unit = 30,000 DLH to produce widgets

Use remaining 10,000 DLH available to produce gadgets.

10,000 DLH/1.2 DLH per unit = 8,333 units of gadgets

Widgets (20,000 units  £90) £1,800,000

Gadgets (8,333 units  £60) ___499,980
Total contribution margin £2,299,980

PTS: 1

14. Terrazo Ltd. produces three kinds of ceramic tile that are used in home and office construction. Details
of each type of tile are as follows:

Type I Type II Type III

Price per unit £40 £60 £100
Unit variable cost £10 £28 £ 48
Machine hours required .2 .5 1.25

Terrazo has 30,000 machine hours available for production.

Required:

Assume that Terrazo can sell all of each type of tile that it produces.

a. Determine the amount of each type of tile that Terrazo should produce.
b. Determine Terrazo's contribution margin using your decision in requirement a.
 c. Assume that the demand for each type of tile is limited to 20,000 units each. Determine
the amount of each type of tile that Terrazo should produce.
d. Determine Terrazo's contribution margin using your decision in requirement b.

ANS:
Contribution margin per scarce unit of resource:
Type I: (£40 - £10)/.2 = £150 per machine hour
Type II: (£60 - £28)/.5 = £64 per machine hour
Type III: (£100 - £48)/1.25 = £41.60 per machine hour

a. Type I: 150,000 units (30,000 machine hours/.20)

b. £4,500,000 (150,000 units  £30)

c. Type I: 20,000 units

Type II: 20,000 units
Type III: 12,800 units

Type I: 20,000 units  .2 = 4,000 hours

Type II: 20,000 units  .5 = 10,000 hours
Type III: 12,800 units  1.25 = 16,000 hours
30,000 hours

d. £1,905,600

Type I: 20,000 units  £30 = £ 600,000

Type II: 20,000 units  £32 = 640,000
Type III: 12,800 units  £52 = __665,600
£1,905,600

PTS: 1

15. KnitWorks Ltd. produces three kinds of yarn. Details of each type of yarn are as follows:

Type I Type II Type III

Price per unit £200 £250 £100
Unit variable cost £150 £100 £ 60
Machine hours required 0.5 2.0 0.1

KnitWorks has 15,000 machine hours available for production.

Required:

Assume that KnitWorks can sell all of each type of yarn that it produces.

a. Determine the amount of each type of yarn that KnitWorks should produce.
b. Assume that the demand for each type of yarn is limited to 10,000 units each. Determine the amount
of each type of yarn that KnitWorks should produce.
c. Assume that the demand for each type of yarn is limited to 10,000 units each. Determine KnitWorks'
contribution margin.

ANS:
 Contribution margin per scarce unit of resource:

Type I: (£200 - £150)/0.5 = £100 per machine hour

Type II: (£250 - £100)/2.0 = £75 per machine hour
Type III: (£100 - £60)/0.1 = £400 per machine hour

a. Type III: 150,000 units (15,000 machine hours/0.1)

b. Type III: 10,000 units

Type I: 10,000 units
Type II: 4,500 units

Type III: 10,000 units  0.1 = 1,000 hours

Type I: 10,000 units  0.5 = 5,000 hours
Type II: 4,500 units  2.0 = _9,000 hours
15,000 hours

c. £1,575,000

Type III: 10,000 units  £40 = £ 400,000

Type I: 10,000 units  £50 = 500,000
Type II: 4,500 units  £150 = _675,000
£1,575,000

PTS: 1

SHORT ANSWER

1. What is a sunk cost? Under what circumstances are sunk costs relevant to a decision? Construct an
example of a sunk cost. Briefly discuss why you think financial reports for investors and managerial
reports for mangers may or may not differ in their treatment of sunk costs.

ANS:
Sunk costs are costs that result from past decisions and cannot be changed. Sunk costs are never
relevant to decision making because decisions involve implications for the future. (However, some
students may note that sunk costs considered in a decision context can have implications for future
cash flows by affecting tax calculations). Financial reports are designed to provide investors with
information that is, among other things, reliable. Such reports generally measure events on the basis of
historical costs, which are obviously sunk costs reflecting past actions. Managerial reports are
designed to provide decision makers with the information to make good decisions. Such reports omit
sunk costs, which could lead decision makers to erroneous conclusions.

PTS: 1

2. What is an opportunity cost? Under what circumstances are opportunity costs relevant to a decision?
Construct an example of an opportunity cost. Briefly discuss why you think financial reports for
investors and managerial reports for mangers may or may not differ in their treatment of opportunity
costs.

ANS:
Opportunity costs are the net cash inflows that could have been obtained if the resources committed to
one action were used in the most desirable alternative. Opportunity costs are relevant to decision
making because the cost of selecting a particular alternative includes the implications from not being
able to select the other alternatives. Financial reporting is concerned with providing investors with
information that is, among other things, reliable. These reports would not attempt to measure events on
the basis of something so subjective and theoretical as an opportunity cost. Managerial reports are
concerned with providing decision makers the information to make good decisions. Such reports
should include some consideration of the opportunities that decision makers are conceding when
making a particular decision.

PTS: 1