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EXERCISES

Ex. 24–1 (FIN MAN); Ex. 9–1 (MAN)

a.

A B C D

1 Differential Analysis

2 Lease Machine (Alt. 1) or Sell Machine (Alt. 2)

3 January 3, 2012

4 Lease Equipment (Alternative 1)

Sell Equipment(Alternative 2)

Differential Effecton Income

(Alternative 2)

5 Revenues $285,000 $276,000 –$ 9,000

6 Costs –25,500 –13,800* 11,700

7 Income (Loss)

$259,500 $262,200 $ 2,700

*$276,000 × 5%

b. Sell the machinery. The net gain from selling is $2,700.

Ex. 24–2 (FIN MAN); Ex. 9–2 (MAN)

Note to Instructors: This differential analysis is a “lease or buy,” which is fromthe user perspective. The “lease or sell ” decision is from the perspective of theequipment owner. Thus, the analysis is similar to the text examples, but must beset up from the user’s, rather than the owner’s perspective.

A B C D


2 Lease Machine (Alt. 1) or Buy Machine (Alt. 2)

3 October 3, 2012

4 Lease Machine(Alternative 1)

Buy Machine(Alternative 2)


(Alternative 2)

5 Costs:

6 Purchase price $ 0 –$3,200 –$3,200

7 Freight and installation 0 –640 –640

8 Repair and maintenance (4 years) 0 –1,600 –1,600

9 Lease (4 years) –5,600 0 5,600

10 Income (Loss)

–$5,600 –$5,440 $ 160

1$400 × 4 years2$1,400 × 4 years

The company should buy the machine.

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Ex. 24–3 (FIN MAN); Ex. 9–3 (MAN)

a.

A B C D


2 Continue King Cola (Alt. 1) or Discontinue King Cola (Alt. 2) 3 March 3, 2012

4

ContinueKing Cola

(Alternative 1)

DiscontinueKing Cola

(Alternative 2)


(Alternative 2)

5 Revenues $ 235,000 $ 0 –$235,000

6 Costs:

7 Variable cost of goods sold –92,400 0 92,400

8 Variable operating expenses –115,200 0 115,200

9 Fixed costs –46,400 –46,400 0

10 Income (Loss)

–$ 19,000 –$46,400 –$ 27,400

1

(1 – 16%) × $110,0002(1 – 20%) × $144,0003(16% × $110,000) + (20% × $144,000)

b. King Cola should be retained. As indicated by the differential analysis in part(a), the income would decrease by $27,400 if the product were discontinued.

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Ex. 24–4 (FIN MAN); Ex. 9–4 (MAN)

a.

A B C D


2 Continue Cups (Alt. 1) or Discontinue Cups (Alt. 2) 3 December 31, 2012

4

ContinueCups

(Alternative 1)

DiscontinueCups

(Alternative 2)


(Alternative 2)

5 Revenues $ 26,900 $ 0 –$26,900

6 Costs:

7 Variable cost of goods sold –12,580 0 12,580

8 Variable selling and admin. expenses –9,240 0 9,240

9 Fixed costs –8,380 –8,380 0

10 Income (Loss)

–$ 3,300 –$8,380 –$ 5,080

1

$14,800 × (1 – 15%)2$15,400 × (1 – 40%)3($14,800 × 15%) + ($15,400 × 40%)

b. The Cups line should be retained. As indicated by the differential analysis inpart (a), the income would decrease by $5,080 if the Cups line were discontin-ued.

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Ex. 24–5 (FIN MAN); Ex. 9–5 (MAN)

Note to Instructors: Many students may be unfamiliar with the financial servicesindustry. This exercise provides an opportunity to introduce students to somebasic terms and concepts used within the industry.

a. The “Investor Services” segment serves the retail customer, you and me.These are the brokerage, Internet, and mutual fund services used by individ-ual investors. The “Institutional Services” segment includes the same servic-es provided for financial institutions, such as banks, mutual fund managers,insurance companies, and pension plan administrators.

b. Variable costs in the “Investor Services” segment include:

1. Commissions to brokers

2. Fees paid to exchanges for executing trades

3. Transaction fees incurred by Schwab mutual funds to purchase and sell

shares4. Advertising

Fixed costs in the “Investor Services” segment include:

1. Depreciation on brokerage offices

2. Depreciation on brokerage office equipment, such as computers and com-puter networks

3. Property taxes on brokerage offices

c.

