QUESTIONS 6-1 The answer depends on the time frame considered. - - PDF document

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Chapter 6

Cost Information for Pricing and Product Planning

QUESTIONS 6-1 The answer depends on the time frame considered. Short-run prices need only cover the costs that vary in the short run. However, in the long run, most costs become flexible (variable). In fact, in the long run, prices must cover both capacity-related (fixed) and flexible costs for the firm to survive. 6-2 Since capacities made available for many production and support activities cannot be altered easily in the short term, managers need to pay attention to whether surplus capacity is available for additional production or whether the available capacity limits production alternatives. In contrast, in the long term, managers have considerably more flexibility in adjusting the capacities of activity resources to match the demand that is placed on these resources by the actual production of different products. 6-3 In commodity-type businesses, prices are set by traders in the commodity markets based on industry supply and demand. Firms in commodity-type industries are price-takers, unable to influence the market prices. 6-4 The following two considerations complicate short-term product mix decisions: 1. Deciding what costs are relevant to the short-term product mix decision. 2. Recognizing that in the short term managers may not have the flexibility to alter the capacities of some activity resources. 6-5 A firm that is one of a large number of small firms in an industry in which there is little to distinguish the products of different firms from each other is likely to be a price-taker. A price-taker firm cannot influence prices significantly by its

• wn decisions because the prices are set by overall industry supply and demand

forces, or by a large dominant firm in its industry.

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6-6 Firms in an industry with relatively few competing firms, and firms enjoying large market shares and exercising leadership in an industry are likely to behave as price setters or price leaders. Also, firms in industries in which products are highly customized or otherwise differentiated from each other because of special features, characteristics, or customer service, are able to set prices for their differentiated products. 6-7

• No. Products should be ranked by the contribution margin per unit of the

constrained resource rather than by the contribution margin per unit of the product. 6-8

• Yes. When capacity is fixed in the short run, the firm may need to sacrifice the

production of some profitable products to make capacity available for a new

• rder. The contribution margin on the production of profitable products

sacrificed for a new order is an opportunity cost that must be considered to evaluate the profitability of the new order. 6-9 When surplus capacity is not available and overtime, extra shift, subcontracting, or

• ther means must be employed to augment the limited capacity, a short-term

pricing decision must consider the additional costs of overtime wages, supervision, heating, lighting, cleaning, security, machine maintenance and engineering, along with human factors such as a decline in morale. 6-10 If facility-sustaining (business-sustaining) costs do not vary with the decision alternatives, such as when there is some idle capacity, then these costs should not be considered for a short-run pricing decision. However, if facility- sustaining costs vary with the decision, such as when heating, or lighting and security costs increase for overtime work, they must be considered for the short-run pricing decision. 6-11 Contracts for the development and production of new, customized products, including contracts with governmental agencies such as the Department of Defense, specify prices as full costs plus a markup. Prices set in regulated industries, such as electric utilities, are also based on full costs. Also, when a firm enters into a long-term contractual relationship with a customer to supply a product, it will price the product based on its full costs. This is because it has flexibility in adjusting the level of commitment for all activity resources and as a result most of its costs become flexible (variable) in the long run. Finally, prices based on full costs are used as benchmark prices to guide short-run price adjustments in response to fluctuations in short-run demand conditions.

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6-12 The stronger the demand, the higher will be the markup. When demand is more elastic, markup will be lower because customers are sensitive to higher prices. Finally, when competition is more intense, a firm cannot sustain a high markup. 6-13 Short-run prices fluctuate over time because of changes in demand conditions. When the demand for products is low, firms adjust their prices downward. Conversely, when the demand is high, they adjust prices upward. 6-14 Several strategic factors may affect the level of markup. A firm may choose a low markup to penetrate the market and win market share from its competitors. In contrast, a firm may employ a high markup if it employs a skimming strategy for a market segment in which some customers are willing to pay higher prices. 6-15 If long-run market prices are lower than full costs, managers may consider reengineering the product to lower costs, raising prices by further differentiating the product, offering customer incentives such as quantity discounts, or dropping these unprofitable products. 6-16 In the long run, a firm has the flexibility to adjust most of its activity resources, and therefore, most costs are flexible (variable). Thus, full costs approximate long-run flexible costs that are relevant for long-run pricing decisions. EXERCISES 6-17 Healthy Hearth has sufficient excess capacity to handle the one-time order for 1000 meals next month. Consequently, the analysis focuses on incremental revenues and costs: Incremental revenue per meal $3.50 Incremental cost per meal 3.00 Incremental contribution margin per meal $0.50 Number of meals × 1,000 Increase in operating income $ 500

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6-18 In order to accept the new order for 1,500 modules next week, McGee must give up regular sales of 500 modules per week. Variable costs are $800 per module ($2,400,000/3,000 modules). The contribution margin per unit on regular sales is $900 – $800 = $100 per

• module. Therefore, the opportunity cost (lost CM) of accepting the new order is

500($100) = $50,000, and McGee will be indifferent between filling the special

• rder and not filling the special order when the contribution margins of the two

alternatives are equal (fixed costs will remain unchanged). That is, McGee will be indifferent at a price P where 1,500(P – $800) = $50,000, or P = $833.33. 6-19 This order will require 500 = 5 × (10,000 ÷ 100) machine hours. Since there is excess capacity of 800 = 4,000 × (100% − 80%) machine hours per month, Shorewood Shoes Company can accept this order without expanding its

• capacity. Therefore, Shorewood should charge at least as much as the

incremental variable costs for this order. Direct material $6.00 Direct labor 4.00 Variable manufacturing support 2.00 Additional cost of embossing the private label 0.50 Minimum price to be charged for this order $12.50 Shorewood’s costs stated in the problem are average costs per pair of shoes. Shorewood should determine whether the costs are reasonably accurate for the discount store’s order. Shorewood should also consider how its regular customers might react to the lower price offered to the discount store. 6-20 (a) Superstore faces a problem of maximizing contribution margin per unit

• f scarce resource. Here, the scarce resource is shelf space. Superstore

requires at least 24 square feet for each category. The store manager should assign additional available space to the category with the highest contribution margin per square foot, i.e., ice cream. After assigning a total of 100 square feet to ice cream, there is sufficient available shelf space to assign a total of 100 square feet to frozen dinners and 26 square feet to juices. The frozen vegetable receives the minimum required assignment of 24 square feet.

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Ice Cream Juices Frozen Dinners Frozen Vegetables Selling price per unit (square-foot package) $12.00 $13.00 $24.00 $9.00 Variable costs per unit (square-foot package) $8.00 $10.00 $20.50 $7.00 Unit CM (square-foot package) $4.00 $3.00 $3.50 $2.00 Minimum required 24 24 24 24 Maximum allowed 100 100 100 100 Allocation to maximize total CM 100 26 100 24 (b) In setting the minimum required and maximum allowed square footage per category, the manager might consider seasonality (for example, permitting more ice cream space during the summer or more frozen vegetable space during the winter) and the effect on contribution margins

• f variability in costs and prices. The analysis does not take into account

the rate at which products are sold within each category. The analysis should also consider the effect of the mix on other product sales. If the store offers only a limited selection of frozen vegetables, for example, shoppers may switch to another store for their regular grocery shopping. 6-21 Regular Deluxe Sale price per sq. yard $16 $25 Variable costs per sq. yard 10 15 Contribution margin per sq. yard $6 $10 DLH required per sq. yard 0.15 0.20 Contribution margin per DLH $40a $50b

a $6 ÷ 0.15 = $40 b $10 ÷ 0.20 = $50

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Because deluxe grade has a higher contribution margin per unit of scarce resource (DLH) than regular grade, and no more than 8,000 square yards of deluxe grade can be produced, Boyd Wood Company should produce the maximum of 8,000 square yards of deluxe grade first and then use the remaining available capacity of 3,000 DLH (= 4,600 − [8,000 × 0.20]) to produce regular grade. Therefore, the

