CHAPTER 14

Decision Making: Relevant Costs and Benefits

ANSWERS TO REVIEW QUESTIONS
14-12 An opportunity cost is the potential benefit given up when the choice of one action
precludes a different action. For example, one opportunity cost associated with
getting a college education is the students forgone wages from a job that might
have been held during the educational period.
14-15 In a differential-cost analysis, the decision maker determines the difference in each
cost or revenue item that will occur under each of the alternatives under
consideration. Then the decision maker focuses on the differences in the costs and
revenues in making the decision.
14-21 Sensitivity analysis may be used to cope with uncertainty in decision making by
analyzing how sensitive a decision problem is to the estimates of certain parameters.
One important question that can be answered is: How much can a particular
parameter estimate change before the optimal decision changes?

SOLUTIONS TO PROBLEMS
PROBLEM 14-46 (25 MINUTES)
1.
Food
Blender Processor
Unit cost if purchased from an outside supplier .............................. $60
$114
Incremental unit cost if manufactured:
Direct material ................................................................................... $18
$ 33
12
27
Direct labor ........................................................................................
Variable overhead
18
$48 $30 per hour fixed ...............................................................
$96 (2)($30 per hour fixed) ........................................................
36
$ 96
Total ................................................................................................ $48
Unit cost savings if manufactured ..................................................... $12
$ 18
1
2
Machine hours required per unit ........................................................
Cost savings per machine hour if manufactured
$12 1 hour ...................................................................................... $12
$18 2 hours ....................................................................................
$ 9
Therefore, each machine hour devoted to the production of blenders saves the
company more than a machine hour devoted to food processor production.
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2.

Machine hours available ......................................................................................

Machine hours needed to manufacture 20,000 blenders .................................

50,000
20,000

Remaining machine hours ..................................................................................

30,000

Number of food processors to be produced (30,000 2) ................................

Conclusion: Manufacture 20,000 blenders
Manufacture 15,000 food processors
Purchase
13,000 food processors

15,000

If the companys management team is able to reduce the direct material cost per
food processor to $18 ($15 less than previously assumed), then the cost savings
from manufacturing a food processor are $33 per unit ($18 savings computed in
requirement (1) plus $15 reduction in material cost):

New unit cost savings if manufactured ..........................................

Machine hours required per unit .....................................................
Cost savings per machine hour if manufactured
$12 1 hour ...................................................................................
$33 2 hours .................................................................................

Food
Blender Processor
$12.00
$33.00
1 MH
2 MH
$12.00
$16.50

Therefore, devote all 50,000 hours to the production of 25,000 food processors.
Conclusion:
Manufacture: 25,000 food processors
Purchase: 3,000 food processors
Purchase: 20,000 blenders
PROBLEM 14-47 (25 MINUTES)
1.

Incremental unit cost if purchased:

Purchase price ...........................................................................................
Material handling .......................................................................................
Total ............................................................................................................

$ 45,000
9,000
$ 54,000

Incremental unit cost if manufactured:

Direct material ............................................................................................
Material handling .......................................................................................
Direct labor .................................................................................................
Variable manufacturing overhead ($36,000 1/3) ..................................
Total ............................................................................................................
Increase in unit cost if purchased ($54,000 $39,600) .............................

$ 3,000
600
24,000
12,000
$ 39,600
$ 14,400

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Solutions Manual

2.

3.

Increase in monthly cost of acquiring part RM67 if purchased

(10 $14,400, as computed above) ...........................................................
Less: rental revenue from idle space ..........................................................
Increase in monthly cost ..............................................................................

Contribution forgone by not manufacturing alternative product .............

Savings in the cost of acquiring RM67
(10 $14,400 as computed in requirement 1) ..........................................
Net cost of using limited capacity to produce part RM67 .........................

$144,000
75,000
$ 69,000

$156,000
144,000
$ 12,000

PROBLEM 14-48 (20 MINUTES)

The analysis prepared by the engineering, manufacturing, and accounting departments of
Cincinnati Flow Technology (CFT) was not correct. However, their recommendation was
correct, provided that potential labor-cost improvements are ignored. An incremental cost
analysis similar to the following table should have been prepared to determine whether the
pump should be purchased or manufactured. In the following analysis, fixed factory
overhead costs and general and administrative overhead costs have not been included
because they are not relevant; these costs would not increase, because no additional
equipment, space, or supervision would be required if the pumps were manufactured.
Therefore, if potential labor cost improvements are ignored, CFT should purchase the
pumps because the purchase price of $102 is less than the $108 relevant cost to
manufacture.
Incremental cost analysis:

Purchased components ...................................................................

Assembly labor .................................................................................
Variable manufacturing overhead ...................................................
Total relevant cost .........................................................................

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Cost of
10,000 Unit
Assembly Run Per Unit
$ 180,000
$ 18
450,000
45
45
450,000
$1,080,000
$108

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PROBLEM 14-49 (25 MINUTES)

1.

Per-unit contribution margins:

Standard
Selling price..
Less: Variable costs:
Direct material
Direct labor..
Variable manufacturing overhead
Sales commission
$375 x 10%; $495 x 10%.
Total unit variable cost.
Unit contribution margin

Enhanced

$375.00
$42.00
22.50
36.00
37.50

$495.00
$67.50
30.00
48.00

138.00
$237.00

49.50

195.00
$300.00

2.

The following costs are not relevant to the decision:

Development costssunk
Fixed manufacturing overheadwill be incurred regardless of which product is
selected
Sales salariesidentical for both products
Market studysunk

3.

Martinez, Inc. expects to sell 10,000 Standard units (40,000 units x 25%) or 8,000
Enhanced units (40,000 units x 20%). On the basis of this sales forecast, the
company would be advised to select the Standard model.

4.

Standard

Enhanced

Total contribution margin:

10,000 units x $237; 8,000 units x $300. $2,370,000
Less: Marketing and advertising
195,000
Income... $2,175,000

$2,400,000
300,000
$2,100,000

The quantitative difference between the profitability of Standard and Enhanced is

relatively small, which may prompt the firm to look at other factors before a final
decision is made. These factors include:
-

Competitive products in the marketplace

Data validity
Growth potential of the Standard and Enhanced models
Production feasibility
Effects, if any, on existing product sales
Break-even points

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Solutions Manual

PROBLEM 14-51 (25 MINUTES)

1.

Yes, the order should be accepted because it generates a profit of $68,100 for the
firm. Note: The fixed administrative cost is irrelevant to the decision, because this
cost will be incurred regardless of whether Mercury accepts or rejects the order.
Selling price
Less: Direct material ($16.40 - $4.20)...
Direct labor..
Variable manufacturing overhead
(.5 hours x $15.00*)..
Unit contribution margin.
Total contribution margin (11,000 units x $7.30)..
Less: Additional setup costs
Special device.
Net contribution to profit.

$31.50
$12.20
4.50
7.50

24.20
$ 7.30
$80,300

$7,400
4,800

12,200
$68,100

* Fixed manufacturing overhead: $1,500,000 60,000

machine hours = $25.00 per hour
Variable manufacturing overhead: $40.00 - $25.00 =
$15.00
2.

No, Mercury lacks adequate machine capacity to manufacture the entire order.
Planned machine hours (5,000 hours x 3 months) 15,000
Current usage (15,000 hours x 70%).. 10,500
Available hours 4,500
Required machine hours (11,000 units x .5 hours)

3.

5,500

Options include the following:

Sacrificing some current business in the hope that a long-term relationship with
Venus can be established and proves to be profitable
Acquiring more machine capacity
Outsourcing some units
Working overtime

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