CHAPTER 11 (COST) - HOMEWORK SOLUTIONS

CHAPTER 11 - HOMEWORK SOLUTIONS PROBLEM 1 Sharman Athletic Gear Incorporated (SAG) is considering a special order for 15,000 baseball caps with the logo of East Texas University (ETU) to be purchased by the ETU alumni association. The ETU alumni association is planning to use the caps as gifts and to sell some of the caps at alumni events in celebration of the university’s recent national championship by its baseball team. Sharman’s full manufacturing cost per hat is $3.50, which includes $1.50 fixed overhead cost related to plant capacity and equipment. ETU has made a firm offer of $35,000 for the hats, and Sharman, considering the price to be far below production costs, decides to decline the offer. Required: 1-a. Determine the total cost of the special order. ’E)tal cost of the special order r $ 30,000 1-b. In terms of maximizing short-term operating profit, did Sharman make the wrong decision in declining the offer from ETU? ® Yes O No Explanation: 1. By accepting the special sales order, short-term operating profit for Sharman would have increased by $5,000: The relevant manufacturing cost is $3.50 — $1.50 = $2.00 per cap, or $2.00 x 15,000 = $30,000 total cost. The special sales offer was for $35,000. Thus, short-term operating profit would have increased by $5,000 ($35,000 - $30,000). This is a missed opportunity for Sharman, caused by a mistaken reliance on full-cost, rather than relevant cost, information.

PROBLEM 2 Vista Company manufactures electronic equipment. In 2021, it purchased from an outside supplier the special switches used in each of its products. The supplier charged Vista $2 per switch. As an alternative, Vista’s CEO considered purchasing either machine A or machine B so the company could manufacture its own switches. The CEO decided at the beginning of 2022 to purchase machine A, based on the following data: Machine A Machine B Annual fixed cost (depreciation) $ 135,000 $ 204,000 Variable cost per switch 0.65 0.30 Required: 1. Assume that machine A has not yet been purchased. What is the annual volume that would make the company indifferent between the two decision alternatives (i.e., purchasing and then using machine A to make the switches versus purchasing the switches from the outside vendor)? 2. Assume that machine A has already been purchased. Is it preferable to use machine A to make the switches or to purchase the switches from the external supplier? 3. Assume that machine A has already been purchased. At what annual volume level should Vista consider replacing machine A with machine B? Complete this question by entering your answers in the tabs below. | { Required 1 | Required 2 Required 3 1 Assume that machine A has not yet been purchased. What is the annual volume that would make the company indifferent between the two decision alternatives (i.e., purchasing and then using machine A to make the switches versus purchasing the switches from the outside vendor)? (Do not round intermediate calculations. Round your final answer up to the nearest whole number.) Indifference point [ 100,000| units/year i This requirement assumes that machine A has not yet been purchased. The proper approach here is to compare the relevant cost of purchasing from an external supplier to the relevant cost of producing the switches internally using Machine A. As indicated below, if annual volume is at least 100,000 units, Vista should purchase and use Machine A to produce the switches: External = Machine A $2.00Q = $0.65Q + $135,000 Q =$135,000/ ($2.00 - $0.65)/unit Q = 100,000 units The above formulation leads to a general model in identifying an indifference point (volume level) when both differential fixed costs and differential variable costs are involved in the decision. Define the indifference point (volume) as the difference in fixed costs for the two decision alternatives divided by the difference in variable cost per unit, as follows: Fixed costlyear, if Vista makes $ 135,000 Fixed cost/year, if Vista buys 0 Difference $ 135,000 Variable cost/unit, if Vista buys $2.00 Variable cost/unit, if Vista makes 0.65 Difference $1.35 Thus, the indifference point = $135,000 / $1.35/unit = 100,000 units/year. If anticipated volume > 100,000 units/year, then purchasing Machine A to make the switches is preferable to purchasing the switches from an external supplier. Required 1 Required 2 Required 3 Assume that machine A has already been purchased. Is it preferable to use machine A to make the switches or to purchase the switches from the external supplier? .Use machine A to make the switches. OPurchase the switches from the external supplier.