• ptimal production level for each product is:

Deluxe: 8,000 sq. yards Regular: 20,000 sq. yards (= 3,000 ÷ 0.15). 6-22 This discussion question is motivated by recent articles on controversial strategies adopted by some nursing homes. A sample of relevant articles is listed below. [1] Moss, M. and C. Adams. “For Medicaid Patients, Doors Slam Closed— Citing Finances, Nursing Home Evicts the Needy.” The Wall Street Journal (April 7, 1998), B1. [2] Adams, C. and M. Moss. “Bad News: The Business Potential of Nursing Homes Is Elusive, Vencor Finds—Bid for High-Paying Patients Brings Firm Headaches, and It Has to Regroup—Medicaid Is Welcome Now.” The Wall Street Journal (December 24, 1998), A1. [3] McGinley, L. “Medicaid Fix: House Limits Evictions From Nursing Homes.” The Wall Street Journal (March 11, 1999), B1. [4] McGinley, L. “Health Care: As Nursing Homes Say, ‘No,’ Hospitals Feel Pain.” The Wall Street Journal (May 26, 1999), B1. [5] Conklin, J.C. “Ailing Sun Healthcare Group Files for U.S. Bankruptcy Court Protection.” The Wall Street Journal [Europe] (October 15, 1999), UK5A. [6] Adams, H.J. “U.S. Says Vencor Owes It $1.3 Billion Claim Based Largely

• n Fraud Charges.” The Courier-Journal (March 15, 2000), Louisville, KY,

1a. (a) The nursing home situation can be viewed as similar to a product mix or customer profitability problem. With a given amount of bed and staffing capacity, a major nursing home provider sought to increase profitability by targeting private-insurance or Medicare patients, who generated

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higher revenue per day than Medicaid patients. The provider’s strategy was to market high quality care to patients who could afford high prices. Unfortunately, the strategy was unsuccessful because the provider was unable to maintain the desired quality, and the provider received considerable negative publicity for its active efforts to discharge Medicaid patients, sometimes with little apparent regard for the toll it would take on the patients (see Adams and Moss (1998) and Moss and Adams (1998)). Aside from the concerns about quality of care, desirable patients were deterred by the prospect that they would be discharged from the nursing home if it became necessary to turn to Medicaid funding for their nursing home care. The nursing home provider ultimately reversed its position on Medicaid patients, but later filed for Chapter 11 bankruptcy. Largely motivated by this nursing home provider’s treatment of Medicaid patients, Congress passed legislation prohibiting nursing homes from evicting patients solely because their related reimbursements come from Medicaid. Formerly, such evictions were prohibited in only some states. Students, like nursing home administrators, may argue that it is necessary to consider the projected patient revenue in light of the cost of providing services. McGinley (May 1999) provides examples of out-of- pocket treatment costs that exceed federal reimbursements. Although some patients require very costly medications or equipment, many other patients’ reimbursements will cover the related out-of-pocket costs and contribute to covering capacity costs (Moss and Adams (1998)). (b) An employee who believes policies are unethical can approach management with his or her concerns. If management refuses to change its policy, employees may, as described in the cited articles, choose to

• resign. An employee can also contact elected representatives to introduce

legislation prohibiting unethical policies, and can alert consumer and industry groups, such as the AARP and the American Health Care Association, to encourage the groups to advocate investigations or new legislation. 6-23 Incremental variable costs = ($16 + $5 + $3) × 10,000 = $24 × 10,000 = $240,000. Incremental revenue = $40 × 10,000 = $400,000. Therefore, Berry’s operating income will increase by $160,000 if it accepts this

• ffer.

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6-24 (a) Variable cost per unit = $198,000 ÷ 36,000 = $5.50. Sales (30,000 units × $10 and 30,000 units × $9) $570,000 Variable manufacturing and selling costs (60,000 units × $5.50) (330,000) Contribution margin $240,000 Fixed costs (99,000) Operating income $141,000 If Ritter accepts the export order, its operating income will increase by $78,000 = $141,000 − $63,000. Although Ritter’s operating income will increase with the special order, Ritter must consider the long-run effect

• f displeasing its regular domestic customers by not fulfilling their

demand. (b) Sales (36,000 units × $10 and 30,000 units × $9) $630,000 Variable manufacturing and selling costs (66,000 units × $5.50) (363,000) Contribution margin $267,000 Fixed costs: $99,000 + $25,000 124,000 Operating income $143,000 If Ritter operates the extra shift and accepts the export order, operating income will increase by $80,000. Ritter should consider whether the same quality will be achieved with new operators or existing operators working overtime (with possible fatigue). In addition, Ritter should understand whether the additional fixed costs will be incurred on a continuing basis or are avoidable when production drops back to its previous level. Finally, Ritter should also consider the effect of this price reduction on regular customers.

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6-25 (a)

Cost Overhead

$2,400,000 $2,100,000 $1,200,000 6,000 8,000

Units Produced

Variable component of support costs = − − = $2, , $2, , , , $150 400 000 100 000 8 000 6 000 per unit. Fixed component of support costs = $2,100,000 − ($150 × 6,000) = $1,200,000. Because the fixed cost of $1,200,000 is apparently spread out over 8,000 units (unit fixed cost is $1,200,000 ÷ 8,000 = $150) instead of 6,000 units (unit fixed cost is $1,200,000 ÷ 6,000 = $200), the unit cost is reduced to $550 at the production level of 8,000 units from $600 at the production level of 6,000 units. (b) When excess capacity exists, the price offered for a special order should be at least as high as the variable cost per unit. Here, variable cost per unit is $400, as determined below: Direct material cost $125 Direct labor cost 125 Variable support 150 Unit variable cost $400 Therefore, Delta should accept the offer from the German company.

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6-26 Given variable costs per half-gallon container of $1.50, the contribution margins are as shown below. The maximum contribution margin occurs at a price of $2.75. Demand Price Contribution Margin 75,000 $2.50 $75,000 72,500 2.55 $76,125 70,000 2.60 $77,000 67,500 2.65 $77,625 65,000 2.70 $78,000 62,500 2.75 $78,125 60,000 2.80 $78,000 57,500 2.85 $77,625 55,000 2.90 $77,000 52,500 2.95 $76,125 50,000 3.00 $75,000

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6-27 Model Total Contribution Margin Total Contribution Margin Difference Before 5% Price Cut After 5% Price Cut B112 $30 × 3,000 = $90,000 $27 × 3,120 = $84,240 ($5,760) B116 37 × 4,500 = 166,500 33.5 × 4,680 = 156,780 (9,720) B120 44 × 5,000 = 220,000 40 × 5,200 = 208,000 (12,000) G112 30 × 4,000 = 120,000 27 × 4,160 = 112,320 (7,680) G116 37 × 4,000 = 148,000 33.5 × 4,160 = 139,360 (8,640) G120 44 × 4,000 = 176,000 40 × 4,160 = 166,400 (9,600) M124 58 × 5,000 = 290,000 53 × 5,400 = 286,200 (3,800) M126 74 × 5,000 = 370,000 68 × 5,400 = 367,200 (2,800) M128 90 × 10,000 = 900,000 83 × 10,800 = 896,400 (3,600) W124 58 × 6,000 = 348,000 53 × 6,480 = 343,440 (4,560) W126 74 × 7,000 = 518,000 68 × 7,560 = 514,080 (3,920) Wl 28 100 × 6,000 = 600,000 93 × 6,480 = 602,640 2,640 $(69,440) The five percent price cut will result in a decrease of $69,440 in Columbia’s profits. 6-28 Product Total Sales Without Special Promotion Total Sales With Special Promotion Difference Hamburgers $1.09 × 20,000 = $21,800 $0.69 × 24,000 = $16,560 ($5,240) Chicken — — — Sandwiches 1.29 × 10,000 = $12,900 1.29 × 9,200 = $11,868 (1,032) French fries 0.89 × 20,000 = $17,800 0.89 × 22,400 = $19,936 2,136 ($4,136)