Investor InstitutionalServices Services

(in millions) (in millions)

Income from operations .............................. $1,024 $183Plus depreciation ......................................... 100Estimated contribution margin ................... $1,124 $242

59

d. If one assumes that the fixed costs that serve institutional investors (com-puters, servers, and facilities) would not be sold but would be used by theother sector, then the contribution margin of $242 million would be anestimate of the reduced profitability. If the fixed assets were sold, then the

operating income decline would approach $183 million. Since the institutionaland retail investors use nearly the same assets, the $242 million answer isprobably the better estimate.

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Ex. 24–6 (FIN MAN); Ex. 9–6 (MAN)

The flaw in the decision was the failure to focus on the differential revenues andcosts, which indicate that operating income would be reduced by $47,000 if Child-ren’s Shoes were discontinued. This differential income from sales of Children’s

Shoes can be determined from the following differential analysis:

A B C D


2 Continue Children’s Shoes (Alt. 1) or Discontinue Children’s Shoes (Alt. 2)

3

4

ContinueChildren’s

Shoes(Alternative 1)

DiscontinueChildren’s

Shoes(Alternative 2)


(Alternative 2)

5 Revenues $200,000 $ 0 –$200,000

6 Costs:

7 Variable cost of goods sold –125,000 0 125,0008 Variable selling and admin. expenses –28,000 0 28,000

9 Fixed costs –72,000 –72,000 0

10 Income (Loss)

–$ 25,000 –$72,000 –$ 47,000

Ex. 24–7 (FIN MAN); Ex. 9–7 (MAN)

A B C D


2 Make Carrying Case (Alt. 1) or Buy Carrying Case (Alt. 2)

3 October 11, 2012

4

Make CarryingCase

(Alternative 1)

Buy CarryingCase

(Alternative 2)


(Alternative 2)

5 Costs:

6 Purchase price $ 0 –$55.00 –$55.00

7 Direct materials per unit –28.00 0 28.00

8 Direct labor per unit –20.00 0 20.00

9 Variable factory overhead per unit –3.00 0 3.00

10 Fixed factory overhead per unit –5.00 –5.00 0

11 Income (Loss)

–$56.00 –$60.00 –$ 4.00

1

$20.00 × 15%2$20.00 × (40% – 15%)

b. Assuming there were no better alternative uses for the spare capacity, itwould be advisable to manufacture the carrying cases because the cost sav-ings would be $4.00 per unit. Fixed factory overhead is irrelevant, since it willcontinue whether the carrying cases are purchased or manufactured.

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Ex. 24–8 (FIN MAN); Ex. 9–8 (MAN)

a.

A B C D


2 Layout Pages Internally (Alt. 1) or Purchase Layout Services (Alt. 2)

3 December 15, 2012

4Layout Pages

Internally(Alternative 1)

PurchaseLayout

Services(Alternative 2)


(Alternative 2)

5 Revenues:

6 Salvage of computer equipment $ 0 $ 9,000 $ 9,000

7 Costs:

8 Purchase price of layout work 0 –280,000* –280,000

9 Salaries –185,000 0 185,000

10 Benefits –42,000 0 42,000

11 Supplies –23,000 0 23,000

12 Office expenses –28,000 0 28,000

13 Office depreciation –25,000 –25,000 0

14 Computer depreciation –17,000 –17,000 0

15 Income (Loss)

–$320,000 –$313,000 $ 7,000

*20,000 pages × $14 per page

b. The benefit from using an outside service is shown to be $7,000 greater thanperforming the layout work internally. The fixed costs (depreciationexpenses) in the budget are irrelevant to the decision. Thus, the work should

be purchased from the outside on a strictly financial basis. In addition, thedecision to purchase from the outside would be further favored if the need foradministrative expansion space were great. If more administrative space wereneeded immediately, then any avoided lease costs would become a differen-tial benefit to the decision to outsource.

c. Before electing to terminate the five employees, the guild should consider thelong-run impact of the decision. Specifically, future page layout rates maygrow faster than the cost of internal salaries, thus favoring the use of em-ployees over the long term. This would especially be the case if the outside

company provided a low bid in order to win the initial business. In addition,the guild may wish to consider noneconomic factors such as the ability tomore directly control the quality and timing of the layout work by internal em-ployees.

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Ex. 24–9 (FIN MAN); Ex. 9–9 (MAN)

a.

