CHAPTER 6

COST INFORMATION for PRICING and PRODUCT PLANNING

TRUE/FALSE
1.

Price-taker firms usually enjoy a significant market share.

a.
True
b.
False

2.

Costs that are committed in the short term may be considered flexible in the long term.
a.
True
b.
False

3.

For price-taker firms, the relevant costs for the product mix decisions are the short-run
flexible costs plus any opportunity costs of forgone alternatives.
a.
True
b.
False

4.

For one-time special orders, flexible costs may be relevant but fixed costs are never relevant.
a.
True
b.
False

5.

Giving up the production of some profitable product results in an opportunity cost.

a.
True
b.
False

6.

Opportunity costs are always relevant.

a.
True
b.
False

7.

A price-taker firm should simply produce and sell as much product as it can of all products
that are profitable.
a.
True
b.
False

8.

With price determined, the only short-term decision faced by the manufacturer is how much
of each possible product it should produce.
a.
True
b.
False

9.

The selling price quoted for a one-time special order may be less than the selling price for a
long-term customer.
a.
True
b.
False

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10.

A small firm will always be a price-taker.

a.
True
b.
False

11.

When capacity is limited, companies should rank-order products by contribution margin per
unit, not by contribution per constrained resource.
a.
True
b.
False

12.

By using overtime, a company can increase capacity in the short run.

a.
True
b.
False

13.

Managers have more flexibility in the short-term to adjust the capacities of activity
resources.
a.
True
b.
False

14.

When a firm has limited capacity, incremental costs will be lower than the incremental costs
of a firm with surplus capacity.
a.
True
b.
False

15.

In practice, a special order will be priced above incremental costs.

a.
True
b.
False

16.

When excess capacity exists, the minimum acceptable price must at least cover the
incremental costs of production and delivery.
a.
True
b.
False

17.

Bid prices and costs that are relevant for regular orders are also relevant for special orders.
a.
True
b.
False

18.

Full costs are relevant for short-term pricing decisions.

a.
True
b.
False

19.

Full manufacturing costs include flexible support costs, but not fixed support costs.
a.
True
b.
False

20.

Markups tend to be greater when demand is more elastic.

a.
True
b.
False

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21.

Markups increase with the strength of demand.

a.
True
b.
False

22.

When prices are set in a competitive marketplace, product costs are the most important
influence on pricing decisions.
a.
True
b.
False

23.

Product cost analysis is important even if market forces set prices.

a.
True
b.
False

24.

Because demand conditions fluctuate over time, prices also fluctuate.

a.
True
b.
False

25.

When demand is relatively inelastic, profits will usually increase when prices increase.
a.
True
b.
False

26.

Most firms use full cost-based prices when making long-term pricing decisions.
a.
True
b.
False

27.

If a small manufacturing firm lowers the price of a standardized product, it risks being put
out of business by a larger competitor.
a.
True
b.
False

28.

Dropping unprofitable products will automatically increase profitability.

a.
True
b.
False

29.

Capacity constraints are of less concern for long-term than for short-term product mix
decisions.
a.
True
b.
False

30.

For short-term pricing decisions, many more costs are relevant than for long-term pricing
decisions.
a.
True
b.
False

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MULTIPLE CHOICE
31.

Incremental costs include all of the following EXCEPT:

a.
direct materials
b.
direct labor
c.
flexible support costs
d.
fixed support costs

32.

Direct materials $40, Direct labor $10, Flexible support costs $30, and Fixed support costs
$20. In the short term, the incremental cost of one unit is:
a.
$30
b.
$50
c.
$80
d.
$100

33.

A product mix strategy is MOST influenced by:

a.
the products contribution margins and their use of capacity resources
b.
whether a product is a price-taker or a price-setter
c.
the products price elasticity
d.
full product costs

34.

A product cost analysis provides important information for decisions regarding:

a.
marketing and promotion resources
b.
discounts for large orders
c.
a product-mix strategy
d.
All of the above are correct.

35.

Product cost analysis is important when deciding:

a.
the amount of sales commissions
b.
pricing discounts
c.
special-order pricing
d.
All of the above are correct.

36.

Product mix decisions:

a.
have a long-run focus
b.
help determine how to maximize operating profits
c.
focus on selling price per unit
d.
All of the above are correct.

37.

A company with a large share of the market:

a.
is a price-taker
b.
can influence price
c.
can determine price
d.
can be any of the above because it varies by industry

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38.

For short-run product mix decisions, depreciation is a cost that is:

a.
not relevant
b.
differential
c.
incremental
d.
flexible

39.