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Product Variable Costs Without Special Promotion Variable Costs With Special Promotion Difference Hamburgers $0.51 × 20,000 = $10,200 $0.51 × 24,000 = $12,240 ($2,040) Chicken — — — Sandwiches 0.63 × 10,000 = $6,300 0.63 × 9,200 = $5,796 504 French fries 0.37 × 20,000 = $7,400 0.37 × 22,400 = $8,288 (888) ($2,424) Decrease in sales with special promotion $4,136 Increase in variable costs with special promotion 2,424 Decrease in contribution margin with special promotion $6,560 Incremental advertising expenses with special promotion 4,500 Decrease in profit with special promotion ($11,060) Therefore, Andrea should not go ahead with this special promotion. A countervailing argument is the creation of new customers who may stay with the firm and generate additional contribution margin in the future. 6-29 For auto dealer service departments, the standardized hours facilitate quoting estimates for customers and provide a defensible basis for the estimates. The service department has discretion over the hourly rate, which includes labor and support costs. From the customer’s viewpoint, the standardized hours represent a reasonable amount of time for the requested service. If the technician takes longer than estimated, the customer will not pay for the extra

• time. Conversely, however, if the technician takes less time than estimated, the

customer will pay for the estimated rather than the actual time. 6-30 The lack of competitors suggests Sanders may be selling SM5 at a price competitors find unprofitable; Sanders should consider raising the price. Other actions to increase the profitability of SM5 include reducing manufacturing support costs or customer support costs. To reduce SM5’s manufacturing support costs, Sanders can explore process improvements, for example, to reduce rework, setup times or material handling. To reduce customer support costs, Sanders might improve the ordering process to reduce reprocessing or time to process an order, or implement lower-cost alternatives for ordering (for example, electronically). Sanders might reduce post-sales support costs by improving instructions provided with the product. Finally, Sanders could offer customers incentives, such as quantity discounts, to induce customers to place

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fewer but larger orders, thereby reducing batch-related support costs and order- related costs. 6-31 (a) The Billiards segment currently produces a segment margin of $40,000 − $25,000 = $15,000, so the Bar’s segment margin would have to increase by at least that amount in order for the Grill’s income to be at least as high as it is now. (b) George should consider the effect on the other two segments’ revenues if he drops the Billiards segment. It may be that the availability of billiards attracts customers to the bar and restaurant segments. Traditional segment margin analysis as in part (a) does not capture such interactive effects. PROBLEMS 6-32 (a) Profit = Total Revenue − Cost = (PQ) − [2,000 + (20Q)] = [P × (400 − 5P)] − [2,000 + (20 × (400 − 5P))] = 400P − 5P2 − 2,000 − 8,000 + 100P = 500P − 5P2 − 10,000 (b) Differentiating revenue with respect to P and setting the result equal to 0, we have: 500 − 10P = 0, that is, P* = $50. Therefore, Q* = 400 − (5 × 50) = 150 and total cost is C* = 2,000 + (20 × 150) = $5,000. Therefore, average unit cost when the company produces Q* is $5,000 ÷ 150 = 33.33.

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6-33 (a) XLl XL2 XL3 Sales price $10.00 $14.00 $12.00 Direct materials (4.00) (4.50) (5.00) Direct labor (2.00) (3.00) (2.50) Variable support (2.00) (3.00) (2.50) Unit contribution margin $2.00 $3.50 $2.00 Machine hours per unit 0.20 0.35 0.25 Contribution margin per machine hour $10.00 $10.00 $8.00 Products XLl and XL2 should be produced first because they have a higher contribution margin per machine hour. Maximum production of these two products requires 110,000 machine hours: XL1: 200,000 units × 0.20 machine hours = 40,000 machine hours XL2: 200,000 units × 0.35 machine hours = 70,000 machine hours 110,000 machine hours Therefore, a balance of 10,000 = 120,000 – 110,000 machine hours are available for XL3 production, which is sufficient for 40,000 units of XL3 (10,000 machine hours ÷ 0.25 machine hours). Optimal Production Levels: XL1: 200,000 units; XL2: 200,000 units, XL3: 40,000 units (b) Under the current capacity constraint, Excel Corporation cannot meet all

• f XL3’s demand. If additional capacity becomes available, it can

produce more units of XL3. To determine whether it is worthwhile

• perating overtime, Excel needs to analyze the contribution margin of

XL3 when operating overtime. XL3 Sales price $12.00 Direct materials $5.00 Direct labor 3.75 * Variable support 2.50 11.25 Unit contribution margin $0.75

* 3.75 = 2.50 × 150%

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Because the unit contribution margin of XL3 using overtime is positive, it is worthwhile operating overtime. 6-34 (a) HCD2 requires $100 ÷ $20 = 5 direct labor hours per unit. The new order requires 1,000 = 200 × 5 direct labor hours, so the existing capacity is adequate. The contribution margin per unit of HCD2 for the new order = $400 − (75 + 100 + 125) = $100. The increase in profit is $20,000 = 200 units × $100 contribution margin. (b) HCD1 HCD2 Sales price $400 $500 Variable cost: Direct material $60 $75 Direct labor 80 100 Variable support 100 240 125 300 Contribution margin per unit $160 $200 DLH per unit 4 5 Contribution margin per DLH $40 per DLH $40 per DLH The new order requires a total of 1,500 = 5 × 300 DLH, but only 1,000 = 15,000 – 14,000 DLH are available. This will leave a capacity shortage of 500 = 1,500 – 1,000 DLH. Therefore, the change in profit is Total contribution margin – opportunity cost = (300 units × $100 contribution margin per unit) – (500 DLH × $40 contribution margin per DLH) = $30,000 – $20,000 = $10,000 increase.

