CHAPTER 11 DECISION MAKING AND RELEVANT INFORMATION 11-1 The five steps in the decision process outlined in Exhibit

11-1 of the text are:

1. 2. 3. !. #. Obtain information Make predictions about future costs hoose an alternative "mplement the decision Evaluate performance to provide feedback

11-2 $elevant costs are expected future costs that differ amon% the alternative courses of
action bein% considered. &istorical costs are irrelevant because the' are past costs and( therefore( cannot differ amon% alternative future courses of action.

11-3 )o. $elevant costs are defined as those expected future costs that differ amon%
alternative courses of action bein% considered. Thus( future costs that do not differ amon% the alternatives are irrelevant to decidin% *hich alternative to choose.

11-4 +uantitative factors are outcomes that are measured in numerical terms.

,ome -uantitative factors are financial..that is( the' can be easil' expressed in monetar' terms. /irect materials is an example of a -uantitative financial factor. +ualitative factors are outcomes that are difficult to measure accuratel' in numerical terms. 0n example is emplo'ee morale.

11-5 T*o potential problems that should be avoided in relevant cost anal'sis are:
1. 2. /o not assume all variable costs are relevant and all fixed costs are irrelevant. /o not use unit-cost data directl'. "t can mislead decision makers because a. it ma' include irrelevant costs( and b. comparisons of unit costs computed at different output levels lead to erroneous conclusions

11-6 )o. ,ome variable costs ma' not differ amon% the alternatives under consideration and(
hence( *ill be irrelevant. ,ome fixed costs ma' differ amon% the alternatives and( hence( *ill be relevant.

11-7 )o. ,ome of the total unit costs to manufacture a product ma' be fixed costs( and( hence(
*ill not differ bet*een the make and bu' alternatives. These fixed costs are irrelevant to the make-or-bu' decision. The ke' comparison is bet*een purchase costs and the costs that *ill be saved if the compan' purchases the component parts from outside plus the additional benefits of usin% the resources freed up in the next best alternative use 1opportunit' cost2.

11-8 Opportunit' cost is the contribution to income that is for%one 1re3ected2 b' not usin% a
limited resource in its next-best alternative use.

11-1

11-9

)o. 4hen decidin% on the -uantit' of inventor' to bu'( mana%ers must consider both the purchase cost per unit and the opportunit' cost of funds invested in the inventor'. 5or example( the purchase cost per unit ma' be lo* *hen the -uantit' of inventor' purchased is lar%e( but the benefit of the lo*er cost ma' be more than offset b' the hi%h opportunit' cost of the funds invested in ac-uirin% and holdin% inventor'.

11-10 )o. Mana%ers should aim to %et the hi%hest contribution mar%in per unit of the
constrainin% 1that is( scarce( limitin%( or critical2 factor. The constrainin% factor is *hat restricts or limits the production or sale of a %iven product 1for example( availabilit' of machine-hours2.

11-11 )o. 5or example( if the revenues that *ill be lost exceed the costs that *ill be saved(
the branch or business se%ment should not be shut do*n. ,huttin% do*n *ill onl' increase the loss. 0llocated costs are al*a's irrelevant to the shuttin% do*n decision.

11-12

ost *ritten off as depreciation is irrelevant *hen it pertains to a past cost. 6ut the purchase cost of ne* e-uipment to be ac-uired in the future that *ill then be *ritten off as depreciation is often relevant.

11-13 )o. Mana%ers tend to favor the alternative that makes their performance look best so
the' focus on the measures used in the performance-evaluation model. "f the performanceevaluation model does not emphasi7e maximi7in% operatin% income or minimi7in% costs( mana%ers *ill most likel' not choose the alternative that maximi7es operatin% income or minimi7es costs.

11-14 The three steps in solvin% a linear pro%rammin% problem are:

1. 2. 3. /etermine the ob3ective function. ,pecif' the constraints. ompute the optimal solution.

11-15 The text outlines t*o methods of determinin% the optimal solution to an 89 problem:
1. Trial-and-error solution approach 2. :raphical solution approach Most 89 applications in practice use standard soft*are packa%es that rel' on the simplex method to compute the optimal solution.

11-2

11-16 12; min.2 Di !" #$ "% # &' (

1. This is an unfortunate situation( 'et the <=;(;;; costs are irrelevant re%ardin% the decision to remachine or scrap. The onl' relevant factors are the future revenues and future costs. 6' i%norin% the accumulated costs and decidin% on the basis of expected future costs( operatin% income *ill be maximi7ed 1or losses minimi7ed2. The difference in favor of remachinin% is <3(;;;: )#* R&,#-.i/& 5uture revenues /educt future costs Operatin% income /ifference in favor of remachinin% <3#(;;; 3;(;;; < #(;;; <3(;;; )+* S-0#! <2(;;; . <2(;;;

2. This( too( is an unfortunate situation. 6ut the <1;;(;;; ori%inal cost is irrelevant to this decision. The difference in relevant costs in favor of rebuildin% is <>(;;; as follo*s: )#* R&!$#-& )e* truck /educt current disposal price of existin% truck $ebuild existin% truck <1;2(;;; 1;(;;; . < ?2(;;; <>(;;; )+* R&+1i$2 . . <=#(;;; <=#(;;;

/ifference in favor of rebuildin%

)ote( here( that the current disposal price of <1;(;;; is relevant( but the ori%inal cost 1or book value( if the truck *ere not brand ne*2 is irrelevant.

11-3

11-17 11; min.2 T.& -#0&&/i/3 !&0 "/#$ -",!1'&0(

onsidered alone( book value is irrelevant as a measure of loss *hen e-uipment is destro'ed. The measure of the loss is replacement cost or some computation of the present value of future services lost because of e-uipment loss or dama%e. "n the specific case described( the follo*in% observations ma' be apt: 1. 0 full' depreciated item probabl' is relativel' old. hances are that the loss from this e-uipment is less than the loss for a partiall' depreciated item because the replacement cost of an old item *ould be far less than that for a nearl' ne* item. 2. The loss of an old item( assumin% replacement is necessar'( automaticall' accelerates the timin% of replacement. Thus( if the old item *ere to be 3unked and replaced tomorro*( no economic loss *ould be evident. &o*ever( if the old item *ere supposed to last five more 'ears( replacement is accelerated five 'ears. The best practical measure of such a loss probabl' *ould be the cost of comparable used e-uipment that had five 'ears of remainin% useful life. The fact that the computer *as full' depreciated also means the accountin% reports *ill not be affected b' the accident. "f accountin% reports are used to evaluate the office mana%er@s performance( the mana%er *ill prefer an' accidents to be on full' depreciated units.

11-18 11# min.2 M1$'i!$& -."i-&(

1. 1b2 ,pecial order price per unit Bariable manufacturin% cost per unit ontribution mar%in per unit Effect on operatin% income 2. 1b2 C <1.#; 2;(;;; units C <3;(;;; increase <1(2;;(;;; <!= ? <#> 1(1!;(;;; A;(;;; 2#(;;; < =#(;;; <A.;; !.#; <1.#;

osts of purchases( 2;(;;; units <A; Total relevant costs of makin%: Bariable manufacturin% costs( <A! . <1A 5ixed costs eliminated osts saved b' not makin% Multipl' b' 2;(;;; units( so total costs saved are <#> 2;(;;; Extra costs of purchasin% outside Minimum overall savin%s for $eno )ecessar' relevant costs that *ould have to be saved in manufacturin% 9art )o. #>#

11-!

11-19 13; min.2 S!&-i#$ "02&04 #-'i5i'6-+# &2 -" 'i/3 1 M0( adapted2.
1. 0*ard 9lus@s operatin% income under the alternatives of acceptin%Dre3ectin% the special order are: 7i'."1' O/&7i'. O/&Ti,& O/$6 Ti,& O/$6 S!&-i#$ O02&0 S!&-i#$ O02&0 74500 8/i' 104000 8/i' $evenues Bariable costs: /irect materials /irect manufacturin% labor 6atch manufacturin% costs 5ixed costs: 5ixed manufacturin% costs 5ixed marketin% costs Total costs Operatin% income
1

Di%%&0&/-& 24500 8/i' <2#;(;;; =>(#;; 1;;(;;; 12(#;; .. .. 2;;(;;; < #;(;;;

<1(12#(;;; 2A2(#;; 3;;(;;; >#(;;; 2>#(;;; 1>#(;;; 1(;=>(#;; < 3>(#;;

2

<1(3>#(;;; 3#;(;;;1 !;;(;;;2 =>(#;;3 2>#(;;; 1>#(;;; 1(2=>(#;; < =>(#;;

3

<2A2(#;; 1;(;;; >(#;;

<3;;(;;; 1;(;;; >(#;;

<>#(;;; E 12# <#;;2

0lternativel'( *e could calculate the incremental revenue and the incremental costs of the additional 2(#;; units as follo*s: "ncremental revenue <1;; 2(#;; "ncremental direct manufacturin% costs "ncremental direct manufacturin% costs "ncremental batch manufacturin% costs Total incremental costs Total incremental operatin% income from acceptin% the special order
<2A2(#;; 2(#;; >(#;; 3;;(;;; 2(#;; >(#;;

<2#;(;;; =>(#;; 1;;(;;; 12(#;; 2;;(;;; < #;(;;;

<#;; 2#

0*ard 9lus should accept the one-time-onl' special order if it has no lon%-term implications because acceptin% the order increases 0*ard 9lus@s operatin% income b' <#;(;;;. "f( ho*ever( acceptin% the special order *ould cause the re%ular customers to be dissatisfied or to demand lo*er prices( then 0*ard 9lus *ill have to trade off the <#;(;;; %ain from acceptin% the special order a%ainst the operatin% income it mi%ht lose from re%ular customers.

11-#

11(19 1 ontFd.2 2. 0*ard 9lus has a capacit' of ?(;;; medals. Therefore( if it accepts the special one-time order of 2(#;; medals( it can sell onl' A(#;; medals instead of the >(#;; medals that it currentl' sells to existin% customers. That is( b' acceptin% the special order( 0*ard 9lus must for%o sales of 1(;;; medals to its re%ular customers. 0lternativel'( 0*ard 9lus can re3ect the special order and continue to sell >(#;; medals to its re%ular customers. 0*ard 9lus@s operatin% income from sellin% A(#;; medals to re%ular customers and 2(#;; medals under one-time special order follo*: $evenues 1A(#;; <1#;2 E 12(#;; <1;;2 /irect materials 1A(#;; <3#12 E 12(#;; <3#12 /irect manufacturin% labor 1A(#;; <!;22 E12(#;; <!;22 6atch manufacturin% costs 113;3 <#;;2 E 12# <#;;2 5ixed manufacturin% costs 5ixed marketin% costs Total costs Operatin% income
1

<1(22#(;;; 31#(;;; 3A;(;;; >>(#;; 2>#(;;; 1>#(;;; 1(2;2(#;; < 22(#;;

<2A2(#;; 3;;(;;; 2 <!; C >(#;; >(#;; 3 0*ard 9lus makes re%ular medals in batch si7es of #;. To produce A(#;; medals re-uires 13; 1A(#;; G #;2 batches.