Opportunity costs:
a.
result in a cash outlay
b.
only are considered when selecting among alternatives
c.
are recorded in the accounting records
d.
should be maximized for the best decision

40.

When a firm has constrained capacity as opposed to surplus capacity, opportunity costs will
be:
a.
lower
b.
the same
c.
greater
d.
it varies

41.

The opportunity cost of holding significant inventory includes:

a.
the interest forgone on an alternative investment
b.
additional insurance costs
c.
additional storage costs
d.
All of the above are correct.

42.

A supplier offers to make Part A for $70. Jansen Company has relevant costs of $80 a unit to
manufacture Part A. If there is excess capacity, the opportunity cost of buying Part A from
the supplier:
a.
is zero
b.
is $10,000
c.
is $70,000
d.
cannot be determined using the above information

43.

Fixed manufacturing support costs include the cost of:

a.
plant administration
b.
employee wages for assembly
c.
advertising
d.
product delivery

44.

Flexible manufacturing support costs include the cost of:

a.
wages for the finishing department
b.
indirect materials
c.
depreciation of equipment
d.
parts for the product

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45.

For determining the best mix of products, the one with the LEAST amount of influence is:
a.
the elasticity of the market prices
b.
selling and distribution costs
c.
the use of capacity resources
d.
contribution margins

46.

When deciding to accept a special order from a wholesaler, management must do all of the
following EXCEPT:
a.
analyze product costs
b.
consider the special orders impact on future prices of their products
c.
determine whether excess capacity is available
d.
verify the retail-selling price

47.

For short-term product mix decisions, relevant costs include short-run _________ costs plus
any _________ costs.
a.
direct material, direct labor
b.
flexible, opportunity
c.
fixed, differential
d.
support, distribution

48.

One firm has a large market share for a product in a particular industry. A company with a
smaller market share for the same product within the same industry:
a.
uses variable-cost pricing
b.
uses full-cost pricing
c.
is a price-taker
d.
is a price-setter

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 49 THROUGH 53.

Truck Parts Manufacturing is approached by a European customer to fulfill a special one-time
order for a product similar to one offered to domestic customers. Truck Parts Manufacturing has
excess capacity. The following per unit data apply for sales to regular customers:
Direct materials
Direct labor
Variable manufacturing support
Fixed manufacturing support
Total manufacturing costs
Markup (50%)
Targeted selling price

$40
20
50
60
170
85
$255

49.

What is the full manufacturing cost per unit?

a.
$110
b.
$170
c.
$255
d.
$85

50.

What is the contribution per unit?

a.
$85
b.
$110
c.
$145
d.
$255

51.

Which costs are relevant for making the decision regarding this special order?
a.
full costs
b.
incremental costs
c.
targeted selling price
d.
it varies

52.

For Truck Parts Manufacturing, what is the minimum acceptable price of this special order?
a.
$110
b.
$145
c.
$170
d.
$255

53.

For this special order, Truck Parts Manufacturing should consider:

a.
any price less than $110
b.
any price less than $170
c.
any price less than $255
d.
a price of $150 per unit

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 54 THROUGH 57.

Kevins Kitchens has excess capacity. Kevins Kitchens is approached by Mr. Cathay, a new
customer, to fill a large one-time order of cherry cabinets, a product similar to one offered to
regular customers. The following per unit data apply for sales to regular customers:
Direct materials
Direct labor
Variable manufacturing support
Fixed manufacturing support
Total manufacturing costs
Markup (60%)
Targeted selling price

$455
300
45
100
900
540
$1,440

54.

For Kevins Kitchens, what is the minimum acceptable price of this special order?
a.
$800
b.
$900
c.
$755
d.
$1,440

55.

Other than price, what other items should Kevins Kitchens consider before accepting this
special order?
a.
contribution margin sacrificed
b.
reaction of existing customers to the lower price offered to Mr. Cathay
c.
demand for cherry cabinets
d.
price is the only consideration

56.

If there was limited capacity, all would change EXCEPT:

a.
opportunity costs
b.
incremental costs
c.
flexible costs
d.
the minimum acceptable price

57.

If Mr. Cathay wanted a long-term commitment for supplying this product, this analysis
would:
a.
definitely be different
b.
may be different
c.
not be different
d.
need more information to determine

58.

Plant capacity:
a.
is fixed or committed in the long run
b.
costs are used to determine special-price orders when there is excess capacity
c.
constraints can be used to justify higher price markups
d.
All of the above are correct.

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59.