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(c) If the plant is worked overtime to manufacture HCD2 for the new order, the contribution margin is negative $12.50 as shown below: Unit Variable Cost for Overtime Material 1 × 75 = $75.00 Labora 1.5 × 100 = 150.00 Variable support 1.5 × 125 = 187.50 Total variable cost $412.50 Sales price 400.00 Contribution margin $(12.50)

a or 5 hours × $30 per hour

Change in Profit During 200 × 100 = $20,000 Regular hours 100 × (12.50) = (1,250) Overtime hours Increase $18,750 6-35 (a) Product A Product B Product C Direct material $12.00 $15.00 $18.00 Direct labor 9.00 15.00 20.00 Machine

• perations and

maintenance 4 × 0.4 = 1.60 4 × 0.7 = 2.80 4 × 0.9 = 3.60 Supervision 9 × 0.20 = 1.80 15 × 0.20 = 3.00 20 × 0.20 = 4.00 Materials handling 4 × 0.75 = 3.00 5 × 0.75 = 3.75 7 × 0.75 = 5.25 Quality control 120 × 0.02 = 2.40 120 × 0.02 = 2.40 120 × 0.05 = 6.00 Machine setups 300 × 0.01 = 3.00 300 × 0.01 = 3.00 300 × 0.02 = 6.00 Production cost per unit $32.80 $44.95 $62.85

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(b) Product A Product B Product C Production cost per unit $32.80 $44.95 $62.85 Markup, 25% $8.20 $11.24 $15.71 Target price $41.00 $56.19 $78.56 (c) Product costs with overtime premium: Product A Product B Product C Direct material $12.00 $15.00 $18.00 Direct labor 1.5 × 9 = 13.50 1.5 × 15 = 22.50 1.5 × 20 = 30.00 Machine

• perations and

maintenance 1.3 × 1.60 = 2.08 1.3 × 2.80 = 3.64 1.3 × 3.60 = 4.68 Supervision 1.3 × 1.80 = 2.34 1.3 × 3.00 = 3.90 1.3 × 4.00 = 5.20 Materials handling 1.3 × 3.00 = 3.90 1.3 × 3.75 = 4.88 1.3 × 5.25 = 6.83 Quality control 1.3 × 2.40 = 3.12 1.3 × 2.40 = 3.12 1.3 × 6.00 = 7.80 Machine setups 1.3 × 3.00 = 3.90 1.3 × 3.00 = 3.90 1.3 × 6.00 = 7.80 Product A Product B Product C Production cost per unit $40.84 $56.94 $80.31 Markup, 25% $10.21 $14.23 $20.08 Target price $51.05 $71.17 $100.39 MH per unit 0.4 0.7 0.9 Actual production 10,000 5,000 5,000 MH for actual production 4,000 3,500 4,500 Total MH used: 4,000 + 3,500 + 4, 500 12,000 Maximum demand 12,000 12,000 6,000 MH for maximum demand 4,800 8,400 5,400 Total MH: 4,800 + 8,400 + 5, 400 18,600

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The company’s production last year used all available machine hours. If the company desires to increase production and sales, costs will increase for all units as the company increases capacity through use of overtime. Last year’s sales prices were roughly equal to the company’s target prices that are designed to cover costs and desired profit. Although the company could have sold more units at last year’s prices, using overtime will increase target prices (based on a 25% markup over unit production costs) to amounts that substantially exceed last year’s sales prices for the products. In making the decision on overtime production, the company will need to assess the market demand for products A, B, and C at the desired prices. Also, even if the company uses its available overtime hours, it will not be able to meet the maximum demand for all the products. 6-36 (a) “Large” “Small” Sales price per unit $32 $21 Variable cost per unit Direct material ($12) ($10) Direct labor (6) (2) Support (2) (1) Contribution margin per unit $12 $8 Machine hours per unit 10 ÷ 100 = 10 ÷ 200 = 0.10 0.05 Contribution margin per MH $120 $160 (b) Small stuffed animals are more profitable to make under constrained capacity than the large stuffed animals. “Large” “Small” MH required per batch 10 10 Estimated number of batches 150a 125b Estimated MH required 1,500 1,250

a 15,000 ÷ 100 = 150 b 25,000 ÷ 200 = 125

Since total machine hour capacity is adequate to fill the estimated demand for both large and small stuffed animals, Barney should produce 15,000 and 25,000 units of large and small stuffed animals, respectively.

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(c) Special order: Price per unit $37 Variable cost per unit: ($12 + 6 + 2) 20 Contribution margin per unit $17 “Large” “Small” Special Order Contribution margin per batch $1,200 (12 × 100) $1,600 (8 × 200) $1,700 (17 × 100) Contribution margin per MH $120 $160 $170 Based on contribution margin per MH, Barney should first choose to produce the 5,000 special order units, then 25,000 small stuffed animals, and then use the remaining MH to produce12.500 other large stuffed animals. Total available MH 3,000 MH required: Special order (5,000 ÷ 100) × 10 = (500) “Small” (25,000 ÷ 200) × 10 = (1,250) MH available for “Large” 1,250 Number of “Large” that can be produced: (1,250 ÷ 10) × 100 = 12,500 Unfilled demand 15,000 – 12,500 = 2,500 Opportunity cost 2,500 × $12 CM per unit = $30,000 (d) Yes, Barney should accept the special order because the contribution margin obtained from this order is $85,000 = $17 × 5,000, which is greater than the opportunity cost of $30,000, resulting in a net profit increase of $55,000.

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(e) Without Subcontract With Subcontract Difference Special order $17 × 5,000 = $85,000 $17 × 5,000 = $85,000 $0 Small $8 × 25,000 = $200,000 $155,000*

($8 × 20,000) − ($1 × 5,000)

(45,000) Large $12 × 12,500 = $150,000 $12 × 15,000 = $180,000 30,000 Total CM $435,000 $420,000 ($15,000)

*Total available MH = 3,000

MH required: Special order (5,000 ÷ 100) × 10 = (500) Regular “Large” (15,000 ÷ 100) × 10 = (1500) Available MH for “Small” 1,000 Number of “Small” produced: In-house (1,000 ÷ 10) × 200 =20,000 Subcontract 5,000 Contribution margin on sub-contracted “Small” $21 – $22 = – $1 Barney should not subcontract, but instead, should produce the special

• rder of 5,000 large stuffed dinosaurs, 12,500 other large stuffed

animals, and 25,000 small stuffed animals. To obtain any additional benefit from the subcontract, the subcontract price per unit would have to be less than $19, as shown below. Barney should also consider qualitative factors such as the quality of subcontracted stuffed animals and the reliability of the subcontract delivery schedule. To determine the price P at which Barney is better off with the subcontract than without, we solve the following inequality: $435,000 < ($17 × 5,000)+ ($8 × 20,000) + 5,000($21 – P) +($12 × 15,000) $435,000 < $85,000 + $160,000 + $105,000 – 5,000P +$180,000 5,000P < $95,000 P < $19

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6-37 (a) In order to produce 10,000 units of standard doors and 5,000 units of deluxe doors, the following number of direct labor hours and machine hours are required: Cutting: Direct labor hours: 0.5 × 10,000 + 1 × 5,000 = 10,000 > 8,000 capacity Machine hours: 2 × 10,000 + 3 × 5,000 = 35,000 < 40,000 capacity Assembly: Direct labor hours: 1 × 10,000 + 1.5 × 5,000 = 17,500 = 17,500 capacity Machine hours: 2 × 10,000 + 3 × 5,000 = 35,000 < 40,000 capacity Finishing: Direct labor hours: 0.5 × 10,000 + 0.5 × 5,000 = 7,500 < 8,000 capacity Machine hours: 1 × 10,000 + 1.5 × 5,000 = 17,500 > 15,000 capacity Evidently, the direct labor hour capacity in the cutting department, and the machine hour capacity in the finishing department are not adequate to meet the next month’s demand. (b) Standard Deluxe Sales price per unit $150 $200 Variable cost per unit 110 155 Contribution margin per unit $40 $45 CM per DLH in the cutting department $80a $45b CM per MH in the finishing department $40c $30d

a $40 ÷ 0.5 = $80 b $45 ÷ 1 = $45 c $40 ÷ 1 = $40 d $45 ÷ 1.5 = $30

Since the standard door has a higher contribution margin per unit of both scarce resources than the deluxe door, the following production plan is recommended in order to maximize profit: Standard door: 10,000 units; Deluxe door: 3,000 units*.

* Constraints on the number of deluxe doors that can be made in each production department: Cutting: [8,000 − (10,000 × 0.5)] ÷ 1 = 3,000 units. Finishing: [15,000 − (10,000 × 1)] ÷ 1.5 = 3,333 units.