<3# C

0cceptin% the special order *ill result in a decrease in operatin% income of <1#(;;; 1<3>(#;; . <22(#;;2. The special order should( therefore( be re3ected. 0 more direct approach *ould be to focus on the incremental effects..the benefits of acceptin% the special order of 2(#;; units versus the costs of sellin% 1(;;; fe*er units to re%ular customers. "ncrease in operatin% income from the 2(#;;-unit special order e-uals <#;(;;; 1re-uirement 12. The loss in operatin% income from sellin% 1(;;; fe*er units to re%ular customers e-uals: 8ost revenue( <1#; 1(;;; ,avin%s in direct materials costs( <3# 1(;;; ,avin%s in direct manufacturin% labor costs( <!; 1(;;; ,avin%s in batch manufacturin% costs( <#;; 2; Operatin% income lost <11#;(;;;2 3#(;;; !;(;;; 1;(;;; < 1A#(;;;2

0cceptin% the special order *ill result in a decrease in operatin% income of <1#(;;; 1<#;(;;; . <A#(;;;2. The special order should( therefore( be re3ected. 3. 0*ard 9lus should not accept the special order. "ncrease in operatin% income b' sellin% 2(#;; units under the special order 1re-uirement 12 Operatin% income lost from existin% customers 1<1; >(#;;2 )et effect on operatin% income of acceptin% special order The special order should( therefore( be re3ected. < #;(;;; 1>#(;;;2 <12#(;;;2

11-A

11-20 13; min.2 M#9& 5&0 1 +164 #-'i5i'6-+# &2 -" 'i/3(
1. The expected manufacturin% cost per unit of M 6s in 2;;! is as follo*s: T"'#$ M#/1%#-'10i/3 C" ' "% CMC: )1* <1(>;;(;;; !#;(;;; 12;(;;; 32;(;;; =;;(;;; <3(3?;(;;; M#/1%#-'10i/3 C" ' !&0 8/i' )2* ; )1* < 104000 <1>; !# 12 32 =; <33?

/irect materials( <1>; 1;(;;; /irect manufacturin% labor( <!# 1;(;;; Bariable batch manufacturin% costs( <1(#;; =; 5ixed manufacturin% costs 0voidable fixed manufacturin% costs Hnavoidable fixed manufacturin% costs Total manufacturin% costs

2. The follo*in% table identifies the incremental costs in 2;;! if ,venson 1a2 made M 6s and 1b2 purchased M 6s from Minton. T"'#$ I/-0&,&/'#$ C" ' M#9& :16 < 3(;;;(;;; <1(>;;(;;; !#;(;;; 12;(;;; 32;(;;; <2(#?;(;;; <3(;;;(;;; =!1;(;;; P&0-8/i' I/-0&,&/'#$ C" ' M#9& :16 <3;; <1>; !# 12 32 <2#? <3;; <!1

I/-0&,&/'#$ I'&, ost of purchasin% M 6s from Minton /irect materials /irect manufacturin% labor Bariable batch manufacturin% costs 0voidable fixed manufacturin% costs Total incremental costs /ifference in favor of makin%

)ote that the opportunit' cost of usin% capacit' to make M 6s is 7ero since ,venson *ould keep this capacit' idle if it purchases M 6s from Minton. ,venson should continue to manufacture the M 6s internall' since the incremental costs to manufacture are <2#? per unit compared to the <3;; per unit that Minton has -uoted. )ote that the unavoidable fixed manufacturin% costs of <=;;(;;; 1<=; per unit2 *ill continue to be incurred *hether ,venson makes or bu's M 6s. These are not incremental costs under either the make or the bu' alternative and are( hence( irrelevant. 3. ,venson should continue to make M 6s. The simplest *a' to anal'7e this problem is to reco%ni7e that ,venson *ould prefer to keep an' excess capacit' idle rather than use it to make 63s. 4h'I 6ecause expected incremental future revenues from 63s( <2(;;;(;;; are less than expected incremental future costs( <2(1#;(;;;. "f ,venson keeps its capacit' idle( *e kno* from re-uirement 2 that it should make M 6s rather than bu' them.

11->

11(20 1 ontFd.2 0n important point to note is that( because ,venson for%oes no contribution b' not bein% able to make and sell 63s( the opportunit' cost of usin% its facilities to make M 6s is 7ero. "t is( therefore( not for%oin% an' profits b' usin% the capacit' to manufacture M 6s. "f it does not manufacture M 6s( rather than lose mone' on 63s( ,venson *ill keep capacit' idle. 0 lon%er and more detailed approach is to use the total alternatives or opportunit' cost anal'ses sho*n in Exhibit 11-> of the chapter. C."i-& %"0 S5&/ "/ M#9& CMC: :16 CMC: :16 CMC: #/2 D" N"' #/2 D" N"' #/2 M#9& R&$&5#/' I'&, M#9& C:3 M#9& C:3 C:3 TOT08-08TE$)0T"BE, 099$O0 & TO M0JE-O$-6HK /E ","O), Total incremental costs of makin%Dbu'in% M 6s 1from re-uirement 22 Excess of future costs over future revenues from 63s Total relevant costs

<2(#?;(;;; ; <2(#?;(;;;

<3(;;;(;;; ; <3(;;;(;;;

<3(;;;(;;; 1#;(;;; <3(1#;(;;;

,venson *ill minimi7e manufacturin% costs b' makin% M 6s. O99O$TH)"TK- O,T 099$O0 & TO M0JE-O$-6HK /E ","O), Total incremental costs of makin%Dbu'in% M 6s 1from re-uirement 22 <2(#?;(;;; <3(;;;(;;; Opportunit' cost: profit contribution for%one because capacit' *ill not be used to make 63s ;L ;L Total relevant costs <2(#?;(;;; <3(;;;(;;;

<3(;;;(;;; ; <3(;;;(;;;

LOpportunit' cost is ; because ,venson does not %ive up an'thin% b' not makin% 63s. ,venson is best off leavin% the capacit' idle 1rather than manufacturin% and sellin% 63s2.

11-=

11-21 11; min.2 I/5&/'"06 2&-i i"/4 "!!"0'1/i'6 -" ' (

1. Hnit cost( orders of 2;(;;; Hnit cost( order of 2!;(;;; 1;.?# <=.;;2 Alternatives under consideration: 1a2 6u' 2!;(;;; units at start of 'ear. 1b2 6u' 2;(;;; units at start of each month. Average investment in inventory: 1a2 12!;(;;; <>.A;2 G 2 1b2 1 2;(;;; <=.;;2 G 2 /ifference in avera%e investment <?12(;;; =;(;;; <=32(;;; <=.;; <>.A;

Opportunit' cost of interest for%one from 2!;(;;;-unit purchase at start of 'ear C <=32(;;; ;.;= C <AA(#A; 2. )o. The <AA(#A; is an opportunit' cost rather than an incremental or outla' cost. )o actual transaction records the <AA(#A; as an entr' in the accountin% s'stem. 3. The follo*in% table presents the t*o alternatives: A$'&0/#'i5& A> A$'&0/#'i5& :> P10-.# & P10-.# & 2404000 204000 !#09 !$13 #' !#09 !$13 +&3i//i/3 "% #' +&3i//i/3 6&#0 "% &#-. ,"/'. Di%%&0&/-& )1* )2* )3 *; )1* ? )2* 0nnual purchase-order costs 11 <2;;M 12 <2;;2 0nnual purchase 1incremental2 costs 12!;(;;; <>.A;M 2!;(;;; <=2 0nnual interest income that could be earned if investment in inventor' *ere invested 1opportunit' cost2 1=N <?12(;;;M =N <=;(;;;2 $elevant costs < 2;; 1(=2!(;;; < 2(!;; 1(?2;(;;; < 12(2;;2 1?A(;;;2

>2(?A; <1(=?>(1A;

A(!;; <1(?2=(=;;

AA(#A; < 131(A!;2

olumn 132 indicates that purchasin% 2!;(;;; spark plu%s at the be%innin% of the 'ear is preferred relative to purchasin% 2;(;;; spark plu%s at the be%innin% of each month because the lo*er purchase cost exceeds the opportunit' cost of holdin% lar%er inventor'. "f other incremental benefits of holdin% lo*er inventor' such as lo*er insurance( materials handlin%( stora%e( obsolescence( and breaka%e costs *ere considered( the costs under 0lternative 0 *ould have been hi%her( and 0lternative 6 ma' have been preferred.

11-?

11-22 12;.2# min.2 R&$&5#/' -" ' 4 -"/'0i+1'i"/ ,#03i/4 !0"21-' &,!.# i (
1. ,ellin% price /educt variable cost per case ontribution mar%in per case C"$# <1=.;; 13.#; < !.#; L&,"/#2& <1?.2; 1#.2; < !.;; P1/-. <2A.!; 2;.1; < A.3; N#'10#$ O0#/3& @1i-& <3=.!; 3;.2; < =.2;

2. The ar%ument fails to reco%ni7e that shelf space is the constrainin% factor. There are onl' 12 feet of front shelf space to be devoted to drinks. ,exton should aim to %et the hi%hest dail' contribution mar%in per foot of front shelf space: N#'10#$ O0#/3& @1i-& < =.2; #

ontribution mar%in per case ,ales 1number of cases2 per foot of shelf space per da' /ail' contribution per foot of front shelf space 3.

C"$# < !.#; 2#

L&,"/#2& < !.;; 2!

P1/-. < A.3; !

<112.#;

<?A.;;

<2#.2;

<!1.;;

The allocation that maximi7es the dail' contribution from soft drink sales is: F&&' "% S.&$% S!#-& A ! 1 1 D#i$6 C"/'0i+1'i"/ !&0 F""' "% F0"/' S.&$% S!#-& <112.#; ?A.;; !1.;; 2#.2; T"'#$ C"/'0i+1'i"/ M#03i/ !&0 D#6 < A>#.;; 3=!.;; !1.;; 2#.2; <1(12#.2;

ola 8emonade )atural Oran%e Ouice 9unch

The maximum of six feet of front shelf space *ill be devoted to ola because it has the hi%hest contribution mar%in per unit of the constrainin% factor. 5our feet of front shelf space *ill be devoted to 8emonade( *hich has the second hi%hest contribution mar%in per unit of the constrainin% factor. )o more shelf space can be devoted to 8emonade since each of the remainin% t*o products( )atural Oran%e Ouice and 9unch 1that have the second lo*est and lo*est contribution mar%ins per unit of the constrainin% factor2 must each be %iven at least one foot of front shelf space.

11-1;

11-23 11; min.2 S&$&-'i"/ "% ," ' !0"%i'#+$& !0"21-'(

Onl' Model 1! should be produced. The ke' to this problem is the relationship of manufacturin% overhead to each product. )ote that it takes t*ice as lon% to produce Model ?M machine-hours for Model ? are t*ice that for Model 1!. Mana%ement should choose the product mix that maximi7es operatin% income for a %iven production capacit' 1the scarce resource in this situation2. "n this case( Model 1! *ill 'ield a <?.#; contribution to fixed costs per machine hour( and Model ? *ill 'ield <?.;;: M"2&$ 9 ,ellin% price Bariable costs per unit ontribution mar%in per unit $elative use of machine-hours per unit of product ontribution mar%in per machine hour <1;;.;; =2.;; < 1=.;; G 2 < ?.;; M"2&$ 14 <>;.;; A;.#; < ?.#; G 1 < ?.#;

11-23 EA-&$ A!!$i-#'i"/

Decision-Making and Relevant Information Body-Builders, Inc. Original Data

Selling Price Costs Direct materials Direct manufacturing labor !ariable manufacturing o"er#ead $i%ed manufacturing o"er#ead Mar&eting costs 'all "ariable( *otal costs ,-erating .ncome

Model 9 $100.00 28.00 1 .00 2 .00 10.00 1).00 92.00 $8.00

$70.00 13.00 2 .00 12. 0 .00 10.00 + . 0 $). 0

Product Mix Analysis Selling -rice !ariable cost -er unit Contribution margin -er unit /elati"e use of mac#ine0#ours -er unit of -roduct Contribution margin -er mac#ine0#our Model 9 $100 82.00 18.00 2 $9.00 Model 1) $70 +0. 0 9. 0 1 $9. 0

11-11

11-24 12; min.2 7.i-. +# & '" -$" &4 0&$&5#/'--" ' #/#$6 i 4 "!!"0'1/i'6 -" ' (
The future outla' operatin% costs *ill be <!;; million re%ardless of *hich base is closed( %iven the additional <1;; million in costs at Everett if 0lameda is closed. 5urther( one of the bases *ill permanentl' remain open *hile the other *ill be shut do*n. The onl' relevant revenue and cost comparisons are: a. <#;; million from sale of the 0lameda base. )ote that the historical cost of buildin% the 0lameda base 1<1;; million2 is irrelevant. )ote( also( that future increases in the value of the land at the 0lameda base is also irrelevant. One of the bases must be kept open( so if it is decided to keep the 0lameda base open( the /efense /epartment *ill not be able to sell this land at a future date. b. <A; million in savin%s in fixed income note if the Everett base is closed. 0%ain( the historical cost of buildin% the Everett base 1<1#; million2 is irrelevant. The relevant costs and benefits anal'sis favors closin% the 0lameda base despite the ob3ections raised b' the alifornia dele%ation in on%ress. The net benefit e-uals <!!; 1<#;; . <A;2 million.