When there is no excess capacity, it makes sense to accept a one-time special order when:
a.
incremental revenues exceed incremental costs
b.
there is no required increase in fixed costs
c.
the company placing the order is a price setter
d.
never, because it doesnt makes sense

60.

When there is no available plant capacity, considerations for a one-time special order
include:
a.
expanding capacity with the use of subcontractors
b.
temporarily dropping another product
c.
authorizing overtime at time-and-a-half of the current wage rate
d.
All of the above are correct.

61.

Contribution per machine hour is:

a.
full-cost per unit / number of machine hours per unit
b.
number of machine hours per unit / full-cost per unit
c.
price per unit less variable costs per unit
d.
contribution per unit / number of machine hours per unit

62.

When there is limited capacity, the minimum acceptable price of a special order will earn at
least as much __________ as that which is sacrificed.
a.
selling price
b.
contribution margin
c.
flexible cost
d.
full cost

63.

Special orders should only be accepted if __________ revenues exceed ________ costs.
a.
incremental, incremental
b.
total, total
c.
incremental, fixed
d.
total, fixed

64.

When a firm has constrained capacity as opposed to surplus capacity, incremental costs will
be:
a.
lower
b.
the same
c.
greater
d.
it varies

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 65 THROUGH 69.

Brendas Brakes manufactures three different product lines: Model X, Model Y, and Model Z.
Considerable market demand exists for all models. The following per unit data apply:
Selling price
Direct materials
Direct labor ($12 per hour)
Flexible support costs ($4 per machine hour)
Fixed support costs

Model X
$50
6
12
4
10

Model Y
$60
6
12
8
10

Model Z
$70
6
24
8
10

65.

Which model has the greatest contribution per unit?

a.
Model X
b.
Model Y
c.
Model Z
d.
both Models X and Y

66.

Which model has the greatest contribution per machine hour?

a.
Model X
b.
Model Y
c.
Model Z
d.
both Models Y and Z

67.

If there is excess capacity, which model is the most profitable to produce?

a.
Model X
b.
Model Y
c.
Model Z
d.
both Models X and Y

68.

If there is a machine breakdown, which model is the most profitable to produce?

a.
Model X
b.
Model Y
c.
Model Z
d.
both Models Y and Z

69.

How can Brenda encourage her salespeople to promote the more profitable model?
a.
Brenda can put all sales persons on salary.
b.
Brenda can provide higher sales commissions for higher priced items.
c.
Brenda can provide higher sales commissions for items with the greatest contribution
margin per constrained resource.
d.
Both (b) and (c) are correct.

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 70 THROUGH 72.

Rosas Rockers manufactures two models: Standard and Premium. Weekly demand is estimated to
be 100 units of the Standard Model and 70 units of the Premium Model. Only 496 machine hours
are available per week. The following per unit data apply:
Standard
$18
3

Contribution margin per unit

Number of machine hours required

Premium
$20
4

70.

The contribution per machine hour is:

a.
$18 for Standard and $20 for Premium
b.
$54 for Standard and $80 for Premium
c.
$15for Standard and $16 for Premium
d.
$6 for Standard and $5 for Premium

71.

To maximize production profits, how many units would you recommend of each model?
a.
100 units of Standard and 49 units of Premium
b.
72 units of Standard and 70 units of Premium
c.
100 units of Standard and 70 units of Premium
d.
85 units of Standard and 60 units of Premium

72.

If there are 600 machine hours available per week (instead of only 496 machine hours per
week), how many rockers of each model should Rosas produce to maximize profits?
a.
100 units of Standard and 49 units of Premium
b.
72 units of Standard and 70 units of Premium
c.
100 units of Standard and 70 units of Premium
d.
85 units of Standard and 60 units of Premium

73.

The amount of markup is usually higher if:

a.
the firm is using a skimming strategy
b.
demand is weak
c.
competition is intense
d.
demand is elastic

74.

Price-setters include:
a.
large companies in the commodity industry
b.
companies with a small share of the market
c.
small firms that manufacture a specialty product
d.
one of many firms within a particular industry

75.

When demand for a product is inelastic and prices are increased, demand will usually
__________ and operating profits will __________.
a.
increase, increase
b.
remain the same, increase
c.
decrease, decrease
d.
remain the same, decrease

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76.

When demand for a product is very elastic and prices are increased, demand will
__________ and operating profits __________.
a.
remain the same, will increase
b.
remain the same, may either increase or decrease
c.
decrease, will decrease
d.
decrease, may either increase or decrease

THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 77 AND 78.