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(c) The following alternatives may be considered: 1. Add more machines in the finishing department. 2. Use overtime or add a second shift in the cutting department. 6-38 (a) To maximize monthly commissions while working 160 hours per month, Loren should devote the maximum allowable time (90 hours) to customer group B because that group provides the largest average commission per hour of Loren’s time. Loren should next allocate the maximum of 60 hours to customer group A because that group provides the next largest average commission per hour. Finally, Loren should devote the remaining 10 hours of his 160 hours to group C. Customer Group A B C Average monthly sales per customer $900 $600 $200 Commission 6% 5% 4% Average commission $54 $30 $8 Hours per customer per monthly visit 3 1.5 0.5 Average commission per hour $18 $20 $16 Current hours 60 90 60 Hours per month 60 90 10 Total: 160 hours (40 hours per week) (b) Loren should also consider the probable future increased profitability from customers in group C, as well as likely future profitability of customers in the other groups. 6-39 (a) DLH per unit = $500 direct labor cost ÷ $20 wage rate = 25 DLH The new order requires 1,000 DLH (40 × 25), so the existing capacity is adequate. Contribution margin per unit = $2,000 – (375 + 500 + 625) = $500

Chapter 6: Cost Information for Pricing and Product Planning – 273 –

Change in profit = 40 units × $500 contribution margin per unit = $20,000 increase. (b) Item L8011 L8033 Sales price $2,000 $2,500 Variable cost: Direct materials $300 $375 Direct labor 400 500 Variable support 500 1,200 625 1,500 Contribution margin per unit $ 800 $1,000 DLH per unit 20 25 Contribution margin per DLH $40 $40 The new order requires a total of 1500 DLH (25 × 60), but there are only 1000 DLH (14,000 – 13,000) available. This will leave capacity short for 500 DLH (1500 – 1000). Therefore, the company will face an

• pportunity cost of $40 per DLH (both products contribute $40 per

DLH). Change in profit = Total contribution margin – opportunity cost = (60 units × $500 contribution margin per unit) – (500 DLH × $40 contribution margin per DLH) = $30,000 – $20,000 = $10,000 increase (c) If the plant is worked overtime to manufacture L8033 for the special

• rder, the contribution margin per unit during overtime work is negative

$62.50, as computed below: Item Contribution Margin Per Unit Computation Variable costs: Direct materials $375.00 1 × $375 Direct labor 750.00 1.5 × $500 Variable support 937.50 1.5 × $625 Total variable costs $2062.50 Sales price 2000.00 Contribution margin $(62.50)

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Therefore, the change in profit from accepting the special order and working the plant overtime is a net increase of $18,750, as detailed below: Special Order Production Change in Contribution Margin Computation Regular hours $20,000 40 × $500 Overtime hours (1,250) 20 × $(62.50) Total increase $18,750 6-40 (Unofficial CMA Answer) (a) The minimum price per blanket that Marcus Fibers, Inc. could bid without reducing the company’s net income is $24.00 calculated as follows: Raw materials (6 lb. × $1.50/lb.) $9.00 Direct labor (0.25 hr. × $7.00/hr.) 1.75 Machine time ($10.00/blanket) 10.00 Variable support (0.25 hr × $3.00/hr.) 0.75 Administrative cost ($2,500 ÷ 1,000) 2.50 Minimum bid price $24.00 (b) Using the full cost criterion and the maximum allowable return specified, Marcus Fibers, Inc.’s bid price per blanket would be $29.90, calculated as follows: Relevant costs from requirement (a) $24.00 Fixed support (0.25 hr × $8.00/hr.) 2.00 Subtotal 26.00 Allowable return (0.15a × $26.00) 3.90 Bid price $29.90

a 9% ÷ (1 – tax rate of 40%)

Chapter 6: Cost Information for Pricing and Product Planning – 275 –

(d) Factors that Marcus Fibers, Inc. should consider before deciding whether to submit a bid at the maximum acceptable price of $25.00 per blanket include the following:

• The company should be sure there is sufficient excess capacity to

fulfill the order and that no additional investment is necessary in facilities or equipment, which would increase the capacity-related (fixed) expense.

• If the order is accepted at $25.00 per blanket, there will be a $1.00

contribution per blanket to fixed costs. However, the company should consider whether there are other jobs that would make a greater contribution.

• Acceptance of the order at a low price could cause problems with

current customers who might demand a similar pricing arrangement. 6-41 (a) Direct materials cost per unit $3.80 Direct labor cost per unit 10.00 Total variable cost per unit $13.80 Shipping cost per unit: $3,200 ÷ 1,000 3.20 Minimum price that Holmes could offer $17.00 (b) A17 B23 XLT Selling price per unit $75.00 $120.00 $160.00 Variable cost of the basic component $13.80 $13.80 $13.80 Direct materials cost per unit — 6.00 4.50 Direct labor costs per unit 9.00 20.00 31.00 Total variable costs per unit $22.80 $39.80 $49.30 Contribution margin per unit $52.20 $80.20 $110.70 (c) A17 B23 XLT Contribution margin per unit $52.20 $80.20 $110.70 Direct labor hours per unit ÷ 0.3 ÷ 0.8 ÷ 1.05 Contribution margin per DLH $174.00 $100.25 $105.43 Therefore, it is optimal to make only model A17 if there is sufficient demand.

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Contribution margin per unit of B23 at a price of $140.00 = $100.20 Contribution margin per direct labor hour for B23 = $125.25 Therefore, the above answer does not change if the price of model B23 is $140. 6-42 Unit cost of direct materials $9.80 Unit cost of direct labor 4.50 Unit variable manufacturing support cost: ($6,000,000 − $4,50,000) ÷ 500,000 units 3.00 Unit variable selling and administrative cost: $2.50a × (1.0 − 0.6) 1.00 Unit relevant cost of the special order $18.30 Number of units 100,000 Total relevant cost of the special order $1,830,000

a ($3,350,000 − $2,100,000) ÷ 500,000

Total relevant costs of the special order ($1,830,000) are compared with the total revenue of $2,500,000 from this order. Because the associated revenues exceed the relevant costs, Kirby Company should accept this special order from the customer. 6-43 (a) The unit cost relevant to determining the minimum selling price for the damaged units is the incremental cost that will be incurred. Hence, the relevant unit cost is the variable selling and distribution cost of $2.00.

Chapter 6: Cost Information for Pricing and Product Planning – 277 –

(b) The maximum amount per unit Purex Company should pay is the amount that Purex Company saves by not making the product. Variable manufacturing costs: 25,000 × ($1.50 + $2.50 + $0.80) $120,000 Fixed support: $100,000 − $90,000 10,000 Variable selling and distribution costs: 25,000 × ($2.00 −$0.80) 30,000 Total cost savings $160,000 Number of units ÷ 25,000 Cost savings per unit $6.40 (c) The incremental cost per unit includes all variable manufacturing costs and variable selling costs. Thus, the incremental cost per unit is $5.80 = ($1.50 + $2.50 + $0.80 + $1.00) and the minimum acceptable price is $5.80. (d) Kleen Shine Selling price per unit $10.00 $16.00 Variable costs per unit 6.80 11.00 Contribution margin per unit $3.20 $5.00 Machine hours per unit ÷ 1.0 ÷ 2.5 Contribution margin per machine hour $3.20 $2.00 Since the contribution margin per machine hour for Kleen is greater than that for Shine, Purex Company should produce as many units of Kleen as can be sold (80,000 units) to maximize total contribution margin. The remaining 20,000 hours of machine time should be used to manufacture 8,000 (= 20,000 ÷ 2.5) units of Shine. 6-44 (a) P1 (Casting) P2 (Machining) R361: 30,000 × 1.2 = 36,000 72,000 × 1.2 = 86,400 R572: 10,000 × 2 = 20,000 48,000 × 2 = 96,000 Total machine hours required 56,000 182,400 Note: 1.2 = 600,000 ÷ 500,000 and 2 = 800,000 ÷ 400,000.