11-25 12#3; min.2 C$" i/3 #/2 "!&/i/3 '"0& (

1. ,olution Exhibit 11-2#( olumn 1( presents the relevant loss in revenues and the relevant savin%s in costs from closin% the $hode "sland store. 8ope7 is correct that ,anche7 orporationFs operatin% income *ould increase b' <>(;;; if it closes do*n the $hode "sland store. losin% do*n the $hode "sland store results in a loss of revenues of <=A;(;;; but cost savin%s of <=A>(;;; 1from cost of %oods sold( rent( labor( utilities( and corporate costs2. )ote that b' closin% do*n the $hode "sland store( ,anche7 orporation *ill save none of the e-uipment-related costs because this is a past cost. 0lso note that the relevant corporate overhead costs are the actual corporate overhead costs <!!(;;; that ,anche7 expects to save b' closin% the $hode "sland store. The corporate overhead of <!;(;;; allocated to the $hode "sland store is irrelevant to the anal'sis. 2. ,olution Exhibit 11-2#( olumn 2( presents the relevant revenues and relevant costs of openin% another store like the $hode "sland store. 8ope7 is correct that openin% such a store *ould increase ,anche7 orporationFs operatin% income b' <11(;;;. "ncremental revenues of <=A;(;;; exceed the incremental costs of <=!?(;;; 1from hi%her cost of %oods sold( rent( labor( utilities( and some additional corporate costs2. )ote that the cost of e-uipment *ritten off as depreciation is relevant because it is an expected future cost that ,anche7 *ill incur onl' if it opens the ne* store. 0lso note that the relevant corporate overhead costs are the <!(;;; of actual corporate overhead costs that ,anche7 expects to incur as a result of openin% the ne* store. ,anche7 ma'( in fact( allocate more than <!(;;; of corporate overhead to the ne* store but this allocation is irrelevant to the anal'sis.

11-12

11-25 1 ontFd.2 The ke' reason that ,anche7Fs operatin% income increases either if it closes do*n the $hode "sland store or if it opens another store like it is the behavior of corporate overhead costs. 6' closin% do*n the $hode "sland store( ,anche7 can si%nificantl' reduce corporate overhead costs presumabl' b' reducin% the corporate staff that oversees the $hode "sland operation. On the other hand( addin% another store like $hode "sland does not increase actual corporate costs b' much( presumabl' because the existin% corporate staff *ill be able to oversee the ne* store as *ell. SOL8TION EBHI:IT 11-25 $elevant-$evenue and $elevant- ost 0nal'sis of 0nother ,tore 8ike "t. losin% $hode "sland ,tore and Openin% I/-0&,&/'#$ 1L" i/ R&5&/1& * R&5&/1& #/2 #/2 S#5i/3 i/ )I/-0&,&/'#$ C" ' * C" ' %0", "% O!&/i/3 N&C C$" i/3 R."2& S'"0& Li9& R."2& I $#/2 S'"0& I $#/2 S'"0& )1* )2* $evenues ost of %oods sold 8ease rent 8abor costs /epreciation of e-uipment Htilities 1electricit'( heatin%2 orporate overhead costs Total costs Effect on operatin% income 1loss2 <1=A;(;;;2 AA;(;;; >#(;;; !2(;;; ; !A(;;; !!(;;; =A>(;;; < >(;;; < =A;(;;; 1AA;(;;;2 1>#(;;;2 1!2(;;;2 122(;;;2 1!A(;;;2 1!(;;;2 1=!?(;;;2 < 11(;;;

11-13

11-26 12; min.2 C."" i/3 -1 '",&0 (

"f 6road*a' accepts the additional business from Jell'( it *ould take an additional #;; machine-hours. "f 6road*a' accepts all of Jell'Fs and Ta'lorFs business for 5ebruar'( it *ould re-uire 2(#;; machine-hours 11(#;; hours for Ta'lor and 1(;;; hours for Jell'2. 6road*a' has onl' 2(;;; hours of machine capacit'. "t must( therefore( choose ho* much of the Ta'lor or Jell' business to accept. To maximi7e operatin% income( 6road*a' should maximi7e contribution mar%in per unit of the constrained resource. 15ixed costs *ill remain unchan%ed at <1;;(;;; re%ardless of the business 6road*a' chooses to accept in 5ebruar'( and is( therefore( irrelevant.2 The contribution mar%in per unit of the constrained resource for each customer in Oanuar' is: T#6$"0 C"0!"0#'i"/ ontribution mar%in per machine-hour
<>=(;;; C <#2 1(#;;

K&$$6 C"0!"0#'i"/
<32(;;; C <A! #;;

,ince the <=;(;;; of additional Jell' business in 5ebruar' is identical to 3obs done in Oanuar'( it *ill also have a contribution mar%in of <A! per machine-hour( *hich is %reater than the contribution mar%in of <#2 per machine-hour from Ta'lor. To maximi7e operatin% income( 6road*a' should first allocate all the capacit' needed to take the Jell' orporation business 11(;;; machine-hours2 and then allocate the remainin% 1(;;; 12(;;; . 1(;;;2 machine-hours to Ta'lor. C"0!"0#'i"/ ontribution mar%in per machine-hour Machine-hours to be *orked ontribution mar%in 5ixed costs Operatin% income T#6$"0 C"0!"0#'i"/ <#2 1(;;; <#2(;;; K&$$6 T"'#$ <A! 1(;;; <A!(;;;

<11A(;;; 1;;(;;; < 1A(;;;

11-1!

11-27 13;.!; min.2 R&$&5#/-& "% &D1i!,&/' -" ' (

1a.

S'#'&,&/' "% C# . R&-&i!' #/2 Di +10 &,&/' K&&! E&#0 1 E&#0 24 34 4

<1#;(;;; 111;(;;;2 11#(;;;2

F"10 E&#0 T"3&'.&0

<A;;(;;; 1!!;(;;;2 1A;(;;;2 12;(;;;2

:16 N&C M#-.i/& F"10 E&#0 E&#0 E&#0 1 24 34 4 T"3&'.&0

<1#;(;;; 111;(;;;2 1?(;;;2 12;(;;;2 12!(;;;2 =(;;; < 1#(;;;2 <1#;(;;; 111;(;;;2 1?(;;;2 <A;;(;;; 1!!;(;;;2 13A(;;;2 12;(;;;2 12!(;;;2 =(;;; < ==(;;;

$eceipts from operations: $evenues /educt disbursements: Other operatin% costs Operation of machine 9urchase of PoldP machine 9urchase of Pne*P e-uipment ash inflo* from sale of old e-uipment )et cash inflo*

<1#;(;;; 111;(;;;2 1 1#(;;;2 12;(;;;2L

<

#(;;;

< 2#(;;;

< =;(;;;

< 31(;;;

L,ome students i%nore this item because it is the same for each alternative. &o*ever( note that a statement for the entire year has been re-uested. Obviousl'( the <2;(;;; *ould affect Kear 1 onl' under both the PkeepP and Pbu'P alternatives.

The difference is <=(;;; for four 'ears taken to%ether. "n particular( note that the <2;(;;; book value can be omitted from the comparison. Merel' cross out the entire lineM althou%h the column totals are affected( the net difference is still <=(;;;.

11-1#

11(27 1 ontFd.2 1b. 0%ain( the difference is <=(;;;: I/-",& S'#'&,&/' K&&! E&#0 14 24 34 4 $evenues osts 1excludin% disposal2: Other operatin% costs /epreciation Operatin% costs of machine Total costs 1excludin% disposal2 8oss on disposal: 6ook value 1PcostP2 9roceeds 1PrevenueP2 8oss on disposal Total costs Operatin% income F"10 E&#0 T"3&'.&0 :16 N&C M#-.i/& F"10 E&#0 E&#0 T"3&'.&0 E&#0 1 24 34 4 <1#;(;;; 11;(;;; A(;;; ?(;;; 12#(;;; <1#;(;;; 11;(;;; A(;;; ?(;;; 12#(;;; <A;;(;;; !!;(;;; 2!(;;; 3A(;;; #;;(;;; 2;(;;;L 1=(;;;2 12(;;; #12(;;; < ==(;;;

<1#;(;;; <A;;(;;; 11;(;;; #(;;; 1#(;;; 13;(;;; !!;(;;; 2;(;;; A;(;;; #2;(;;;

13;(;;; #2;(;;; < 2;(;;; < =;(;;;

2;(;;; 1=(;;;2 12(;;; 13>(;;; 12#(;;; < 13(;;; < 2#(;;;

L0s in part 112( the <2;(;;; book value ma' be omitted from the comparison *ithout chan%in% the <=(;;; difference. This ad3ustment *ould mean excludin% the depreciation item of <#(;;; per 'ear 1a cumulative effect of <2;(;;;2 under the PkeepP alternative and excludin% the book value item of <2;(;;; in the loss on disposal computation under the Pbu'P alternative. 1c. The <2;(;;; purchase cost of the old e-uipment( the revenues( and the other costs are irrelevant because their amounts are common to both alternatives.

2. The net difference *ould be unaffected. 0n' number ma' be substituted for the ori%inal <2;(;;; fi%ure *ithout chan%in% the final ans*er. Of course( the net cash outflo*s under both alternatives *ould be hi%h. The 0uto 4ash mana%er reall' blundered. &o*ever( keepin% the old e-uipment *ill increase the cost of the blunder to the cumulative tune of <=(;;; over the next four 'ears. 3. 6ook value is irrelevant in decisions about the replacement of e-uipment( because it is a past 1historical2 cost. 0ll past costs are do*n the drain. )othin% can chan%e *hat has alread' been spent or *hat has alread' happened. The <2;(;;; has been spent. &o* it is subse-uentl' accounted for is irrelevant. The anal'sis in re-uirement 112 clearl' sho*s that *e ma' completely i%nore the <2;(;;; and still have a correct anal'sis. The onl' relevant items are those expected future items that *ill differ amon% alternatives.

11-1A

11-27 1 ontFd.2 /espite the economic anal'sis sho*n here( man' mana%ers *ould keep the old machine rather than replace it. 4h'I 6ecause( in man' or%ani7ations( the income statements of part 122 *ould be a principal means of evaluatin% performance. )ote that the first-'ear operatin% income *ould be hi%her under the PkeepP alternative. The conventional accrual accountin% model mi%ht motivate mana%ers to*ard maximi7in% their first-'ear reported operatin% income at the expense of lon%-run cumulative betterment for the or%ani7ation as a *hole. This criticism is often made of the accrual accountin% model. That is( the action favored b' the PcorrectP or PbestP economic decision model ma' not be taken because the performance-evaluation model is either inconsistent *ith the decision model or because the focus is on onl' the short-run part of the performance-evaluation model. There is 'et another potential conflict bet*een the decision model and the performance evaluation model. $eplacin% the machine so soon after it is purchased ma' reflect badl' on the mana%erFs capabilities and performance. 4h' didnFt the mana%er search and find the ne* machine before bu'in% the old machineI $eplacin% the old machine one da' later at a loss ma' make the mana%er appear incompetent to his or her superiors. "f the mana%erFs bosses have no kno*led%e of the better machine( the mana%er ma' prefer to keep the existin% machine rather than alert his or her bosses about the better machine.