Northwoods manufactures rustic furniture. The cost accounting system estimates manufacturing
costs to be $90 per table, consisting of 80% flexible costs and 20% fixed costs. The company has
surplus capacity available. It is Northwoods policy to add a 50% markup to full costs.
77.

Northwoods is invited to bid on an order to supply 100 rustic tables. What is the lowest
price Northwoods should bid on this one-time special order?
a.
$6,300
b.
$7,200
c.
$9,000
d.
$13,500

78.

A large hotel chain is currently expanding and has decided to decorate all new hotels using
the rustic style. Northwoods is invited to submit a bid to the hotel chain. What is the lowest
price per unit Northwoods should bid on this long-term order?
a.
$63
b.
$72
c.
$90
d.
$135

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 79 AND 80.

Berryman Products manufactures coffee tables. Berryman Products has a policy of adding a 20%
markup to full costs and currently has excess capacity. The following information pertains to the
company's normal operations per month:
Output units
Machine-hours
Direct manufacturing labor-hours

30,000 tables
8,000 hours
10,000 hours

Direct materials per unit

Direct manufacturing labor per hour
Variable manufacturing overhead costs
Fixed manufacturing overhead costs
Product and process design costs
Marketing and distribution costs

$50
$6
$161,250
$600,000
$450,000
$562,500

79.

Berryman Products is approached by an overseas customer to fill a one-time-only special

order for 2,000 units. All cost relationships remain the same except for a one-time setup
charge of $20,000. No additional design, marketing, or distribution costs will be incurred.
What is the minimum acceptable bid per unit on this one-time-only special order?
a.
$67.38
b.
$77.38
c.
$111.13
d.
$80.85

80.

For long-run pricing of the coffee tables, what price will MOST likely be used by Berryman?
a.
$67.38
b.
$80.85
c.
$111.13
d.
$133.35

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 81 THROUGH 83.

Northern Lighting manufactures small flashlights and is considering raising the price by 50 cents a
unit for the coming year. With a 50-cent price increase, demand is expected to fall by 3,000 units.
Currently
Projected
Demand
20,000 units
17,000 units
Selling price
$4.50
$5.00
Incremental cost per unit
$3.00
$3.00
81.

If the price increase is implemented, operating profit is projected to:

a.
increase by $4,000
b.
decrease by $4,000
c.
increase by $6,000
d.
decrease by $4,500

82.

Would you recommend the 50-cent price increase?

a.
No, because demand decreases.
b.
No, because the selling price increases.
c
Yes, because contribution per unit increases.
d.
Yes, because operating profits increase.

83.

The demand for this product is:

a.
greatly inelastic
b.
slightly inelastic
c.
elastic
d.
indeterminable

84.

Firms with small market shares:

a.
can lower prices and industry target prices will follow
b.
have little influence on the price and demand of products
c.
can demand a higher price and increase company profits
d.
All of the above are correct.

85.

A company that competes as a producer in the grain industry is a:

a.
price-taker firm
b.
price-setter firm
c.
full-cost pricing firm
d.
None of the above is correct.

86.

In an industry with a standardized product, prices will be most influenced by:

a.
incremental production costs
b.
the top ten firms in the industry
c.
the price-taker firms
d.
None of the above is correct.

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87.

When an industry such as the hotel industry has peak and slower times, __________ also
fluctuate(s).
a.
prices
b.
opportunity costs
c.
demand
d.
All of the above are correct.

88.

If customer demand for a product is strong, then a company is able to command a higher:
a.
markup
b.
market share
c.
full cost
d.
All of the above are correct.

89.

Firms lower markups:

a.
to increase market share
b.
to adjust for lower demand conditions
c.
for one-time special orders
d.
All of the above are correct.

90.

A small firm can become a price-setter if the firm:

a.
manufactures a standardized product
b.
differentiates its products from others in the market
c.
competes in a regulated industry
d.
The firm can never become a price setter.

91.

Which statement is correct?

a.
Prices are adjusted upward when competition is intense.
b.
Prices are adjusted downward when capacity is fully utilized.
c.
Markups are increased when demand is strong.
d.
Markups are decreased for the skimming price strategy.

92.

The penetration pricing strategy includes:

a.
winning additional market share
b.
initially charging a higher selling price
c.
maintaining a full product line
d.
charging for the privilege of possessing the latest technological innovations

93.

When a company is evaluating an order and there is available capacity, one of the companys
primary concerns should be:
a.
whether the incremental costs are fixed or flexible
b.
the demand for the product
c.
how long the firm is committing its production capacity
d.
the variety of colors and other complexities of the order

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94.