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Capacity in Casting (P1) is adequate because 56,000 < 80,000. However, capacity in machining (P2) is not adequate because 182,400 > 120,000. (b) Using the activity-based costs as variable costs: R361 R572 Selling price per unit $19.00 $20.00 Variable cost per unit 15.67 17.70 Contribution margin per unit $3.33 $2.30 (c) R361 R572 Contribution margin per unit $3.33 $2.30 P2 MH per unit 72 000 500 000 0144 , , . = 48 000 400 000 012 , , . = Contribution margin per P2 MH $3. . . 33 0144 2313 = $2. . . 30 012 1917 = Estimated demand 600,000 units 800,000 units Note that P2 MH cannot exceed 120,000 hours. Since contribution margin per P2 MH for R361 is greater than contribution margin per P2 MH for R572, Crimson should first produce as many units of R361 as

• possible. P2 MH required to produce 600,000 units of R361

= 72,000 × 1.2 (or 600,000 × 0.144) = 86,400 hours. Next, P2 MH available to produce R572 = 120,000 – 86,400 = 33,600 hours. By using 33,600 P2 MH, the maximum number of R572 that can be produced is = = 33 600 012 280 000 , . , units

Chapter 6: Cost Information for Pricing and Product Planning – 279 –

Summary: Contribution margin per P2 MH for R361 = $23.13 Contribution margin per P2 MH for R572 = $19.17 Optimal production level for R361 = 600,000 units Optimal production level for R572 = 280,000 units (e) First, note that Crimson does not need to operate overtime in the Casting (P1) department because there is surplus capacity. Next, the demand of R361 can be filled without using overtime. Thus, to determine whether it is worthwhile operating machining (P2) department overtime, we need to consider only R572. Overtime can be considered for the remaining 520,000 units of demand for R572. This requires 62,400 MH (= 520,000 × 0.12). The new variable cost per unit is $17.70 + ($0.75 × 0.5) + ($2.16 × 0.5) = $19.155 and the new contribution margin per unit of R572 is $0.845. Thus, it is worthwhile to operate overtime to fulfill the demand for R572. 6-45 (a) Standard Deluxe Selling price (per batch) ($10 × 60) = $600 ($20 × 30) = $600 Less variable cost (per batch): Direct material ($5 × 60) = $300 ($11 × 30) = $330 Direct labora 144 120 Shipmentb 15 45 Contribution margin per batch $141 $105 DLH required per batch 12 10 Batch CM per DLH $11.75 $10.50

a $12 × ([60 × 10] ÷ 60 + 2) = $144; 12 × ([30 × 15] ÷ 60 + 2.5) = $120 b $15 × (60 ÷ 60) = $15; $15 × (30 ÷ 10) = $45

Since the Standard model has a higher contribution margin per unit of the scarce resource (DLH) than the Deluxe model, the company should produce as much of the Standard model as the company can sell and use the remaining DLH to manufacture the Deluxe model. Demand for the Standard model is 6,000, which requires 6,000/60 = 100 batches, and therefore, 100 ×12 = 1,200 DLH. The company would then have 2,000 – 1,200 = 800 DLH remaining for Deluxe production. With the 800 DLH, the company can produce 800/10 = 80 batches, or 80 × 30 = 2,400 Deluxe tents. The optimal production schedule is therefore: 6,000 Standard tents and 2,400 Deluxe tents.

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(b) Deluxe (Northland’s offer) Selling price (per batch): $18.50 × 50 $925 Less variable cost (per batch): Direct material: $11 × 50 550 Direct labor: 12 × ([50 × 15] ÷ 60 + 2.5) 180 Shipment: $15 × 1 15 Contribution margin per batch $180 DLH required per batch ÷ 15 Contribution margin per DLH $12 Orion should accept this offer because it offers a higher contribution margin per DLH than both the Regular and the Deluxe models. However, Orion should also consider other factors such as whether the Northlands arrangement will continue in the long-run, and how its regular customers will react to the lower price offered to Northlands. 6-46 (a)

11.5 15 15.5 1 2 3 4 5 6 7 8 9 1 0 1 1 1 2 1 3 Week Short-run price Long- run price + 12 13.5 13 12.5 14 14.5

Price

Chapter 6: Cost Information for Pricing and Product Planning – 281 –

Week v b at Pt PL X Qt 1 $8.1 500 8,200 $12.25 $13.95 2,150 2,075 2 8.1 500 8,350 12.40 13.95 2,150 2,150 3 8.1 500 8,600 14.95 13.95 2,150 1,125 4 8.1 500 8,500 14.85 13.95 2,150 1,075 5 8.1 500 8,400 14.75 13.95 2,150 1,025 6 8.1 500 8,850 15.20 13.95 2,150 1,250 7 8.1 500 8,300 12.35 13.95 2,150 2,125 8 8.1 500 8,050 12.10 13.95 2,150 2,000 9 8.1 500 8,200 12.25 13.95 2,150 2,075 10 8.1 500 8,800 15.15 13.95 2,150 1,225 11 8.1 500 8,350 12.40 13.95 2,150 2,150 12 8.1 500 7,950 12.00 13.95 2,150 1,950 13 8.1 500 8,650 15.00 13.95 2,150 1,150 Average 13.51 13.95 P a b v a a b w a

t t t t t

= + # = + > 2 2 8 3 5 0 2 2 8 3 5 0 i f i f , , Qt = at -bPt

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(b) Week Revenuea Costb Profitc 1 $25,418.75 $23,257.50 $2,161.25 2 26,660.00 23,865.00 2,795.00 3 16,818.75 15,562.50 1,256.25 4 15,963.75 15,157.50 806.25 5 15,118.75 14,752.50 366.25 6 19,000.00 16,575.00 2,425.00 7 26,243.75 23,662.50 2,581.25 8 24,200.00 22,650.00 l,550.00 9 25,418.75 23,257.50 2,161.25 10 18,558.75 16,372.50 2,186.25 11 26,660.00 23,865.00 2,795.00 12 23,400.00 22,245.00 l,155.00 13 17,250.00 15,765.00 1,485.00 Total Profit $23,723.75

a PQ

t t b vQt + mX c Revenue – Cost

12 20 26 28 1.7 1.8 1.9 2 2.1 2.2 2.3 (Thousands) 14 16 18 24 22 30 2.4 2.5 2.6 Capacity

Total Profit (Thousands)

Chapter 6: Cost Information for Pricing and Product Planning – 283 –

6-47 (Unofficial CMA Answer) (a) The manufacturing support cost driver rate is $18.00 per standard direct labor hour and the standard product cost includes $9.00 of manufacturing support per pressure valve. Accordingly, the standard direct labor hour per finished valve is 0.5 hours ($9 ÷ $18). Therefore, 30,000 units per month would require 15,000 direct labor hours. (b) The incremental analysis of accepting the Glasgow Industries’ order of 120,000 units is presented below. Totals for Per Unit 120,000 Units Incremental revenue $19.00 $2,280,000 Incremental costs Variable costs Direct materials 5.00 600,000 Direct labor 6.00 720,000 Variable support: $9.00 − $6.00 per unit 3.00 360,000 Total variable costs $14.00 1,680,000 Fixed support Supervisory and clerical costs (4 months × $12,000) 48,000 Total incremental costs 1,728,000 Incremental profit before tax $552,000 The following costs are irrelevant to the incremental analysis:

• Shipping
• Sales Commission
• Fixed Manufacturing Support

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(c) The minimum unit price that Sommers could accept without reducing its profits must cover variable costs plus the additional fixed costs. Variable unit costs Direct materials $5.00 Direct labor 6.00 Variable support 3.00 $14.00 Additional fixed cost ($48,000 ÷ 120,000) 0.40 Minimum unit price $14.40 (d) Sommers Company should consider the following factors before accepting the Glasgow Industries order.