PROBLEM 3 Barbour Corporation, located in Buffalo, New York, is a retailer of high-tech products and is known for its excellent quality and innovation. Recently, the firm conducted a relevant cost analysis of one of its product lines that has only two products, T-1 and T-2. The sales for T-2 are decreasing and the purchase costs are increasing. The firm might drop T-2 and sell only T-1. Barbour allocates fixed costs to products on the basis of sales revenue. When the president of Barbour saw the income statements (see below), he agreed that T-2 should be dropped. If T-2 is dropped, sales of T-1 are expected to increase by 10 percent next year, but the firm’s cost structure will remain the same. T1 T-2 Sales $ 200,000 $ 260,000 Variable costs: Cost of goods sold 70,000 130,000 Selling & administrative 20,000 50,000 Contribution margin $ 110,000 $ 80,000 Fixed expenses: Fixed corporate costs 58,700 76,300 Fixed selling and administrative 14,300 18,700 Total fixed expenses $ 73,000 $ 95,000 Operating income $ 37,000 $ (15,000) Required: 1. Find the expected change in annual operating income by dropping T-2 and selling only T-1. 2. By what percentage would sales from T-1 have to increase in order to make up the financial loss from dropping T-2? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).) 3. What is the required percentage increase in sales from T-1 to compensate for lost margin from T-2, if total fixed costs can be reduced by $45,000? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).) f* | Net loss on discontinuing T-2 [ v] $ 69,000 Required % increase in sales from T-1 72.73+-001| % Required % increase in sales from T-1 31.82+-001| % 1 Expected change in annual operating income (rounded to nearst whole dollar): Product T-1: Last year's contribution margin = $200,000 - $70,000 - $20,000 = $110,000 Contribution margin ratio (%) = 55.00% Product T-2: Last year's contribution margin = $260,000 - $130,000 - $50,000 = $80,000 Contribution margin ratio (%) = 30.77% Incremental CM from T-1 if T-2 is dropped = $110,000 x 0.10 = $11,000 The net effect of discontinuing T-2 is the incremental CM for T-1 reduced by the CM lost from T-2: = $11,000 - $80,000 = ($69,000) (rounded tc nearest whole dollar) . Required % increase in sales of T-1, to compensate for lost margin from T-2: Loss of CM, T-2 = Gain in CM, T-1 $80,000 = X% x $110,000 X = $80,000/$110,000 = 72.73% (rounded to 2 decimal places) Check: Last year's total CM = $190,000 Projected (1.7273 x $110,000) = $190,003 (rounding error) B Required % increase in sales for T-1 (rounded to two decimal places) to compensate for the loss of T-2 accompanied by a decrease in total fixed costs of $45,000? Loss of CM, T-2 = Gain in CM, T-1 $80,000 - $45,000 = X% x $110,000 X =$35,000/$110,000 = 31.82% (rounded to two decimal places) Check: Last year's total operating income = $22,000 Projected = ($38,000 - $16,000) + (31.82% x $110,000) — $80,000 + $45,000 = $22,002

PROBLEM 4 Cantel Company produces cleaning compounds for both commercial and household customers. Some of these products are produced as part of a joint manufacturing process. For example, GR37, a coarse cleaning powder meant for commercial sale, costs $1.60 a pound to make and sells for $2.00 per pound. A portion of the annual production of GR37 is retained for further processing in a separate department where it is combined with several other ingredients to form SilPol, which is sold as a silver polish, at $4.00 per unit. The additional processing requires ¥ pound of GR37 per unit; additional processing costs amount to $2.50 per unit of SilPol produced. Variable selling costs for SilPol average $0.30 per unit. If production of SilPol were discontinued, $5,600 of costs in the processing department would be avoided. Cantel has, at this point, unlimited demand for, but limited capacity to produce, product GR37. Required: 1. Calculate the minimum number of units of SilPol that would have to be sold in order to justify further processing of GR37. 2. Assume that the cost data reported for GR37 are obtained at a level of output equal to 5,000 pounds, which is the maximum that the company can produce at this time. What is the expected operating income (loss) under each of the following scenarios: (a) all available capacity is used to produce GR37, but no SilPol; (b) 4,000 units of SilPol are produced, with the balance of capacity devoted to the production and sale of GR37; (c) 8,000 units of SilPol are produced, with the balance of capacity devoted to the production and sale of GR37; and (d) 10,000 units of SilPol are produced, with the balance of capacity devoted to the production and sale of GR37. Complete this question by entering your answers in the tabs below. Required 1 Required 2 Calculate the minimum number of units of SilPol that would have to be sold in order to justify further processing of GR37. (Round your answer to nearest whole number.) ‘Mflmum number of units of SilPol r 8,000” The key is to identify the relevant costs and revenues associated with any GR37 diverted for production of SilPol (silver polish). Incremental fixed costs (SilPol) = $5,600 Incremental contribution margin/unit sold: Selling price per unit $4.00 Less: Relevant costs: Opportunity cost: lost revenue from GR37: GR37 selling price/pound $2.00 Conversion rate 0.25 $ 0.50 Out-of-Pocket costs: Additional processing/unit $2.50 Variable selling cost/unit $0.30 $2.80 Contribution margin/unit of SilPol sold $0.70 Thus, to justify diversion of GR37 to produce SilPol (thereby incurring additional fixed costs of $5,600), we would have to sell at least $5,600 / $0.70 per unit = 8,000 units of SilPol.