A B C D


2 Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)

3 October 3, 2012

4Continue withOld Machine

(Alternative 1)

Replace OldMachine

(Alternative 2)


(Alternative 2)

5 Revenues:

6 Proceeds from sale of old machine $ 0 $ 63,000 $ 63,000

7 Costs:

8 Purchase price 0 –485,000 –485,000

9 Direct labor (8 years) –$1,256,000 –804,000 452,000

10 Income (Loss)

–$1,256,000 –$1,226,000 $ 30,000

1$157,000 × 8 years2$100,500 × 8 years

The company should replace the old machine.

b. The sunk cost is the $250,000 book value ($600,000 cost less $350,000 ac-cumulated depreciation) of the present equipment. The original cost andaccumulated depreciation were incurred in the past and are irrelevant to thedecision to replace the machine.

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Ex. 24–10 (FIN MAN); Ex. 9–10 (MAN)

a.

A B C D


2 Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2) 3 September 27, 2012

4

Continue withOld Machine

(Alternative 1)

Replace OldMachine

(Alternative 2)


(Alternative 2)

5 Revenues:

6 Sales (5 years)* $ 950,000 $ 950,000 $ 0

7 Costs:

8 Purchase price 0 –125,000 –125,000

9 Direct materials (5 years)* –325,000 –325,000 0

10 Direct labor (5 years) –225,000 0 225,000

11 Power and maintenance (5 years)* –20,000 –110,000 –90,000

12 Taxes, insurance, etc. (5 years)* –7,500 –25,000 –17,50013 Selling and admin. expenses (5 years)* –225,000 –225,000 0

14 Income (Loss)

$ 147,500 $ 140,000 –$ 7,500

*Each annual revenue and cost is multiplied by five years.

b. The proposal should not be accepted.

c. In addition to the factors given, consideration should be given to such factorsas: Do both present and proposed operations provide the same capacity?

What opportunity costs are associated with alternative uses of the $125,000outlay required to purchase the automatic machine? Is the product improvedby using automatic machinery? Does the federal income tax have an effect onthe decision?

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Ex. 24–11 (FIN MAN); Ex. 9–11 (MAN)

A B C D


2 Sell Rough Cut (Alt. 1) or Process Further into Finished Cut (Alt. 2)

3 March 4, 2012

4Sell Rough Cut(Alternative 1)

ProcessFurther intoFinished Cut

(Alternative 2)


(Alternative 2)

5 Revenues, per 100 board ft. $ 555 $ 760 $ 205

6 Costs, per 100 board ft. –390 –525 –135

7 Income (Loss), per 100 board ft.

$ 165 $ 235 $ 70

Jackson Lumber Company should process further and sell finished-cut lumber.

Ex. 24–12 (FIN MAN); Ex. 9–12 (MAN)

a.

A B C D


2 Sell Regular Columbian (Alt. 1) or Process Further into Decaf Columbian (Alt. 2)

3 August 28, 2012

4 Sell RegularColumbian

(Alternative 1)

ProcessFurther into

DecafColumbian

(Alternative 2)


(Alternative 2)

5 Revenues $ 50,400 $ 57,000 $6,600

6 Costs –30,000 –39,450 –9,450

7 Income (Loss)

$ 20,400 $ 17,550 –$2,850

1$8.40 × 6,000 lbs.2$10.00 × (6,000 lbs. – 300 lbs.)3$5.00 × 6,000 lbs.4$30,000 + $9,450

b. The differential revenue from processing further to Decaf Columbian is less

than the differential cost of processing further by $2,850. Thus, Abica RoastCoffee Company should sell Columbian coffee and not process further to De-caf Columbian.

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Ex. 24–12 (FIN MAN); Ex. 9–12 (MAN) (Concluded)

c. The price of Decaf Columbian would need to increase to $10.50 per pound inorder for the differential analysis to yield neither an advantage nor a disad-vantage (indifference). This is determined as follows:

ColumbianDecaf of Volume

ProcessingFurther of geDisadvantaNet=

lbs.700,5

850,2$ = $0.50 per lb.

The price of Decaf Columbian would need to be $0.50 higher, or $10.50, toyield no net differential income or loss. This is verified by the following differ-ential analysis:

A B C D


2 Sell Regular Columbian (Alt. 1) or Process Further into Decaf Columbian (Alt. 2)

3 August 28, 2012

4 Sell RegularColumbian

(Alternative 1)

ProcessFurther into

DecafColumbian

(Alternative 2)


(Alternative 2)

5 Revenues $ 50,400 $ 59,850* $ 9,450

6 Costs –30,000 –39,450 –9,450

7 Income (Loss)

$ 20,400 $ 20,400 $ 0

*$10.50 × (6,000 lbs. – 300 lbs.)

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Ex. 24–13 (FIN MAN); Ex. 9–13 (MAN)

a.