• The effect of the special order on Sommers’ sales at regular prices.
• The possibility of future sales to Glasgow Industries and the

effects of participating in the international marketplace.

• The company’s relevant range of activity and whether the special
• rder will cause volume to exceed this range.
• The impact on local, state and federal taxes.
• The effect on machinery or the scheduled maintenance of equipment.

Chapter 6: Cost Information for Pricing and Product Planning – 285 –

6-48 (Unofficial CMA Answer) (a) Bakker Industries will not be able to meet the monthly sales demand for the three products because of insufficient machine capacity in Department 1. However, there is sufficient capacity for both labor and machine hours in all other departments as shown below. Bakker Industries Sales Demand vs. Machine and Labor Hour Capacities Departments 1 2 3 4 Machine hours needed: (hours × demand) Product: 611 1,000 500 1,000 1,000 613 400 400 — 800 615 2,000 2,000 1,000 1,000 Total hours required 3,400 2,900 2,000 2,800 Machine hours available 3,000 3,100 2,700 3,300 Excess (deficiency) (400) 200 700 500 Labor hours needed (hours × demand) Product: 611 1,000 1,500 1,500 500 613 400 800 — 800 615 2,000 2,000 1,000 1,000 Total hours required 3,400 4,300 2,500 2,300 Labor hours available 3,700 4,500 2,750 2,600 Excess (deficiency) 300 200 250 300

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(b) Bakker Industries has a scarce resource, machine hour capacity in Department

• 1. Therefore, the company should maximize contribution per machine

hour in Department 1 in order to maximize overall profit, as calculated below. Bakker Industries Contribution Maximization Calculation

• Calculation of contribution per machine hour:

Product 611 613 615 Unit selling price $196.00 $123.00 $167.00 Less variable costs 103.00 73.00 89.00 Contribution per unit $93.00 $50.00 $78.00 Machine hours in Department 1 2 1 2 Contribution per machine hour $46.50 $50.00 $39.00

• Use available machine capacity to maximize contribution per MH

Machine hours available in Department 1 3,000 Use 400 hours to produce 400 units of Product 613 400 Remaining available hours 2,600 Use 1,000 hours to produce 500 units of Product 611 1,000 Remaining available hours 1,600 Use remaining 1,600 hours to produce 800 units

• f Product 615

1,600 Remaining available hours

• Contribution from this production schedule:

Product 613 (400 × $50) $20,000 Product 611 (500 × $93) 46,500 Product 615 (800 × $78) 62,400 Total contribution $128,900 (c) Bakker might operate overtime or subcontract some of Department 1’s production to outside firms.

Chapter 6: Cost Information for Pricing and Product Planning – 287 –

6-49 (Unofficial CMA Answer) In order to maximize the company’s profitability, Sportway, Inc. should purchase 9,000 tackle boxes from Maple Products, manufacture 17,500 skateboards and manufacture 1,000 tackle boxes. This combination of purchased and manufactured goods maximizes the contribution margin per direct labor hour available, as calculated below in Tables 1 and 2. Table 1: Calculate Unit Contribution Purchased Tackle Boxes Manufactured Tackle Boxes Skateboards Selling price $86.00 $86.00 $45.00 Less: Variable costs Material 68.00 17.00 12.50 Direct labor n/a 18.75 7.50 Manufacturing support* n/a 6.25 2.50 Selling and admin. cost** 4.00 11.00 3.00 Contribution margin $14.00 $33.00 $19.50 Direct labor hours per unit none 1.25 0.50 Contribution margin per hour n/a $26.40 $39.00 * Calculation of variable support cost per unit:

Tackle boxes: Direct labor hours = $18.75 ÷ $15.00 = 1.25 hours Support costs/DLH = $12.50 ÷ 1.25 = $10.00 Capacity = 8,000 boxes × 1.25 = 10,000 hours Total support costs = 10,000 hours × $10 = $100,000 Total variable support = $100,000 – $50,000 = $50,000 Variable support per hour = $50,000 ÷ 10,000 = $5.00 Variable support per box = $5.00 × 1.25 = $6.25 Skateboards: Direct labor hours = $7.50 ÷ $15.00 = .5 hours Variable support = $5.00 × .5 = $2.50 ** For calculating contribution, $6.00 of fixed support cost per unit for distribution must be deducted from selling and administrative cost.

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Table 2: Optimal Use of Sportway’s Available Direct Labor Item Quantity Unit Contribution DLH Per Unit Total DLH Balance

• f DLH

Total Contribution Total hours 10,000 Skateboards 17,500 $19.50 0.50 8,750 1,250 $341,250 Make boxes 1,000 33.00 1.25 1,250 — 33,000 Buy boxes 9,000 14.00 — — — 126,000 Total contribution $500,250 Less: Contribution for manufacturing 8,000 boxes (8,000 × $33.00) 264,000 Improvement in contribution margin $236,250 6-50 (a) Fixed costs of Process A: $36,000,000a × 0.6 = $21,600,000 Fixed costs of Process B: $12,000,000b × (1.2 + 0.6) = $21,600,000 The total amount of fixed manufacturing support is common to both processes and does not change with different alternatives. Therefore, it is irrelevant to this analysis. The scarce resource is hours of capacity. The

• bjective here is to maximize the contribution margin per hour.

a 12,000,000 = 600,000 hrs × $20 per hr. b $36,000,000 = 600,000 hrs × $60 per hr.

Chapter 6: Cost Information for Pricing and Product Planning – 289 –

Process A Output Process B Output Selling price per unit $2.00 $5.10 Variable costs per unit: Transferred-in variable costs from Process A — 1.20 Direct material 1.00 1.50 Direct labor 0.20 0.40 Total variable costs per unit $1.20 $3.10 Contribution margin per unit $0.80 $2.00 Capacity hours per unit 1 ÷ 60 = 0.01667 1 ÷ 20 = 0.05 Contribution margin per capacity hour $48.00 $40.00 Therefore, Process B output should be dropped and all facilities should be devoted to the sale of only Process A output. (b) Required contribution margin per capacity hour: $48.00 Required capacity hours per unit: 0.05 Required contribution margin per unit: 48 × 0.05 = $2.40 Variable costs per unit: $3.10 Minimum required selling price of Process B output: $5.50

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(c) For (a): Process A Output Process B Output Selling price per unit $2.00 $5.10 Variable costs per unit: 1.50a 4.00b Contribution margin per unit $0.50 $1.10 Capacity hours per unit 1 ÷ 60 = 0.01667 1 ÷ 20 = 0.05 Contribution margin per capacity hour $30.00 $22.00

a $1.50 = $1.20 + (0.5 × $0.60) b $4.00 = $3.10 + 0.5($1.20 + $.60)

Therefore, the earlier answer to (a) does not change. For (b): Required contribution margin per capacity hour: $30.00 Required capacity hour per unit: 0.05 Required contribution margin per unit: $1.50 Variable costs per unit $4.00 Minimum required selling price of Product B $5.50 Therefore, the earlier answer to (b) does not change.