11-28 13; min.2 ED1i!,&/' 1!30#2& 5&0 1 0&!$#-&,&/' 10. ,pero( adapted2.
1. ,olution Exhibit 11-2= presents a cost comparison of the up%rade and replacement alternatives for the three 'ears taken to%ether. "t indicates that 9acifica orporation should replace the production line because it is better off b' <1=;(;;; b' replacin% rather than up%radin%. SOL8TION EBHI:IT 11-28 omparin% Hp%rade and $eplace 0lternatives T.0&& E&#0 T"3&'.&0 8!30#2& R&!$#-& Di%%&0&/-& )1* )2* )3* ; )1* ? )2* <2(1A;(;;; <1(A2;(;;; < #!;(;;; 1?;(;;;2 ?;(;;; 3;;(;;; <2(!A;(;;; >#;(;;; <2(2=;(;;; 1!#;(;;;2 < 1=;(;;;

ash-operatin% costs( <12M <? 1=;(;;; urrent disposal price One-time capital costs( *ritten off periodicall' as depreciation Total relevant costs

)ote that sales and book value of the existin% machine are the same under both alternatives and( hence( are irrelevant.

11-1>

11(28 1 ontFd.2 2a. ,uppose the capital expenditure to replace the production line is <Q. Hsin% data from ,olution Exhibit 11-2=( the cost of replacin% the production line is e-ual to <1(A2;(;;; . <?;(;;; E <Q. Hsin% data from ,olution Exhibit 11-2=( the cost of up%radin% the production line is e-ual to <2(1A;(;;; E <3;;(;;; C <2(!A;(;;;. 4e *ant to find <Q such that <1(A2;(;;; . <?;(;;; E <Q C <2(!A;(;;; that is( <1(#3;(;;; E <Q C <2(!A;(;;; that is( <Q C <2(!A;(;;; . <1(#3;(;;; or <Q C < ?3;(;;; 9acifica *ould prefer replacin%( rather than up%radin%( the existin% line if the replacement cost of the ne* line does not exceed <?3;(;;;. )ote that the <?3;(;;; can also be obtained b' addin% the <1=;(;;; calculated in re-uirement 1 to the replacement cost of <>#;(;;; for the ne* machine assumed in re-uirement 1 1<>#;(;;; E <1=;(;;; C <?3;(;;;2. 2b. ,uppose the units produced and sold each 'ear e-ual '. Hsin% data from ,olution Exhibit 11-2=( the cost of replacin% the production line is <?' . <?;(;;; E <>#;(;;;( *hile the cost of up%radin% is <12' E <3;;(;;;. 4e solve for the ' at *hich the t*o costs are the same. <?' . <?;(;;; E <>#;(;;; <?' E <AA;(;;; <3' ' C C C C <12' E <3;;(;;; <12' E <3;;(;;; <3A;(;;; 12;(;;; units

5or expected production and sales of less than 12;(;;; units over 3 'ears 1!;(;;; units per 'ear2( the up%rade alternative is cheaper. 4hen production and sales are lo*( the hi%her operatin% costs of up%radin% are more than offset b' the si%nificant savin%s in capital costs *hen up%radin% relative to replacin%. 5or expected production and sales exceedin% 12;(;;; units over 3 'ears( the replace alternative is cheaper. 5or hi%h output( the benefits of the lo*er operatin% costs of replacin%( relative to up%radin%( exceed the hi%her capital costs. 3. Operatin% income for the first 'ear under the up%rade and replace alternatives are as follo*s: 8!30#2& R&!$#-& $evenues <2# A;(;;; <1(#;;(;;; <1(#;;(;;; ash-operatin% costs <12 A;(;;;( <? A;(;;; >2;(;;; #!;(;;; a /epreciation 22;(;;; 2#;(;;;b 8oss on disposal of old production line .. 2>;(;;;c Total costs ?!;(;;; 1(;A;(;;; Operatin% income < #A;(;;; < !!;(;;;
a c b 1<3A;(;;; E <3;;(;;;2 G 3 C <22;(;;; <>#;(;;; G 3 C <2#;(;;; 6ook value . current disposal price C <3A;(;;; . <?;(;;; C <2>;(;;;

5irst-'ear operatin% income is hi%her b' <12;(;;; under the up%rade alternative. "f first 'ear@s operatin% income is an important component of 07in%er@s bonus( he *ould prefer the up%rade over the replace alternative even thou%h the decision model 1in re-uirement 12 prefers the replace to the up%rade alternative. This exercise illustrates the conflict bet*een the decision model and the performance evaluation model. 11-29 13; min.2 C"/'0i+1'i"/ #!!0"#-.4 0&$&5#/' -" ' ( 11-1=

1. 0vera%e one-*a' fare per passen%er ommission at =N of <#;; )et cash to 0ir 5risco per ticket 0vera%e number of passen%ers per fli%ht $evenues per fli%ht 1<!A; R 2;;2 5ood and bevera%e cost per fli%ht 1<2; R 2;;2 Total contribution mar%in from passen%ers per fli%ht 2. "f fare is ommission at =N of <!=; )et cash per ticket 5ood and bevera%e cost per ticket ontribution mar%in per passen%er Total contribution mar%in from passen%ers per fli%ht 1<!21.A; R 2122 0ll other costs are irrelevant.

<

#;; !; < !A; R 2;; <?2(;;; !(;;; <==(;;; <!=;.;; 3=.!; !!1.A; 2;.;; <!21.A; <=?(3>?.2;

On the basis of -uantitative factors alone( 0ir 5risco should decrease its fare to <!=; because reducin% the fare %ives 0ir 5risco a hi%her contribution mar%in from passen%ers 1<=?(3>?.2; versus <==(;;;2. 3. "n evaluatin% *hether 0ir 5risco should charter its plane to Travel "nternational( *e compare the charter alternative to the solution in re-uirement 2 because re-uirement 2 is preferred to re-uirement 1. Hnder re-uirement 2( contribution from passen%ers /educt fuel costs Total contribution per fli%ht <=?(3>?.2; 1!(;;;.;; <>#(3>?.2;

0ir 5risco %ets <>!(#;; per fli%ht from charterin% the plane to Travel "nternational. On the basis of -uantitative financial factors( 0ir 5risco is better off not charterin% the plane and( instead( lo*erin% its o*n fares. Other -ualitative factors that 0ir 5risco should consider in comin% to a decision are: a. The lo*er risk from charterin% its plane relative to the uncertainties re%ardin% the number of passen%ers it mi%ht %et on its scheduled fli%hts. b. The stabilit' of the relationship bet*een 0ir 5risco and Travel "nternational. "f this is not a lon%-term arran%ement( 0ir 5risco ma' lose current market share and not benefit from sustained charter revenues.

11-1?

11-30 13; min.2 R&$&5#/' -" ' 4 "!!"0'1/i'6 -" ' (

1. Eas'spread 2.; has a hi%her relevant operatin% income than Eas'spread 1.;. 6ased on this anal'sis( Eas'spread 2.; should be introduced immediatel': $elevant revenues $elevant costs: Manuals( diskettes( compact discs Total relevant costs $elevant operatin% income E# 6 !0&#2 1(0 <1#; < ; ; <1#; E# 6 !0&#2 2(0 <1=# <2# 2# <1A;

$easons for other cost items bein% irrelevant are: Easyspread 1.0 Manuals( diskettesSalread' incurred /evelopment costsSalread' incurred Marketin% and administrativeSfixed costs of period Easyspread 2.0 /evelopment costsSalread' incurred Marketin% and administrationSfixed costs of period )ote that total marketin% and administration costs *ill not chan%e *hether Eas'spread 2.; is introduced on Oul' 1( 2;;3( or on October 1( 2;;3. 2 2. Other factors to be considered: a. ustomer satisfaction. "f 2.; is si%nificantl' better than 1.; for its customers( a customer driven or%ani7ation *ould immediatel' introduce it unless other factors offset this bias to*ards Tdo *hat is best for the customer.U b. +ualit' level of Eas'spread 2.;. "t is critical for ne* soft*are products to be full' debu%%ed. Eas'spread 2.; must be error-free. onsider an immediate release onl' if 2.; passes all -ualit' tests and can be full' supported b' the salesforce. c. "mportance of bein% perceived to be a market leader. 6ein% first in the market *ith a ne* product can %ive 6asil ,oft*are a Tfirst-mover advanta%e(U e.%.( capturin% an initial lar%e share of the market that( in itself( causes future potential customers to lean to*ards purchasin% Eas'spread 2.;. Moreover( b' introducin% 2.; earlier( 6asil can %et -uick feedback from users about *a's to further refine the soft*are *hile its competitors are still *orkin% on their o*n first versions. Moreover( b' lockin% in earl' customers( 6asil ma' increase the likelihood of these customers also bu'in% future up%rades of Eas'spread 2.;. d. Morale of developers. These are ke' people at 6asil ,oft*are. /ela'in% introduction of a ne* product can hurt their morale( especiall' if a competitor then preempts 6asil from bein% vie*ed as a market leader.

11-2;

11-31 12; min.2 O!!"0'1/i'6 -" ' 1&. ,chaefer2.

1. The opportunit' cost to 4olverine of producin% the 2(;;; units of Oran%ebo is the contribution mar%in lost on the 2(;;; units of $osebo that *ould have to be for%one( as computed belo*: ,ellin% price Bariable costs per unit: /irect materials /irect manufacturin% labor Bariable manufacturin% overhead Bariable marketin% costs ontribution mar%in per unit ontribution mar%in for 2(;;; units <2; <2 3 2 !

11 < ? < 1=(;;;

The opportunit' cost is <1=(;;;. Opportunit' cost is the maximum contribution to operatin% income that is for%one 1re3ected2 b' not usin% a limited resource in its next-best alternative use. 2. ontribution mar%in from manufacturin% 2(;;; units of Oran%ebo and purchasin% 2(;;; units of $osebo from 6ucke'e is <1A(;;;( as follo*s: M#/1%#-'10& O0#/3&+" ,ellin% price Bariable costs per unit: 9urchase costs /irect materials /irect manufacturin% labor Bariable manufacturin% costs Bariable marketin% overhead Bariable costs per unit ontribution mar%in per unit ontribution mar%in from sellin% 2(;;; units of Oran%ebo and 2(;;; units of $osebo <1# . 2 3 2 2 ? < A <12(;;; P10-.# & R" &+" <2; 1! T"'#$

! 1= < 2 <!(;;; <1A(;;;

0s calculated in re-uirement 1( 4olverine@s contribution mar%in from continuin% to manufacture 2(;;; units of $osebo is <1=(;;;. 0cceptin% the Miami ompan' and 6ucke'e offer *ill cost 4olverine <2(;;; 1<1A(;;; . <1=(;;;2. &ence( 4olverine should refuse the Miami ompan' and 6ucke'e orporation@s offers. 3. The minimum price *ould be <?( the sum of the incremental costs as computed in re-uirement 2. This follo*s because( if 4olverine has surplus capacit'( the opportunit' cost C <;. 5or the short-run decision of *hether to accept Oran%ebo@s offer( fixed costs of 4olverine are irrelevant. Onl' the incremental costs need to be covered for it to be *orth*hile for 4olverine to accept the Oran%ebo offer. 11-21

11-32 13;-!; min.2 P0"21-' ,iA4 0&$&5#/' -" ' 1). Melumad( adapted2.
1.