If a small manufacturing firm RAISES the price of its generic aspirin product, it will
probably:
a.
become more profitable
b.
lose customers to competing firms
c.
increase its market share
d.
lose its price-setting status

95.

If a small manufacturing firm LOWERS the price of its generic aspirin product, its
GREATEST long-term risk is:
a.
a lower contribution margin per unit
b.
decreased profits
c.
reduced market share
d.
being put out of business by a large competitor

96.

If a product is unprofitable, a firm:

a.
may choose to continue the product to maintain a full product line
b.
should drop the product immediately
c.
may choose to add costly features to the product to increase the value
d.
may choose to better duplicate similar products

97.

When the greatest portion of a firms costs are fixed rather than flexible:
a.
the firm enjoys lower financial risk
b.
offering discounts during non-peak times will generally increase profits
c.
incremental costs will also be proportionately higher
d.
the firm should always use full-cost pricing to maximize profits

98.

Dropping unprofitable products will increase profitability:

a.
if the activity resources no longer required are eliminated
b.
if capacity constraints are adjusted
c.
automatically
d.
when they are part of a full product line

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99.

Camera Corner is considering eliminating Model AE2 from its camera line because of losses
over the past quarter. The past three months of information for Model AE2 are summarized
below.
Sales (1,000 units)
Manufacturing costs:
Direct materials
Direct labor ($15 per hour)
Support
Operating loss

$300,000
150,000
60,000
100,000
($10,000)

Support costs are 70% flexible and the remaining 30% is depreciation of special equipment
for model AE2 that has no resale value.
If Model AE2 is dropped from the product line, operating income will:
a.
increase by $10,000
b.
decrease by $20,000
c.
increase by $30,000
d.
decrease by $10,000
THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 100 AND 101.
Denly Company has three products, A, B, and C. The following information is available:
Sales
Variable costs
Contribution margin
Fixed costs:
Avoidable
Unavoidable
Operating income

Product A
$60,000
36,000
24,000

Product B
$90,000
48,000
42,000

9,000
6,000
$ 9,000

18,000
9,000
$15,000

Product C
$24,000
15,000
9,000
6,000
5,400
$ (2,400)

100. Denly Company is thinking of dropping Product C because it is reporting a loss. Assuming
Denly drops Product C and does not replace it, operating income will:
a.
increase by $2,400
b.
increase by $3,000
c.
decrease by $3,000
d.
decrease by $5,400
101. Assuming Product C is discontinued and the space formerly used to produce Product C is
rented for $12,000 per year, operating income will:
a.
increase by $6,600
b.
increase by $9,000
c.
increase by $12,000
d.
increase by $14,400

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EXERCISE/PROBLEM
102. Axle and Wheel Manufacturing is approached by a European customer to fill a special, onetime special order for a product similar to one offered to domestic customers. The following
per unit data apply for sales to regular customers:
Direct materials
Direct labor
Flexible manufacturing support
Fixed manufacturing support
Total manufacturing costs
Markup (50%)
Targeted selling price

$33
15
24
52
124
62
$186

Axle and Wheel Manufacturing has excess capacity.

a.
b.
c.
d.
e.

What is the full manufacturing cost per unit?

What is the contribution margin per unit?
Which costs are relevant for making the decision regarding this special order? Why?
For Axle and Wheel Manufacturing, what is the minimum acceptable price of this
special order?
For this special order, should Axle and Wheel Manufacturing consider a price of $100
per unit? Why or why not?

103. Silver Lake has excess capacity. Silver Lake Cabinets is approached by Ms. Jenny Zhang, a
new customer, to fill a large one-time order for a product similar to one offered to regular
customers. The following per unit data apply for sales to regular customers:
Direct materials
Direct labor
Variable manufacturing support
Fixed manufacturing support
Total manufacturing costs
Markup (60%)
Targeted selling price
a.
b.
c.
d.

$100
125
60
75
360
216
$576

For Silver Lake, what is the minimum acceptable price of this special order?
Other than price, what other items should Silver Lake consider before accepting this
special order?
How would the analysis differ if there was limited capacity?
How would this analysis differ if Ms. Jenny Zhang wanted a long-term commitment for
supplying this product?

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104. Maggies Mufflers manufactures three different product lines: Model X, Model Y, and
Model Z. Considerable market demand exists for all models. The following per unit data
apply:
Model X
Model Y
Model Z
Selling price
$80
$90
$100
Direct materials
30
30
30
Direct labor ($10 per hour)
15
15
20
Variable support costs ($5 per machine hour)
5
10
10
Fixed support costs
20
20
20
a.
b.
c.
d.
e.