Chapter 6: Cost Information for Pricing and Product Planning – 291 –

CASES 6-51 (a) Unit cost AA100 AA101 AA102 Direct materials: Chem. & frag. $560 $400 $470 Direct materials: AA 100 — 680 680 Direct labor 60 30 60 Variable mfg. support 60 30 60 Total variable mfg. cost $680 $1,140 $1,270 Total selling support 20 30 30 Total variable cost $700 $1,170 $1,300 Sales price 940 1,500 1,700 Contribution margin per ton $240 $330 $400 Hours per ton 4 hrs 6 hrs 8 hrs Contribution margin per hour $60 $55 $50 (b) AA100 has a higher contribution margin per hour than AA101 and

• A102. Aramis should produce AA100 up to 600 tons. Since the

production of 600 tons of AA100 requires 2,400 = 600 × 4 hours, which equals available capacity, no other products will be manufactured. Therefore, the optimal production levels are: AA100: 600 tons; AA101: 0 tons; and AA102: 0 tons. (c) Opportunity cost is $60 per hour (the contribution margin per hour for AA100 production that must be sacrificed) and each ton of AA101 requires 6 hours. Required contribution margin per ton (= $60 × 6) $360 Variable cost per ton 1,170 Required minimum sales price per ton $1,530 (d) It is worthwhile operating the plant overtime. The optimal production level is AA100: 600 tons; AA101: 100 tons; and AA102: 0 tons. Explanation: The regular capacity of 2,400 hours (before operating the plant overtime) is used to produce 600 tons of AA100. How should 600 hours of overtime be used? We know that the demand for AA100 has been filled fully. Therefore, we consider AA101 and AA102. AA101 has a higher contribution margin per hour than A102. With 600 hours of

Atkinson, Solutions Manual t/a Management Accounting, 5E – 292 –

• vertime, the company can produce 100 tons of A101 (600 hours ÷ 6

hours per ton), which is less than the maximum demand. This leaves no hours for A102. Under overtime: AA100 AA101 AA102 Direct materials: Chem. & frag. $560 $400 $470 Direct materials: AAA100 — 740 740 Direct labor 90 45 90 Variable mfg. support 90 45 90 Total variable mfg. cost $740 $1,230 $1,390 Variable selling support 20 30 30 Total variable cost $760 $1,260 $1,420 Sales price 940 1,500 1,700 Contribution margin per ton $180 $240 $280 Hours per ton 4 6 8 Contribution margin per hour $45 $40 $35 Since contribution margins per hour for AA101 and AA102 are positive, it is worthwhile operating the plant overtime. 6-52 (a) Avoidable costs for 400 units of DLX: Direct material = $(80 + 20) × 400 = $40,000 Direct labor = $(40 + 30) × 400 = 28,000 Support: MNTa: $4 × 5 MH × 400 8,000 QLCb: $10 × 2 inspection hours × 400 8,000 Total cost $84,000

a

• MNT. Let FC = fixed costs and VC = variable costs.

Week 45: FC + VC×[450 × (2 + 1) + 430 × (3 + 2)] = $35,000 (1) Week 46: FC + VC×[450 × (2 + 1) + 450 × (3 + 2)] = $35,400 (2) Solving equations (1) and (2) simultaneously yields VC = $4 per MH.

b

• QLC. Let FC = fixed costs and VC = variable costs.

Week 45: FC + VC×[450 × (0.5 + 0.5) + 430 × (1 + 1)] = $63,100 (3) Week 46: FC + VC×[450 × (0.5 + 0.5) + 450 × (1 + 1)] = $63,500 (4) Solving equations (3) and (4) simultaneously yields VC = $10 per inspection hour.

Chapter 6: Cost Information for Pricing and Product Planning – 293 –

Since the total avoidable costs are more than the total subcontracting charges of $80,000 (= $200 × 400) under the French offer, it is profitable to accept the offer. Qualitative factors such as quality of purchased model and reliability of delivery schedule should also be considered in evaluating this offer. (b) Relevant costs include direct material costs, direct labor costs, and avoidable maintenance and inspection costs. (c) From (a) above, we can determine the fixed costs for MNT and QLC as follows: MNT: FC = $21,000 QLC: FC = $50,000 Cost savings from capacity reduction: Expected total machine hours = 3,600 Expected total inspection hours = 1,350 MNT: $21,000 × [(3 + 2) × 400/3,600] = $11,666.67 QLC: $50,000 × [(1 + 1) × 400/1,350] = $29,629.63 Total cost savings: Direct material $40,000.00 Direct labor 28,000.00 MNT - VC 8,000.00 MNT - FC 11,666.67 QLC - VC 8,000.00 QLC - FC 29,629.63 Total cost savings $125,296.30 It is profitable for Sweditrak to accept the long-term offer because the total cost savings are greater than the total subcontracting charges. 6-53 This case consists of running an experiment, and students are required to submit a report and statements after the experiment.

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6-54 The responses below are based on “Survival Strategies: After Cost Cutting, Companies Turn Toward Price Increases,” by Timothy Aeppel, The Wall Street Journal (September 18, 2002, p. A1). (a) Jergens’ president based the price on what he determined to be the cost of producing the order of 10 odd-sized fasteners from scratch. The cost included setup for the odd size and overtime labor. The company actually produced the

• dd-sized fasteners by producing full-size fasteners and then shortening 10.

This method was less costly than setting up the equipment to run a small batch of the required odd size. (b) Goodyear had been rewarding its sales force based on volume, providing an incentive for the sales force to deeply discount prices to large distributors. The discounts were so substantial that the large distributors could resell the tires to smaller distributors (even with transportation costs to other regions), reducing Goodyear’s sales at higher prices to smaller distributors. Goodyear responded by cutting the discounts to large distributors, removing discount approval authority from the sales force and transferring it to a “tactical pricing group” that determines whether Goodyear can profitably match a competitor’s prices. Goodyear also modified its sales force bonus scheme to include a “revenue per tire” metric. (c) Emerson discovered that customers were willing to pay about 20% more than Emerson’s initially proposed cost-based price of $2,650 for a new compact

• sensor. Emerson priced the sensor at $3,150. Note that the article does not

provide information on how Emerson determined product costs that it used as a basis for its markups. A traditional cost system is more likely to undercost a low-volume or customized product because it allocates manufacturing support costs to products based on unit-level drivers. An activity-based costing system more accurately assigns costs based on resource usage. (d) Wildeck, “a maker of metal guard rails, mezzanines and material lifts for factories and warehouses,” promoted packages that included installing its

• products. The installations bring higher profit than parts catalog sales.

Wildeck responded to a competitor’s lower-priced storage-rack protector by developing its own “lite” version and pricing it much lower than the competitor’s price. When customers called about purchasing the lite version, they were informed of the benefits of the original version, and most of these customers bought the original version. An accurate costing system, such as a good activity-based costing system that includes both manufacturing and nonmanufacturing costs of providing goods and services to customers,

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provides reasonably precise information to managers for making decisions about the mix of products and services to offer to customers and prices to charge in order to generate the desired level of profitability. (e) Union Pacific introduced a minimum price that was higher than a third of its customers paid. The company was not concerned if it lost these customers because customers who were paying higher prices would fill up the newly free space. Dropping unprofitable customers will not lead to an immediate increase in profit if the associated capacity-related costs are committed costs and the resources cannot be put to other profitable use.