,ellin% price Bariable manufacturin% cost per unit Bariable marketin% cost per unit Total variable costs per unit ontribution mar%in per unit ontribution mar%in per hour of the constrained resource 1the re%ular machine2 Total contribution mar%in from sellin% onl' $3 or onl' &9A $3: <2# #;(;;;M &9A: <3; #;(;;; Less 8ease costs of hi%h-precision machine to produce and sell &9A )et relevant benefit

R3 <1;; A; 1# ># < 2#

<2# C <2# 1

HP6 <1#; 1;; 3# 13# < 1#

<1# C <3; ;.#

<1(2#;(;;; <1(2#;(;;;

<1(#;;(;;; 3;;(;;; <1(2;;(;;;

Even thou%h &9A has the hi%her contribution mar%in per unit of the constrained resource( the fact that 9endleton must incur additional costs of <3;;(;;; to achieve this hi%her contribution mar%in means that 9endleton is better off usin% its entire #;(;;;-hour capacit' on the re%ular machine to produce and sell #;(;;; units 1#;(;;; hours 1 hour per unit2 of $3. The additional contribution from sellin% &9A rather than $3 is <2#;(;;; 1<1(#;;(;;; <1(2#;(;;;2( *hich is not enou%h to cover the additional costs of leasin% the hi%h-precision machine. )ote that( because all other overhead costs are fixed and cannot be chan%ed( the' are irrelevant for the decision. 2. "f capacit' of the re%ular machines is increased b' 1#(;;; machine-hours to A#(;;; machine-hours 1#;(;;; ori%inall' E 1#(;;; ne*2( the net relevant benefit from producin% $3 and &9A is as follo*s: R3 Total contribution mar%in from sellin% onl' $3 or onl' &9A $3: <2# A#(;;;M &9A: <3; A#(;;; Less 8ease costs of hi%h-precision machine that *ould be incurred if &9A is produced and sold Less ost of increasin% capacit' b' 1#(;;; hours on re%ular machine )et relevant benefit HP6

<1(A2#(;;;

<1(?#;(;;; 3;;(;;;

1#;(;;; <1(!>#(;;;

1#;(;;; <1(#;;(;;;

11-22

11-32 1 ontFd.2 "nvestin% in the additional capacit' increases 9endletonFs operatin% income b' <2#;(;;; 1<1(#;;(;;; calculated in re-uirement 2 minus <1(2#;(;;; calculated in re-uirement 12( so 9endleton should add 1#(;;; hours to the re%ular machine. 4ith the extra capacit' available to it( 9endleton should use its entire capacit' to produce &9A. Hsin% all A#(;;; hours of capacit' to produce &9A rather than to produce $3 %enerates additional contribution mar%in of <32#(;;; 1<1(?#;(;;; <1(A2#(;;;2 *hich is more than the additional cost of <3;;(;;; to lease the hi%hprecision machine. 9endleton should therefore produce and sell 13;(;;; units of &9A 1A#(;;; hours ;.# hours per unit of &9A2 and 7ero units of $3. 3. R3 ,ellin% price Bariable manufacturin% costs per unit Bariable marketin% costs per unit Total variable costs per unit ontribution mar%in per unit
ontribution mar%in per hour of the constrained resource 1the re%ular machine2 <3#

HP6 <1#; 1;; 3# 13# < 1#

S3 <12; >; 1# =# < 3#

<3# C 1

<1;; A; 1# ># < 2#

<2# <1# C <2# C <3; 1 ;.#

The first step is to compare the operatin% profits that 9endleton could earn if it accepted the arter orporation offer for 2;(;;; units *ith the operatin% profits 9endleton is currentl' earnin%. ,3 has the hi%hest contribution mar%in per hour on the re%ular machine and re-uires no additional investment such as leasin% a hi%h-precision machine. To produce the 2;(;;; units of ,3 re-uested b' arter orporation( 9endleton *ould re-uire 2;(;;; hours on the re%ular machine resultin% in contribution mar%in of <3# 2;(;;; C <>;;(;;;. 9endleton no* has !#(;;; hours available on the re%ular machine to produce $3 or &9A. R3 Total contribution mar%in from sellin% onl' $3 or onl' &9A $3: <2# !#(;;;M &9A: <3; !#(;;; Less 8ease costs of hi%h-precision machine to produce and sell &9 A )et relevant benefit HP6

<1(12#(;;; <1(12#(;;;

<1(3#;(;;; 3;;(;;; <1(;#;(;;;

9endleton should use all the !#(;;; hours of available capacit' to produce !#(;;; units of $3. Thus( the product mix that maximi7es operatin% income is 2;(;;; units of ,3( !#(;;; units of $3( and 7ero units of &9A. This optimal mix results in a contribution mar%in of <1(=2#(;;; 1<>;;(;;; from ,3 and <1(12#(;;; from $32. $elative to re-uirement 2( operatin% income increases b' <32#(;;; 1<1(=2#(;;; minus <1(#;;(;;; calculated in re-uirement 22. &ence( 9endleton should accept the arter orporation business and suppl' 2;(;;; units of ,3. 11-23

11-33 13#.!; min.2 Di -"/'i/1i/3 # !0"21-' $i/&4 &$$i/3 ,"0& 1/i' (

1. The incremental revenue losses and incremental savin%s in cost b' discontinuin% the Tables product line follo*s:

Di%%&0&/-&> I/-0&,&/'#$ )L" i/ R&5&/1& * #/2 S#5i/3 i/ C" ' %0", D0"!!i/3 T#+$& Li/& $evenues /irect materials and direct manufacturin% labor /epreciation on e-uipment Marketin% and distribution :eneral administration orporate office costs Total costs Operatin% income 1loss2 <1#;;(;;;2 3;;(;;; ; >;(;;; ; ; 3>;(;;; <113;(;;;2

/roppin% the Tables product line results in revenue losses of <#;;(;;; and cost savin%s of <3>;(;;;. &ence( :rossman orporationFs operatin% income *ill be <13;(;;; hi%her if it does not drop the Tables line. )ote that( b' droppin% the Tables product line( &ome 5urnishin%s *ill save none of the depreciation on e-uipment( %eneral administration costs( and corporate office costs( but it *ill save variable manufacturin% costs and all marketin% and distribution costs on the Tables product line. 2. :rossmanFs *ill %enerate incremental operatin% income of <12=(;;; from sellin% !(;;; additional tables and( hence( should tr' to increase table sales. The calculations follo*: I/-0&,&/'#$ R&5&/1& )C" ' * #/2 O!&0#'i/3 I/-",& <#;;(;;; 13;;(;;;2 1!2(;;;2L 13;(;;;2V ;LL ;LL <12=(;;;

$evenues /irect materials and direct manufacturin% labor ost of e-uipment *ritten off as depreciation Marketin% and distribution costs :eneral administration costs orporate office costs Operatin% income

L)ote that the additional costs of e-uipment are relevant future costs for the Psellin% more tables decisionP because the' represent incremental future costs that differ bet*een the alternatives of sellin% and not sellin% additional tables. V urrent marketin% and distribution costs *hich varies *ith number of shipments C <>;(;;; . <!;(;;; C <3;(;;;. 0s the sales of tables double( the number of shipments *ill double( resultin% in incremental marketin% and distribution costs of 12 <3;(;;;2 . <3;(;;; C <3;(;;;. LL:eneral administration and corporate office costs *ill be unaffected if :rossman decides to sell more tables. &ence( these costs are irrelevant for the decision.

11-2!

11-34 13; min.2 Di -"/'i/1i/3 "0 #22i/3 #/"'.&0 2i5i i"/ )-"/'i/1#'i"/ "% 11-33*(
1. ,olution Exhibit 11-3!( olumn 1( presents the relevant loss of revenues and the relevant savin%s in costs from closin% the )orthern /ivision. 0s the calculations sho*( :rossmanFs operatin% income *ould decrease b' <1!;(;;; if it shut do*n the )orthern /ivision 1loss in revenues of <1(#;;(;;; versus savin%s in costs of <1(3A;(;;;2. :rossman *ill save variable manufacturin% costs( marketin% and distribution costs( and division %eneral administration costs b' closin% the )orthern /ivision but e-uipment-related depreciation and corporate office allocations are irrelevant to the decision. E-uipment-related costs are irrelevant because the' are past costs 1and the e-uipment has 7ero disposal price2. orporate office costs are irrelevant because :rossman *ill not save an' actual corporate office costs b' closin% the )orthern /ivision. The corporate office costs that used to be allocated to the )orthern /ivision *ill be allocated to other divisions. 2. The mana%er at corporate head-uarters responsible for makin% the decision is evaluated on )orthern /ivisionFs operatin% income after allocatin% corporate office costs. The mana%er *ill evaluate the options as follo*s: "f the mana%er does not close the )orthern /ivision in 2;;2( the division is expected to sho* an operatin% loss of <11;(;;; after allocatin% all corporate office costs. "f the mana%er closes the )orthern /ivision( the division *ould sho* an operatin% loss of <1;;(;;; from the *rite off of e-uipment. "t *ould sho* no revenues and( hence( *ould not attract an' corporate office costs. "t *ould also not incur an' manufacturin%( marketin% and distribution( and %eneral administration costs. 5rom the vie*point of maximi7in% the operatin% income a%ainst *hich the mana%er is evaluated( the mana%er *ould prefer to shut do*n )orthern /ivision 1and sho* an operatin% loss of <1;;(;;; instead of an operatin% loss of <11;(;;; b' operatin% it2. "n fact( the mana%er mi%ht ar%ue that even the <1;;(;;; operatin% loss is more a conse-uence of accountin% *rite offs rather than a TrealU operatin% loss. $ecall from re-uirement 1 that the decision model favored keepin% the )orthern /ivision open. The performance evaluation model of the mana%er makin% the decision su%%ests that the )orthern /ivision be closed. &ence( the performance evaluation model is inconsistent *ith the decision model. 3. ,olution Exhibit 11-3!( olumn 2( presents the relevant revenues and relevant costs of openin% the ,outhern /ivision 1a division *hose revenues and costs are expected to be identical to the revenues and costs of the )orthern /ivision2. :rossman should open the ,outhern /ivision because it *ould increase operatin% income b' <!;(;;; 1increase in relevant revenues of <1(#;;(;;; and increase in relevant costs of <1(!A;(;;;2. The relevant costs include direct materials( direct manufacturin% labor( marketin% and distribution( e-uipment( and division %eneral administration costs but not corporate office costs. )ote( in particular( that the cost of e-uipment *ritten off as depreciation is relevant because it is an expected future cost that :rossman *ill incur onl' if it opens the ,outhern /ivision. orporate office costs are irrelevant because actual corporate office costs *ill not chan%e if :rossman opens the ,outhern /ivision. The current corporate staff *ill be able to oversee the ,outhern /ivisionFs operations. :rossman *ill allocate some corporate office costs to the ,outhern /ivision but this allocation represents corporate office costs that are alread' currentl' bein% allocated to some other division. 6ecause actual total corporate office costs do not chan%e( the' are irrelevant to the division.

11-2#

11-34 1 ontFd.2 SOL8TION EBHI:IT 11-34 $elevant-$evenue and $elevant- ost 0nal'sis for ,outhern /ivision losin% )orthern /ivision and Openin% I/-0&,&/'#$ )L" i/ R&5&/1& * R&5&/1& #/2 #/2 S#5i/3 i/ )I/-0&,&/'#$ C" ' * C" ' %0", C$" i/3 %0", O!&/i/3 N"0'.&0/ Di5i i"/ S"1'.&0/ Di5i i"/ )1* )2* <11(#;;(;;;2 <1(#;;(;;; =2#(;;; ; 2;#(;;; 33;(;;; ; 1(3A;(;;; < 11!;(;;;2 1=2#(;;;2 11;;(;;;2 12;#(;;;2 133;(;;;2 ; 11(!A;(;;;2 < !;(;;;

$evenues Bariable direct materials and direct manufacturin% labor costs E-uipment cost *ritten off as depreciation Marketin% and distribution costs /ivision %eneral administration costs orporate office costs Total costs Effect on operatin% income 1loss2

11-35 13;.!; min.2 M#9& "0 +164 1/9/"C/ $&5&$ "% 5"$1,& 10. 0tkinson2.
1. 8et Q C 1 starter assembl'. The variable costs re-uired to manufacture 1#;(;;;Q are: /irect materials /irect manufacturin% labor Bariable manufacturin% overhead Total variable costs <2;;(;;; 1#;(;;; 1;;(;;; <!#;(;;;

The variable costs per unit are <!#;(;;; G 1#;(;;; C <3.;; per unit.