For each model, compute the contribution per unit.

For each model, compute the contribution per machine hour.
If there is excess capacity, which model is the most profitable to produce? Why?
If there is a machine breakdown, which model is the most profitable to produce? Why?
How can Maggie encourage her sales people to promote the more profitable model?

105. Charlies Chairs manufactures two models: Standard and Premium. Weekly demand is
estimated to be 120 units of the Standard Model and 70 units of the Premium Model. Only
420 machine hours are available per week. The following per unit data apply:
Contribution margin per unit
Number of machine hours required
a.
b.
c.

Standard
$12
2

Premium
$15
3

For each model, compute the contribution per machine hour.

To maximize weekly production profits, how many machine hours would you
recommend of each model? How many units of each model?
If there are 500 machine hours available per week (instead of only 420 machine hours
per week), how many chairs of each model should Charlies produce to maximize
profits?

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106. Novelenes Novelties manufactures Green Bay Packer cheese heads (small, medium, and
large) that are sold to area retailers. Production takes 0.20, 0.25, and 0.30 machine hours to
manufacture one unit of the small, medium, and large cheese heads, respectively. The
company has monthly capacity of 2,500 machine hours. The following per unit data apply
for the month of August:
Small
Medium
Large
Projected maximum sales
2,500
4,000
3,000
Machine hours required
0.20
0.25
0.30
Selling price
Direct materials
Direct labor
Variable support costs
Fixed support costs
a.
b.
c.
d.

e.

$30
8
3
4
2

$36
10
3
5
2

$42
12
4
5
2

For each size, compute the contribution per unit.

For each size, compute the contribution per machine hour.
How many units of each size should Novelenes produce this month to maximize
profits?
Suppose a foreign firm places a special order for the purchase of an additional 1,000
medium cheese heads at $50 each.
1.
Determine the opportunity cost for this order.
2.
What other issues might Novelene want to consider before accepting this special
order?
Suppose available machine hour capacity is reduced to 2000 machine hours due to
machine breakdown. How many units of each size should Novelenes produce to
maximize profits?

107. Backwoods Incorporated manufactures rustic furniture. The cost accounting system
estimates manufacturing costs to be $80 per table, consisting of 70% flexible costs and 30%
fixed costs. The company has surplus capacity available. It is Backwoods policy to add a
50% markup to full costs.
a.

Backwoods Incorporated is invited to bid on an order to supply 100 rustic tables.

What is the lowest price Backwoods should bid on this one-time special order?

b.

A large hotel chain is currently expanding and has decided to decorate all new hotels
using the rustic style. Backwoods Incorporated is invited to submit a bid to the hotel
chain. What is the lowest price per unit Backwoods should bid on this long-term
order?

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108. Molar Camera is considering eliminating Model AE1 from its camera line because of losses
over the past quarter. The past three months of information for model AE1 is summarized
below.
Sales (1,000 units)
Manufacturing costs:
Direct materials
Direct labor ($15 per hour)
Support
Operating loss

$250,000
140,000
30,000
100,000
($20,000)

Support costs are 70% flexible and the remaining 30% is depreciation of special equipment
for model AE1 that has no resale value.
Should Molar Camera eliminate Model AE1 from its product line? Why or why not?

109. Central Plains Lighting manufactures small flashlights and is considering raising the price by
20 cents a unit for the coming year. With a 20-cent price increase, demand is expected to fall
by 3,000 units.
Currently
Projected
Demand
20,000 units
17,000 units
Selling price
$4.80
$5.00
Incremental cost per unit
$3.00
$3.00
a.
b.
c.

If the price increase is implemented, how will this change operating profit?
Would you recommend the 20-cent price increase? Why or why not?
Is the demand for this product elastic or inelastic? How can you tell?

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110. The management accountant for the Chocolate Smore Company has prepared the following
income statement for the most current year.
Chocolate
Sales
$40,000
Cost of goods sold
26,000
Contribution margin
14,000
Delivery and ordering costs
2,000
Rent (per sq. foot used)
3,000
Allocated corporate costs
5,000
Corporate profit
$4,000
a.
b.

Other Candy
$25,000
15,000
10,000
3,000
3,000
5,000
$(1,000)

Fudge
$35,000
19,000
16,000
2,000
2,000
5,000
$7,000

Total
$100,000
60,000
40,000
7,000
8,000
15,000
$10,000

Do you recommend discontinuing the Other Candy product line? Why or why not?
If the Chocolate product line had been discontinued, corporate profits for the current
year would have decreased by what amount?