A B C D


2 Reject Order (Alt. 1) or Accept Order (Alt. 2) 3 February 2, 2012

4 Reject Order(Alternative 1)

Accept Order(Alternative 2)


(Alternative 2)

5 Revenues $0 $405,000 $405,000

6 Costs

7 Variable manufacturing costs 0 –375,000 –375,000

8 Income (Loss)

$0 $ 30,000 $ 30,000

115,000 units × $27 per units215,000 units × $25 per unit

b. The additional units can be sold for $27 each, and since unused capacity isavailable, the only costs that would be added if this additional productionwere accepted are the variable costs of $25 per unit. The differential revenueis therefore $27 per unit, and the differential cost is $25 per unit. Thus, the netgain is $2 per unit × 15,000 units, or $30,000.

c. $25.01. Any selling price above $25 (variable costs per unit) will produce apositive contribution margin.

Ex. 24–14 (FIN MAN); Ex. 9–14 (MAN)

Total costs .................................................. $457,000Less fixed costs .........................................Total variable costs .................................... $400,000

57,000

Variable cost per unit:

$400,000/25,000 batteries = $16.00

The lowest bid should be sufficient to cover the variable cost of $16 per unit.

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Ex. 24–15 (FIN MAN); Ex. 9–15 (MAN)

a.

A B C D


2 Reject Order (Alt. 1) or Accept Order (Alt. 2)

3 May 4, 2012

4 Reject Order(Alternative 1)

Accept Order(Alternative 2)


(Alternative 2)

5 Revenues $0 $1,440,000 $1,440,000

6 Costs

7 Direct materials 0 –680,000 –680,000

8 Direct labor 0 –240,000 –240,000

9 Variable factory overhead 0 –240,000 –240,000

10 Variable selling and admin. expenses 0 –36,000 –36,000

11 Shipping costs 0 –100,000 –100,000

12 Certification costs 0 –95,000 –95,000

13 Income (Loss)

$0 $ 49,000 $ 49,000

120,000 tires × $72 per tire220,000 tires × $34 per tire320,000 tires × $12 per tire420,000 tires × ($20 per tire × 60%)520,000 tires × [($18 per tire × 35%) – ($90 × 5%)*]620,000 tires × $5 per tire

*5% × $90. The avoided sales commission should not be computed on the basis

of the $72 price to Euro Motors, but on the existing domestic sales price of $90.

Glide Ride should accept the special order from Euro Motors.

b. $72 –000,20

000,49$ = $72.00 – $2.45 = $69.55

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Ex. 24–16 (FIN MAN); Ex. 9–16 (MAN)

a. Desired Profit = $500,000 × 16% = $80,000

b. Cost amount (product cost) per unit: $30,000/1,200 units = $25

c. Markup Percentage =CostsingManufactur Total

ExpensesativeAdministr andSellingTotalProfitDesired

Markup Percentage =000,30$

000,28$000,80$

Markup Percentage = 360%

d. Cost amount (product cost) per unit ....................................... $ 25Markup ($25 × 360%) ................................................................Selling price .............................................................................. $115

90

Ex. 24–17 (FIN MAN); Ex. 9–17 (MAN)

a. Desired Profit = $600,000 × 15% = $90,000

b. Cost amount (product cost) per unit: $900,000*/5,000 units = $180

*($140 manufacturing variable cost per unit × 5,000 units) + $200,000 manu-facturing fixed cost

c. Markup Percentage = CostsingManufactur Total

ExpensesativeAdministr andSellingTotalProfitDesired


000,520$000,70$000,90$


000,100$000,70$000,90$


000,260$

Markup Percentage = 28.89% (rounded)

d. Cost amount per unit................................................................ $180Markup ($180 × 28.89%) ...........................................................Selling price .............................................................................. $232

52

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Ex. 24–18 (FIN MAN); Ex. 9–18 (MAN)

a. The price will be set at the estimated market price required to remain competi-tive, or $24,000. Under the target cost concept, the market dictates the price,not the markup on cost.

b. The required profit margin of 20% of the estimated $24,000 price implies a$19,200 target product cost as follows:

Target Product Cost = $24,000 – ($24,000 × 20%)

Target Product Cost = $24,000 – $4,800

Target Product Cost = $19,200

Since the estimated manufacturing cost of $19,800 exceeds the target cost of$19,200, Toyota will try to remove $600 from its total costs in order to main-tain competitive pricing within its profit objectives.