11-2A

11(35 1 ontFd.2 The data can be presented in both Pall dataP and Prelevant dataP formats: A$$ D#'# R&$&5#/' D#'# A$'&0/#'i5& A$'&0/#'i5& A$'&0/#'i5& A$'&0/#'i5& 1> 2> 1> 2> :16 M#9& :16 M#9& Bariable manufacturin% costs < 3Q . < 3Q . 5ixed %eneral manufacturin% overhead 1#;(;;; <1#;(;;; . . 5ixed overhead( avoidable 1;;(;;; . 1;;(;;; . /ivision 2 mana%er@s salar' !;(;;; #;(;;; !;(;;; <#;(;;; /ivision 3 mana%er@s salar' #;(;;; . #;(;;; . 9urchase cost( if bou%ht from Tidnish Electronics . !Q . !Q Total <3!;(;;; <2;;(;;; <1?;(;;; <#;(;;; E < 3Q E < !Q E < 3Q E < !Q The number of units at *hich the costs of make and bu' are e-uivalent is: 0ll data anal'sis: or $elevant data anal'sis: Q <3!;(;;; E <3Q C <2;;(;;; E <!Q Q C 1!;(;;; <1?;(;;; E <3Q C <#;(;;; E <!Q C 1!;(;;;

0ssumin% cost minimi7ation is the ob3ective( then: W "f production is expected to be less than 1!;(;;; units( it is preferable to bu' units from Tidnish. W "f production is expected to exceed 1!;(;;; units( it is preferable to manufacture internall' 1make2 the units. W "f production is expected to be 1!;(;;; units( this is the indifference point bet*een bu'in% units from Tidnish and internall' manufacturin% 1makin%2 the units. 2. The information on the stora%e cost( *hich is avoidable if self-manufacture is discontinued( is relevantM these stora%e char%es represent current outla's that are avoidable if self-manufacture is discontinued. 0ssume these <#;(;;; char%es are represented as an opportunit' cost of the make alternative. The costs of internal manufacture that incorporate this <#;(;;; opportunit' cost are: 0ll data anal'sis: <3?;(;;; E <3Q $elevant data anal'sis: <2!;(;;; E <3Q The number of units at *hich the costs of make and bu' are e-uivalent is: 0ll data anal'sis: <3?;(;;; E <3Q C <2;;(;;; E <!Q Q C 1?;(;;; $elevant data anal'sis: <2!;(;;; E <3Q C <#;(;;; E <!Q Q C 1?;(;;; "f production is expected to be less than 1?;(;;;( it is preferable to bu' units from Tidnish. "f production is expected to exceed 1?;(;;;( it is preferable to manufacture the units internall'. 11-2>

11-36 13; min.2 M#9& 5&0 1 +164 #-'i5i'6-+# &2 -" 'i/34 "!!"0'1/i'6 -" '
1). Melumad and ,. $eichelstein( adapted2. 1. $elevant costs under bu' alternative: 9urchases( 1;(;;; <=.2; $elevant costs under make alternative: /irect materials /irect manufacturin% labor Bariable manufacturin% overhead "nspection( setup( materials handlin% Machine rent Total relevant costs under make alternative <=2(;;; <!;(;;; 2;(;;; 1#(;;; 2(;;; 3(;;; <=;(;;;

The allocated fixed plant administration( taxes( and insurance *ill not chan%e if 0ce makes or bu's the chains. &ence( these costs are irrelevant to the make-or-bu' decision. The anal'sis indicates that 0ce should not bu' the chains from the outside supplier. 2. $elevant costs under the make alternative: $elevant costs 1as computed in re-uirement 12 $elevant costs under the bu' alternative: osts of purchases 11;(;;; <=.2;2 0dditional fixed costs 0dditional contribution mar%in from usin% the space *here the chains *ere made to up%rade the bic'cles b' addin% mud flaps and reflector bars( 1;(;;; 1<2; . <1=2 Total relevant costs under the bu' alternative

<=;(;;; <=2(;;; 1A(;;; 12;(;;;2 <>=(;;;

0ce should no* bu' the chains from an outside vendor and use its o*n capacit' to up%rade its o*n bic'cles. 3. "n this re-uirement( the decision on mud flaps and reflectors is irrelevant to the anal'sis. ost of manufacturin% chains: Bariable costs( 1<! E <2 E <1.#; C <>.#;2 A(2;; 6atch costs( <2;;Dbatcha = batches Machine rent ost of bu'in% chains( <=.2; A(2;;
a

<!A(#;; 1(A;; 3(;;; <#1(1;; <#;(=!;

<2(;;; 1; batches

"n this case( 0ce should bu' the chains from the outside vendor.

11-2=

11-37 1A; min.2 M1$'i!$& -."i-&F -",!0&.&/ i5& !0"+$&, "/ 0&$&5#/' -" ' (
Kou ma' *ish to assi%n onl' some of the parts. Manufacturin% costs: /irect materials /irect manufacturin% labor Bariable manufac. indirect costs 5ixed manufac. indirect costs Marketin% costs: Bariable 5ixed T"'#$ <1.;; 1.2; ;.=; ;.#; <1.#; ;.?; P&0 8/i' FiA&2 V#0i#+$&

<3.#; 2.!; <#.?;

<;.#; ;.?; <1.!;

<3.;; 1.#; <!.#;

1. 1b2 <3.#;

M#/1%#-'10i/3 C" ' Bariable <3.;; 5ixed ;.#; Total <3.#;

2. 1e2

)one of the above. /ecrease in operatin% income is <1A(=;;.

Di%%&0&/'i#$ E < ?1(2;;L E >2(;;; E 3A(;;; E 1;=(;;; . 1A(=;; .. .. .. . < 1A(=;; N&C 2A!(;;; <#.=; <1(#31(2;; 2A!(;;; <3.;; 2A!(;;; <1.#; >?2(;;; 3?A(;;; 1(1==(;;; 3!3(2;; 12;(;;; 21A(;;; 33A(;;; < >(2;;

O$2 $evenues 2!;(;;; <A.;; <1(!!;(;;; Bariable costs Manufacturin% 2!;(;;; <3.;; >2;(;;; Marketin% and other 2!;(;;; <1.#; 3A;(;;; Bariable product costs 1(;=;(;;; ontribution mar%in 3A;(;;; 5ixed costs: Manufacturin% <;.#; 2;(;;; 12 mos. C 12;(;;; Marketin% and other <;.?; 2!;(;;; 21A(;;; 5ixed product costs 33A(;;; Operatin% income < 2!(;;; L"ncremental revenue: <#.=; 2!(;;; /educt price reduction <;.2; 2!;(;;; <13?(2;; !=(;;; < ?1(2;;

3.

1c2 <3(#;;

"f this order *ere not landed( fixed manufacturin% overhead *ould be underallocated b' <2(#;;( <;.#; per unit #(;;; units. Therefore( takin% the order increases operatin% income b' <1(;;; plus <2(#;;( or <3(#;;.

11-2?

11-37 1 ontFd.2 0nother *a' to present the same idea follo*s: $evenues *ill increase b' 1#(;;; <3.#; C <1>(#;;2 E <1(;;; osts *ill increase b' #(;;; <3.;; 5ixed overhead *ill not chan%e han%e in operatin% income <1=(#;; 1#(;;; . < 3(#;;

)ote that this ans*er to 132 assumes that variable marketin% costs are not influenced b' this contract. These #(;;; units do not displace an' re%ular sales. !. 1a2 <!(;;; less 1<>(#;; . <3(#;;2 G"5&0/,&/' C"/'0#-' 0s above <3(#;; R&31$#0 C.#//&$ ,ales( #(;;; <A.;; "ncrease in costs: Bariable costs onl': Manufacturin%( #(;;; <3.;; <1#(;;; Marketin%( #(;;; <1.#; >(#;; 5ixed costs are not affected < >(#;;

<3;(;;;

22(#;; han%e in

operatin% income #. 1b2 <!.1#

/ifferential costs: Bariable: Manufacturin% ,hippin% 5ixed: <!(;;; G 1;(;;; !(;;; <!1(#;;

<3.;; ;.>#

<3.># 1;(;;; ;.!; <!.1#

<3>(#;;

,ellin% price to break even is <!.1# per unit. A. 1e2 >. 1e2 <1.#;( the variable marketin% costs. The other costs are past costs( and are( therefore( irrelevant. )one of these. The correct ans*er is <3.##. This part al*a's %ives students trouble. The short-cut solution belo* is follo*ed b' a lon%er solution that is helpful to students.

11-3;

11-37 1 ontFd.2 ,hort-cut solution: The hi%hest price to be paid *ould be measured b' those costs that could be avoided b' haltin% production and subcontractin%: Bariable manufacturin% costs 5ixed manufacturin% costs saved <A;(;;; G 2!;(;;; Marketin% costs 1;.2; <1.#;2 Total costs 8on%er but clearer solution: C",!#0#'i5& A//1#$ I/-",& S'#'&,&/' P0& &/' Di%%&0&/-& P0"!" &2 $evenues Bariable costs: Manufacturin%( 2!;(;;; 3.;; Marketin% and other( 2!;(;;; <1.#; Bariable costs ontribution mar%in 5ixed costs: Manufacturin% Marketin% and other Total fixed costs Operatin% income <1(!!;(;;; >2;(;;; 3A;(;;; 1(;=;(;;; 3A;(;;; 12;(;;; 21A(;;; 33A(;;; < 2!(;;; < . <1(!!;(;;; =#2(;;;L 2==(;;; 1(1!;(;;; 3;;(;;; A;(;;; 21A(;;; 2>A(;;; < 2!(;;; <3.;; ;.2# ;.3; <3.##

E132(;;; . >2(;;;

. A;(;;; < ;

LThis solution is obtained b' fillin% in the above schedule *ith all the kno*n fi%ures and *orkin% Pfrom the bottom upP and Pfrom the top do*nP to the unkno*n purchase fi%ure. Maximum variable costs that can be incurred( <1(1!;(;;; . <2==(;;; C maximum purchase costs( or <=#2(;;;. /ivide <=#2(;;; b' 2!;(;;; units( *hich 'ields a maximum purchase price of <3.##.

11-31

11-38 11# min.2 M#9& "0 +16 )-"/'i/1#'i"/ "% 11-37*(

The maximum price lass ompan' should be *illin% to pa' is <3.?!1> per unit.
Expected unit production and sales of ne* product must be half of the old product 11D2 2!;(;;; C 12;(;;;2 because the fixed manufacturin% overhead rate for the ne* product is t*ice that of the fixed manufacturin% overhead rate for the old product.

$evenues Bariable 1or purchase2 costs: Manufacturin% Marketin% and other Total variable costs ontribution mar%in 5ixed costs: Manufacturin% Marketin% and other Total fixed costs Operatin% income

P0& &/' <1(!!;(;;; >2;(;;; 3A;(;;; 1(;=;(;;; 3A;(;;; 12;(;;; 21A(;;; 33A(;;; < 2!(;;;

P0"!" &2 M#9& N&C O$2 P0"21-' P0"21-' <1(;=;(;;; <1(!!;(;;; A;;(;;; 2!;(;;; =!;(;;; 2!;(;;; 12;(;;; A;(;;; 1=;(;;; < A;(;;; ?!A(;;;L 2==(;;; 1(23!(;;; 2;A(;;;

T"'#$ <2(#2;(;;; 1(#!A(;;; #2=(;;; 2(;>!(;;; !!A(;;;

12;(;;; 21A(;;; 2>A(;;; 21A(;;; 3?A(;;; < 11;(;;;2 < #;(;;;

LThis is an example of opportunit' costs( *hereb' subcontractin% at a price *ell above the <3.#; current manufacturin% 1absorption2 cost is still desirable because the old product *ill be displaced in manufacturin% b' a ne* product that is more profitable.