111. Freeman Company has a demand function given by Q = 600 (2 x P)

and a cost function given by
C = $8,000 + ($30 x Q)
where P is the price, and Q is the quantity produced and sold.
Determine the optimal price, the corresponding demand quantity, and unit product cost.

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CRITICAL THINKING/ESSAY
112. What considerations other than cost need to be evaluated for one-time special orders?
113. An activity-based costing system allocates fixed manufacturing costs to various product
lines. When should these allocated costs be used to evaluate short-term pricing decisions?
114. For short-term pricing decisions, what costs are relevant when there is available surplus
capacity? When there is no available surplus capacity?
115. When there is inadequate capacity, under what conditions may a firm consider accepting a
one-time special order?
116. Under what conditions might a manufacturing firm sell a product for less than its long-term
price? Why?
117. Why is the evaluation of short-term pricing decisions different from the evaluation of longterm pricing decisions?
118. Under what conditions will a firm become a price-setter? A price-taker?
119. Vlasic has a large market share of the pickle industry. What influences how Vlasic
determines its prices?
120. Clark Manufacturing offers two product lines IN2 and EL5. The demand of the IN2 product
line is inelastic, while the demand of the EL5 product line is very elastic. If Clark initiates a
price increase for both product lines, how will customer demand change? How will the price
increase affect operating profits?
121. What factors may influence the level of markups?
122. When is full-cost information useful for pricing decisions?
123. Explain how price markups relate to the strength of demand, the elasticity of demand, and
the intensity of competition.
124. Vlasic has a large market share of the pickle industry. Dean Foods holds a much smaller
share of the pickle market. What influences how Dean Foods determines its prices?
125. Vlasic has a large market share of the pickle industry. Dean Foods holds a much smaller
share of the pickle market. What are the possible consequences if Dean Foods raises the
price of their pickles? Lowers the price of their pickles?
126. Is a company that competes in commodities such as corn and wheat a price-taker or a pricesetter? Why?
127. A hotel in Orlando, Florida, experiences peak periods and slower times. How should prices
be adjusted during peak periods? During slow times?
128. What options may be considered when long-run market prices are below full costs?

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CHAPTER 6

SOLUTIONS

COST INFORMATION for PRICING and PRODUCT PLANNING

TRUE/FALSE

MULTIPLE CHOICE

LO1
LO1
LO1
LO1
LO1

1.
2.
3.
4.
5.

b
a
a
a
a

LO1
LO1
LO1
LO1
LO1

31.
32.
33.
34.
35.

d
c
a
d
d

LO2
LO2
LO2
LO2
LO2

66.
67
68.
69.
70.

a
b
a
c
d

LO1
LO1
LO1
LO1,3
LO1,4

6.
7.
8.
9.
10.

a
a
a
a
b

LO1
LO1
LO1
LO1
LO1

36.
37.
38.
39.
40.

b
d
a
b
c

LO2
LO2
LO3
LO3
LO3

71.
72.
73.
74.
75.

a
c
a
c
b

LO2
LO2
LO2
LO2
LO2

11.
12.
13.
14.
15.

b
a
b
b
a

LO1
LO1
LO1
LO1
LO1

41.
42.
43.
44.
45.

a
a
a
b
a

LO3
LO1,3
LO1,3
LO1,3
LO1,3

76.
77.
78.
79.
80.

d
b
d
a
d

LO2
LO2,3
LO2,3
LO3
LO3

16.
17.
18.
19.
20.

a
b
b
b
b

LO1
LO1
LO1
LO1
LO1

46.
47.
48.
49.
50.

d
b
c
b
c

LO3
LO3
LO3
LO3,4
LO4

81.
82.
83.
84.
85.

a
d
c
b
a

LO3
LO3
LO3
LO3
LO3

21.
22.
23.
24.
25.

a
b
a
a
a

LO1
LO1
LO1
LO1,2,3
LO1,2,3

51.
52.
53.
54.
55.

b
a
d
a
b

LO4
LO4
LO4
LO4
LO4

86.
87.
88.
89.
90.

d
d
a
d
b

LO3
LO4
LO4
LO4
LO4

26.
27.
28.
29.
30.

a
a
b
a
b

LO1,2,3
LO1,2,3
LO1,2
LO2
LO2

56.
57.
58.
59.
60.

c
a
c
a
d

LO4
LO4
LO4
LO4
LO4

91.
92.
93.
94.
95.

c
a
c
b
d

LO2
LO2
LO2
LO2
LO2

61.
62.
63.
64.
65

d
b
a
c
b

LO4
LO4
LO4
LO4
LO4

96.
97.
98.
99.
100.

a
b
a
b
c

LO4

101. b

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MULTIPLE CHOICE
49.
50.
52.
53.
54.
65.
66.
67.
68.