Note to Instructors: Target costing provides pressure to keep costs competi-tive. The method assumes that the company may not be able to successfullyadd a markup to its costs because the resulting price may be too high in themarketplace. For example, merely adding the 25% markup on the $19,800product cost would result in an uncompetitive price of $24,750. The targetcost concept moves backward by taking the price as given and then deter-mining the cost that is required for a given profit objective.

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Ex. 24–19 (FIN MAN); Ex. 9–19 (MAN)

a. Historical markup percentage on product cost:288$

288$360$

= 25%,

or360$72$ = 20% of selling price

$340 revised selling price × 20% = $68 amount of markup on target productcost

$340 selling price – $68 markup = $272 target product cost

(Also, $272 × 25% = $68 markup on product cost; $272 + $68 = $340 sellingprice)

b. Required cost reduction: $288 – $272 = $16

c.

1. Direct labor reduction:min.60

25$ × 12 min. = $ 5.00

2. Additional inspection:min.60

25$ × 6 min. = $(2.50)

Direct material reduction: 4.507.00

3. Injection molding productivity improvement:Direct labor improvement (25%* × 40% × $50) $ 5.00

Factory overhead improvement (25%* × 42% × $20) 2.10Total savings

7.10$16.60

*Improving the cycle time from four minutes to three minutes is a 25% reduc-tion.

The total savings exceeds the required target cost reduction by $0.60. Thus,these improvements are sufficient to meet the target cost.

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Ex. 24–20 (FIN MAN); Ex. 9–20 (MAN)

Determine the contribution margin per furnace hour as follows:

Type 5 Type 10 Type 20

Revenue ........................................... $ 39,000 $ 41,000 $ 26,500Variable cost .................................... 25,000 20,500Contribution margin ........................ $ 14,000 $ 20,500 $ 13,000

13,500

Divide by number of units .............. ÷ 5,000 units ÷ 5,000 units ÷ 5,000Unit contribution margin ................ $ 2.80 $ 4.10 $ 2.60

units

*Unit contribution marginper furnace hour ............................ $ 0.56 $ 0.41 $ 0.52

*Calculated as follows:

Type 5:hours580.2$ = $0.56 per furnace hour

Type 10:hours10

10.4$ = $0.41 per furnace hour

Type 20:hours5

60.2$ = $0.52 per furnace hour

Emphasize Type 5. In a production-constrained environment, Type 5 generatesthe most unit contribution margin per hour of furnace resource and, thus, is themost profitable. While Type 10 has the largest profit per unit ($2.50) and unit con-tribution margin ($4.10), these would not be the correct metrics for determiningthe product to emphasize in the marketing campaign.

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Ex. 24–21 (FIN MAN); Ex. 9–21 (MAN)

a.

Large Medium Small Total

Units produced ........................ 3,000 3,000 3,000

Revenues ................................. $420,000 $345,000 $300,000 $1,065,000Less variable costs ................. 330,000 282,000 264,000Contribution margin ............... $ 90,000 $ 63,000 $ 36,000 $ 189,000

876,000

Less fixed costs ......................Income from operations ......... $ 104,000

85,000

b. The Small glass product is the most profitable in a bottleneck operation,demonstrated as follows:

Large Medium Small

Unit contribution margin ................................ $ 30 $ 21 $ 12Autoclave hours per unit ................................ ÷ 4 ÷ 2Unit contribution margin per production

÷ 1

bottleneck hour ........................................... $ 7.50 $10.50 $12.00

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Ex. 24–22 (FIN MAN); Ex. 9–22 (MAN)

Small is the highest profit item, since it produces more contribution margin perautoclave hour. The prices of Large and Medium would need to be increased inorder to match Small’s profitability. The two calculations are as follows:

Revised price of Large:

Smallof

Hour Bottleneckper

MarginonContributiUnit

=Largeof Unitper HoursBottleneck

Largeof Largeof

CostVariableUnitPriceRevised

$12.00 =hours4

110$Largeof PriceRevised

$48.00 = Revised Price of Large – $110

$158.00 = Revised Price of Large

Revised price of Medium:

Smallof

Hour Bottleneckper

MarginonContributiUnit

=Mediumof Unitper HoursBottleneck

Mediumof Mediumof

CostVariableUnitPriceRevised

$12.00 =hours2

94$Mediumof PriceRevised

$24.00 = Revised Price of Medium – $94

$118.00 = Revised Price of Medium

Thus, prices of $158 for Large and $118 for Medium both produce a unit contribu-tion margin per hour of bottleneck operation of $12.00. The price of Small wouldremain unchanged. At these prices, the company should be indifferent about theproduct mix.

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