6ecause the ne* product promises an operatin% income of <A;(;;; 1i%norin% the irrelevant problems of ho* fixed marketin% costs ma' be ne*l' reallocated bet*een products2( the old product can sustain up to a <1;(;;; loss and still help accomplish mana%ement@s overall ob3ectives. Maximum costs that can be incurred on the old product are <1(!!;(;;; plus the <1;(;;; loss( or <1(!#;(;;;. Maximum purchase cost: <1(!#;(;;; . 1<2==(;;; E <21A(;;;2 C <?!A(;;;. Maximum purchase cost per unit: <?!A(;;; G 2!;(;;; units C <3.?!1> per unit. Alternative Computation Operatin% income is <?.;; . <=.#; C <;.#; per unit for 12;(;;; ne* units Tar%et operatin% income Maximum loss allo*ed on old product Maximum loss per unit allo*ed on old product( <1;(;;; G 2!;(;;; C ,ellin% price of old product 0llo*ance for loss Total costs allo*ed per unit ontinuin% costs for old product other than purchase cost: 5ixed manufacturin% costs..all transferred to ne* product Bariable marketin% costs 5ixed marketin% costs Maximum purchase cost per unit <A;(;;; #;(;;; <1;(;;; <;.;!1> <A.;;;; ;.;!1> A.;!1> < . 1.2; ;.?;

2.1;;; <3.?!1>

11-32

11-39 13; min.2

0ppendix2. 1.

O!'i,#$ !0"21-'i"/ !$#/4 -",!1'&0 ,#/1%#-'10&0 1 hapter

Q C Hnits of printers K C Hnits of desktop computers Ob3ective: Maximi7e total contribution mar%in of <2;;Q E <1;;K onstraints: 5or production line 1: AQ E !K 2! 5or production line 2: 1;Q 2; ,ales of Q and K: Q . K ; )e%ative production impossible: Q ; K ; 2. ,olution Exhibit 11-3? presents a %raphical summar' of the relationships. The sales-mix constraint here is some*hat unusual. The Q . K ; line is the one %oin% up*ard at a !#-de%ree an%le from the ori%in. The optimal corner is the point 12( 32( 2 printers and 3 computers. The corner point *here the production line 1 and production line 2 constraints meet is Q C 2( K C 3 that can be calculated b' solvin%: AQ E !K C 2! 112 9roduction line 1 constraint 1;Q C 2; 122 9roduction line 2 constraint 5rom 122 Q C 2; G 1; C 2 ,ubstitutin% for Q in 112 A 2 E !K C 2! !K C 2! . 12 C 12 K C 12 G ! C 3 The corner point *here the production line 2 constraint and the product-mix constraint meet is Q C 2( K C 2 that can be calculated b' solvin%: 1;Q C 2; 122 9roduction line 2 constraint Q . KC ; 132 9roduct-mix constraint 5rom 122 Q C 2; G 1; C 2 ,ubstitutin% for Q in 132 K C 2 Hsin% the trial-and-error method: T0i#$ 1 2 3 ! C"0/&0 )BF E* 1;M ;2 12M 22 12M 32 1;M A2 T"'#$ C"/'0i+1'i"/ M#03i/ < 2;;1;2 E <1;;1;2 C < ; 2;;122 E 1;;122 C A;; 2;;122 E 1;;132 C >;; 2;;1;2 E 1;;1A2 C A;;

The optimal solution that maximi7es operatin% income is 2 printers and 3 computers.

11-33

11-39 1 ontFd.2 SOL8TION EBHI:IT 11-39 :raphic ,olution to 5ind Optimal Mix( "nformation Technolo%'( "nc. = 9roduct 8ine 1 onstraint P0"21-' E P0"21-'i"/ i/ 8/i' A 9roduct 8ine 2 onstraint Optimal orner 12(32 ! 9roduct-Mix onstraint 2
0rea of 5easible ,olution

E-ual ontribution Mar%in 8ines

; ; 2 ! A P0"21-' B P0"21-'i"/ i/ 8/i' =

11-3!

11-40 13;.!; min.2 O!'i,#$ !0"21-' ,iA(

8et / represent the batches of /ellaFs /eli%ht made and sold. 8et represent the batches of ath'Fs hocolate hips made and sold. The contribution mar%in per batch for /ellaFs /eli%ht is <#2# <1># C <3#;. The contribution mar%in per batch for ath'Fs hocolate hip is <33# <=# C <2#;.
1.

The 89 formulation for the decision is: Maximi7e <3#;/ E <2#; ,ub3ect to 3;/ E 1# A;; 1Mixin% /epartment constraint2 1;/ E 1# 3;; 16akin% /epartment constraint2 2;/ 32; 1/ippin% /epartment constraint2 2. ,olution Exhibit 11-!; presents a %raphical summar' of the relationships. The optimal corner is the point 11#(1;2( 1# /ellaFs /eli%hts and 1; ath'Fs hocolate hips. SOL8TION EBHI:IT 11-40 :raphic ,olution to 5ind Optimal Mix( /ella ,impson( "nc.
Mixin% /ept. onstraint

!; 8/i' "% C#'.6G C."-"$#'& C.i! )C*

/ippin% /ept. onstraint

3;
E-ual ontribution Mar%in 8ines

2;
Optimal orner 11#( 1;2

1;
6akin% /ept. onstraint

1;

2; 3; 8/i' "% D&$$#G D&$i3.' )D*

!;

11-3#

11-40 1 ontFd.2 4e next calculate the optimal production mix usin% the trial-and-error method. The corner point *here the Mixin% /ept. and 6akin% /ept. constraints meet can be calculated b' solvin%: 3;/ E 1# 1;/ E 1# C A;; 112 Mixin% /ept. constraint C 3;; 122 6akin% /ept. constraint

,ubstractin% 122 from 112( *e have 2;/ C 3;; or / C 1# ,ubstitutin% in 122 1; 1# E 1# that is( 1# or C 3;; C 3;; 1#; C 1#; C 1;

The corner point *here the Mixin% /ept. and /ippin% /ept. constraints meet can be calculated b' solvin% 3;/ E 1# C A;; 112 Mixin% /ept. constraint 2;/ C 32; 132 /ippin% /ept. constraint 5rom e-uation 132( / ,ubstitutin% in 112( 13; 1A2 E 1# 1# C 32; 2; C 1A C A;; C A;; !=; C 12; C =

4e next use the trial-and-error method to check the contribution mar%ins at each of the five corner points of the area of feasible solutions. T0i#$ 1 2 3 ! # C"0/&0 )D4C* 1;(;2 11A(;2 11A(=2 11#(1;2 1;(2;2 T"'#$ C"/'0i+1'i"/ M#03i/ 1<3#; ;2 E 1<2#; ;2 C <; 1<3#; 1A2 E 1<2#; ;2 C <#(A;; 1<3#; 1A2 E 1<2#; =2 C <>(A;; 1<3#; 1#2 E 1<2#; 1;2 C <>(>#; 1<3#; ;2 E 1<2#; 2;2 C <#(;;; ath'Fs

The optimal solution that maximi7es operatin% income is 1# /ellaFs /eli%hts and 1; hocolate hips.

11-3A

11-41 13; min.2 M#9& 5&0 1 +164 &'.i- 1 M0( adapted2.

1. 0n anal'sis of relevant costs that sho*s *hether 9aibec orporation should make MT$2;;; or purchase it from Marle' ompan' for 2;;2 follo*s: T"'#$ C" ' %"0 324000 8/i' ost to purchase MT$-2;;; from Marle' 6id price from Marle'( <1>.3; R 32(;;; E-uipment lease penalt' Total incremental cost to purchase ost for 9aibec to make MT$-2;;; in 2;;2 /irect materials 1<1?#(;;; R 1.;=2 R 3;(;;; /irect manuf. labor 1<12;(;;; R 1.;#2 R 3;(;;; 5actor' space rental E-uipment leasin% costs
32(;;; 32(;;; 32(;;;

<##3(A;; A(;;; ##?(A;; 22!(A!; 13!(!;; =!(;;; 3A(;;;

Bariable manufacturin% overhead 1<22#(;;; R !;N2 R 3;(;;; ?A(;;; 5ixed manufacturin% overhead 1not relevant2 .. Total incremental cost to make MT$-2;;; #>#(;!; ,avin%s if purchased from Marle' < 1#(!!;

2. 6ased solel' on the financial results( the 32(;;; units of MT$-2;;; for 2;;2 should be purchased from Marle'. The total cost from Marle' *ould be <##?(A;;( or <1#(!!; less than if the units *ere made b' 9aibec. 0t least three other factors that 9aibec orporation should consider before a%reein% to purchase MT$-2;;; from Marle' ompan' include the follo*in%: The -ualit' of the Marle' component should be e-ual to( or better than( the -ualit' of the internall' made component. Other*ise( the -ualit' of the final product mi%ht be compromised and 9aibecFs reputation affected. Marle'Fs reliabilit' as an on-time supplier is important( since late deliveries could hamper 9aibecFs production schedule and deliver' dates for the final product. 8a'offs ma' result if the component is outsourced to Marle'. This could impact 9aibecFs other emplo'ees and cause labor problems or affect the compan'Fs position in the communit'. "n addition( there ma' be termination costs( *hich have not been factored into the anal'sis.

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11-41 1 ontFd.2 3. $eferrin% to T,tandards of Ethical onduct for Mana%ement 0ccountants(U in Exhibit 1-> 8'nn &ardt *ould consider the re-uest of Oohn 9orter to be unethical for the follo*in% reasons. Competence 9repare complete and clear reports and recommendations after appropriate anal'sis of relevant and reliable information. 0d3ustin% cost numbers violates the competence standard. Integrity $efrain from either activel' or passivel' subvertin% the attainment of the or%ani7ationFs le%itimate and ethical ob3ectives. 9aibec has a le%itimate ob3ective of tr'in% to obtain the component at the lo*est cost possible( re%ardless of *hether it is manufactured internall' or outsourced to Marle'. ommunicate unfavorable as *ell as favorable information and professional 3ud%ments or opinions. &ardt needs to communicate the proper and accurate results of the anal'sis( re%ardless of *hether or not it favors internal production. $efrain from en%a%in% in or supportin% an' activit' that *ould discredit the profession. 5alsif'in% the anal'sis *ould discredit &ardt and the profession.

Objectivity ommunicate information fairl' and ob3ectivel'. &ardt needs to perform an ob3ective makeversus-bu' anal'sis and communicate the results fairl'. /isclose full' all relevant information that could reasonabl' be expected to influence an intended userFs understandin% of the reports( comments( and recommendations presented. &ardt needs to full' disclose the anal'sis and the expected cost increases.

Con identiality )ot affected b' this decision. &ardt should indicate to 9orter that the costs derived under the make alternative are correct. "f 9orter still insists on makin% the chan%es to lo*er the costs of makin% MT$-2;;; internall'( &ardt should raise the matter *ith 9orterFs superior( after informin% 9orter of her plans. "f( after takin% all these steps( there is a continued pressure to understate the costs( &ardt should consider resi%nin% from the compan'( rather than en%a%e in unethical conduct.

11-3=

11-42 1!; min.2 O!'i,#$ !0"21-' ,iA 1 M0( adapted2.

"n order to maximi7e Omni,port "nc.Fs profitabilit'( Omni,port should manufacture 12(;;; sno*board bindin%s( manufacture 1(;;; pairs of skates( and purchase A(;;; pairs of skates from olcott "nc. This combination of manufactured and purchased %oods maximi7es the contribution mar%in per available machine-hour( *hich is the limitin% resource. 6ecause sno*boards have a hi%her contribution mar%in per machine-hour than in-line skates( Omni,port should manufacture the maximum number of sno*boards. 6ecause the contribution mar%in per manufactured pair of in-line skates is hi%her than the contribution mar%in from a purchased pair of in-line skates( total contribution mar%in *ill be maximi7ed b' usin% the remainin% manufacturin% capacit' to produce in-line skates and then purchasin% the remainin% re-uired skates. The calculations for the optimal combination follo*:
P10-.# &2 M#/1%#-'10&2 M#/1%#-'10&2 I/-$i/& S9#'& I/-$i/& S9#'& S/"C+"#02 :i/2i/3 64000 14000 124000 T"'#$ P&0 8/i' T"'#$ P&0 8/i' T"'#$ P&0 8/i' T"'#$ <?= <#==(;;; <?= <?=(;;; <A; <>2;(;;; <1(!;A(;;; ># . . ! >? 1? !#;(;;; . . 2!(;;; !>!(;;; 11!(;;; 2; 2! 12 ? A# 33 2;(;;; 2!(;;; 12(;;; ?(;;; A#(;;; 33(;;; 2; = ! = !; 2; 2!;(;;; ?A(;;; !=(;;; ?A(;;; !=;(;;; 2!;(;;; >1;(;;; 12;(;;; A;(;;; 12?(;;; 1(;1?(;;; 3=>(;;; 3;(;;; A;(;;; ?;(;;; < 2?>(;;; . . 1.# <22.; ;.# <!;.;

,ellin% price Bariable costs /irect materials Machine operatin% costs Manufacturin% overhead costs 112 Markt. X admn. costs Bariable costs ontribution mar%in 5ixed costs Manufacturin% overhead Marketin% X administrative costs 5ixed costs Operatin% income Machine-hours per unit ontribution per machine-hour

,upportin% calculations
112 Manufacturin% overhead Manufactured in-line skates Machine-hours Manufacturin% capacit' Overhead per machine-hour Total overhead Total variable overhead Bariable overhead per machine-hour 5ixed overhead per machine-hour Bariable overhead per pair of skates 5ixed overhead per pair of skates ,no*board bindin%s Machine-hours Bariable overhead per sno*board 5ixed overhead per sno*board C C C C C C C C C C C C <2!.;; per pairD<1A.;; per hour C 1.# hours per pair #(;;; pairs R 1.# hours per pair C >(#;; hours <1=.;; per pairD1.# hours per pair C <12.;; per hour >(#;; hours R <12.;; per hour C <?;(;;; <?;(;;; 1total2 . <3;(;;; 1fixed2 C <A;(;;; 1variable2 <A;(;;;D>(#;; hours C <=.;; per hour <3;(;;; fixed overheadD>(#;; hours C <!.;; per hour 1.# hours R <=.;; per hour C <12.;; per pair 1.# hours R <!.;; per hour C <A.;; per pair <= per boardD<1A.;; per hour C ;.# hour per board <=.;; per hour R ;.# hour per board C <!.;; per board <!.;; per hour R ;.# hour per board C <2.;; per board

11-3?

11-42 1 ontFd.2 O,/iS!"0' I/-( C"/'0i+1'i"/ A/#$6 i

M#-.i/& H"10 !&0 8/i' )2* T"'#$ M#-.i/& H"10 8 &2 )3* ; )1* I )2* T"'#$ P0"21-' C"/'0i+1'i"/ )6* ; )1* I )5* <2!;(;;; 33(;;; 11!(;;; 3=>(;;; 11A#(;;;2 <222(;;;

H1#/'i'6

)1* Machine-hours available ,no*board bindin%s 12(;;; ;.# A(;;; "n-line skatesSmanufacture 1(;;; 1.# 1(#;; "n-line skatesSpurchase A(;;; . . Total contribution 8ess ori%inal contribution 1#(;;; pairs of skates R <33.;; per pair2 "mprovement in contribution

M#-.i/& H"10 :#$#/-& )4* >(#;; 1(#;; . .

8/i' C"/'0i+1'i"/ )5* <2; 33 1?

11-!;

C.#!'&0 11 I/'&0/&' EA&0-i &

!"e Internet e#ercise is available to students only on t"e $rentice %all Companion &ebsite '''.pren"all.com("orngren. )tudents can clic* on Cost Accounting+ 11 t" ed.+ and access t"e Internet E#ercise or t"e c"apter+ '"ic" lin*s to t"e &eb site o a company or organi,ation. !"e Internet E#ercise on t"e &eb 'ill be updated periodically so t"at it is current 'it" t"e latest in ormation available on t"e subject organi,ation-s &eb site. A printout copy o t"e Internet e#ercise or t"is c"apter as o early 2002 appears belo'. !"e solution to t"e Internet e#ercise+ '"ic" 'ill also be updated periodically+ is available to instructors rom t"e Companion &ebsite-s aculty vie'. !o access t"e solution+ clic* on Cost Accounting+ 11t" ed.+ .aculty lin*+ and t"en register once to obtain your pass'ord t"roug" t"e online orm. A ter t"e initial registration+ you 'ill "ave a personal login I/ and pass'ord to use to log in. A printout o t"e solution to t"e Internet e#ercise or t"is c"apter as o early 2002 ollo's. !"e e#ercise and solution provide instructors 'it" an idea o t"e content o t"e Internet e#ercise or t"is c"apter. I/'&0/&' EA&0-i & & offers an excellent online toolkit for small-business o*ners that provides information on startin%( financin%( mana%in%( and marketin% a small business. To access the toolkit( %o to http:DD***.toolkit.cch.comD( and click on PTable of ontentsP for the ,O&O :uidebook. 5rom there( under the headin%( PMana%in% Kour 6usiness 5inances(P click on PMa3or 9urchases and 9ro3ect(P follo*ed b' P&o* can 'ou make an ob3ective decisionIP Hse the toolkit to ans*er the follo*in% -uestions: 1. 4hat is the purpose of capital bud%etin%I

2. 4hat are the four steps to follo* *hen makin% a decision about a ma3or purchase or pro3ectI 3. 4hat are the t*o primar' t'pes of benefits to consider *hen evaluatin% a ma3or purchase or pro3ectI

!. The toolkit identifies t*o primar' benefits associated *ith purchasin% a ne* deliver' truckM *hat are the'I an 'ou think of an' other less tan%ible( -ualitative benefitsI #. 0 potential alternative to purchasin% a ne* deliver' truck is contractin% *ith a deliver' service. &o* *ould contractin% *ith a deliver' service impact fixed and variable costsI A. >. 0ssume that 'ou purchased a ne* deliver' truck. "s the cost of the truck or depreciation expense relevant for settin% deliver' char%es and pricesI lick on the P onsider all the costsP link. 4hat are some potential hidden costs of ma3or purchases or pro3ectsI

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I/'&0/&' EA&0-i & 1 ontFd.2 S"$1'i"/ '" I/'&0/&' EA&0-i & 1. apital bud%etin% is a means of evaluatin% lon%-run pro3ects. The capital bud%etin% process forces mana%ers to examine the costs( benefits( and risks involved *ith these pro3ects( and should help identif' pro3ects that have little chance of success and those *ith a hi%h probabilit' of success. The capital bud%etin% process involves makin% man' predictions and estimates about thin%s like interest rates( local economic conditions( consumer tastes and trends( technolo%ical developments( etc. 2. The four steps to follo* *hen makin% a decision about a capital bud%etin% pro3ect are: 1. 2. 3. onsider all the benefits of the pro3ect. onsider all the costs. reate a pro3ected cash flo* anal'sis that -uantifies costs and benefits( and places them in the correct time frame. !. Hse financial anal'sis tools to determine *hether the pro3ect makes sense. 3. The t*o primar' t'pes of benefits are hi%her revenues or lo*er costs.

!. T*o potential benefits are increased sales 1deliveries2 and lo*er operatin% costs. Other less tan%ible potential benefits mi%ht include: an improved compan' ima%e( on-time deliveries( improved emplo'ee morale and safet'( and less pollution. #. ontractin% *ith a deliver' service *ould lo*er fixed costs( but increase variable costs.

A. Once the deliver' truck has been purchased( it is a sunk cost. The truck@s cost and depreciation expenses are not relevant *hen settin% deliver' char%es and prices. >. 0lon% *ith the cost of the pro3ect itself( there ma' be other costs that ma' not be specificall' identified *ith the pro3ect. These ma' include installation( trainin% sessions( maintenance and repairs( insurance( utilities( supplies( taxes( pa'roll and benefits costs for ne* emplo'ees needed to operate the e-uipment( or an' other incidental costs that relate to ac-uirin% or maintainin% 'our particular pro3ect. There is also the time 'ou and 'our emplo'ees mi%ht devote to the pro3ect instead of re%ular *ork.

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C.#!'&0 11 Vi2&" C# &

!"e video case can be discussed using only t"e case 'riteup in t"e c"apter. Alternatively+ instructors can "ave students vie' t"e videotape o t"e company t"at is t"e subject o t"e case. !"e videotape can be obtained by contacting your $rentice %all representative. !"e case 0uestions c"allenge students to apply t"e concepts learned in t"e c"apter to a speci ic business situation. STORE 24> DECISION MAKING AND RELEVANT INFORMATION 1. The first step is TObtain information.U The information %athered includes the data found in the case . current operatin% data( industr' standards( assumptions( and cost data. The second step is TMake predictions about future costs.U Hsin% the cost data( assumptions and industr' standards( ,tore 2! *ould calculate *hether or not to stock the ne* flavored *ater product based on predicted sales levels( costs( and contribution mar%in. The third step is T hoose an alternative.U 6ased upon the results in ,tep 2( ,tore 2! *ould choose *hether or not to start stockin% the ne* flavored *ater product. ompan' mana%ers also *ould evaluate -ualitative factors( such as market demo%raphics. The fourth step is T"mplement the decision.U "f ,tore 2! chose to stock the ne* product( it *ould undertake the operational steps to %et the product into the stores for sale. The fifth step is TEvaluate performance to provide feedback.U ompan' mana%ers *ould *ant to evaluate individual store product sales( costs( and contribution mar%in to see if predicted levels of activit' actuall' occurred. 2. 4ater T'pe: ,ellin% price Bariable cost per bottle ontribution mar%in per bottle 6ottles per s-uare foot of shelf space ontribution mar%in per s-uare foot ontribution mar%in ratio 1 M per bottle G ,ellin% price2 24 "J( P$#i/ <1.2#; <;.=13 <;.!3> 1A <A(??2 ;.3# 24 "J( S!#09$i/3 <1.>#; <1.22# <;.#2# 1A <=.!;; ;.3 16 "J( F$#5"0&2 <1.#;; <1.12# <;.3># 3A <13.#;; ;.2#

3.

The constrainin% resource is s-uare feet of refri%erated shelf space.

!. ,tore 2! should stock the flavored *ater because it 'ields the maximum contribution mar%in per s-uare foot of shelf space.. <13.#; versus <A.??2 for plain *ater and <=.!; for sparklin% *ater.

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Vi2&" C# & 1 ontFd.2 #. /espite its hi%h contribution mar%in per s-uare foot( ,tore 2! cannot onl' offer the flavored *ater because customers have var'in% tastes and *ill expect a variet' of *ater options. 6' offerin% a sin%le product( ,tore 2! could potentiall' turn a*a' customers seekin% the unavailable products( resultin% in lost revenue for ,tore 2!. Thus ,tore 2! should stock all three *aters.. flavored( plain( and sparklin%. The exact amount of shelf space devoted to each product *ill depend on ,tore 2!Fs expectations about consumer demand for each product and the contribution mar%in per s-uare foot of shelf space for each product.

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