$40 + $20 + $50 + $60 = $170

$255 - $40 - $20 - $50 = $145
$40 + $20 + $50 = $110
Any price equal to or greater than $110
$455 + $300 + $45 = $800
CM per unit of Y = $60 - $6 - $12- $8 = $34
CM per mh of X = $50 - $6 - $12- $4 = $28/1 machine hour = $28 per machine hour
Model Y, because it has the greatest CM per unit
Model X, because it has the greatest CM per machine hour

70.
71.

Standard CM $18/3 mh = $6 CM per mh; Premium CM $20/4 mh = $5 CM per mh

To maximize CM per mh, the constrained resource, manufacture the demand of 100
standard rockers and use the remaining machine hours to manufacture the Premium Model
with the lower CM per machine hour. 100 Standard Rockers x 3 mh per rocker = 300 mh.
496 mh 300 mh = 196 remaining mh / 4 mh per Premium Model = 49 Premium Rockers
Manufacture units demanded of each rocker, which will leave excess capacity of 20
machine hours. (100 x 3 mh = 300 mh) + (70 x 4 mh = 280 mh) + (Excess capacity 0f 20
mh) = 600mh
$90 x .80 = $72 x 100 = $7,200
$90 x 1.50% = $135

72.
77.
78.
79.

Direct materials
Direct manufacturing labor ($6 x 10,000) / 30,000
Variable manufacturing ($161,250 / 30,000)
Setup ($20,000 / 2,000)
Minimum acceptable bid

80.

Direct materials
Direct manufacturing labor ($6 x 10,000)/30,000
Variable manufacturing ($161,250/30,000)
Fixed manufacturing ($600,000/30,000)
Product and process design costs ($450,000/30,000)
Marketing and distribution ($562,500/30,000)
Full cost per unit
Markup (20%)
Estimated selling price

81.

With the price increase, operating profits are expected to increase by $4,000 = [17,000
units x ($5.00 - $3.00)] - [20,000 units x ($4.50 - $3.00)]
$300,000 - $150,000 - $60,000 - $70,000 = $20,000 loss in operating income
$24,000 - $15,000 - $6,000 = $3,000. Product C contributes $3,000 toward corporate
profits. Without Product C, operating income would be $3,000 less than currently
reported.
$(3,000) + $12,000 = $9,000

99.
100.
101.

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$50.000
2.000
5.375
10.000
$67.375
$ 50.000
2.000
5.375
20.000
15.000
18.750
$111.125
22.225
$133.350

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EXERCISE/PROBLEM
LO1
102. a.
b.
c.
d.
e.

LO1,2,3
103. a.
b.
c.
d.

LO1,2
104. a.
b.

c.
d.
e.

$124
$114 = Selling price $186 Variable costs ($33 + $15 + $24).
Relevant costs for decision making are those costs that differ between alternatives
which, in this situation, are the incremental costs. The incremental costs total $72 =
Variable costs ($33 + $15 + $24).
The minimum acceptable price is $72 = Variable costs ($33 + $15 + $24), the
incremental costs in the short term.
Yes, because this price is greater than the minimum acceptable price of this special
order determined in (d).

$285 = flexible costs $100 + $125 + $60

Silver Lake Cabinets should also consider the impact on current customers when these
customers hear that another customer was offered a discounted price, and the impact
on the competition and if they might choose to meet the discounted price.
Currently, the incremental costs total $285. If additional capacity is needed to process
this order, these incremental costs will increase by the cost of adding capacity.
In the long term, Silver Lake Cabinets needs to cover all costs plus profits and, on
average, needs to achieve the targeted selling price of $576.

The contribution per unit is $30 for Model X ($80 - $30 - $15 - $5),
$35 for Model Y ($90 - $30 - $15 - $10),
and $40 for Model Z ($100 - $30 - $20 - $10).
The contribution per machine hour is
$30 for Model X ($30 contribution margin / 1.0 machine hours per unit),
$17.50 for Model Y ($35 / 2.0), and
$20 for Model Z ($40 / 2.0).
When there is excess capacity, Model Y is the most profitable because it has the
greatest contribution per unit.
When there are machine hour capacity constraints, Model X is the most profitable
because it has the greatest contribution per constrained resource.
To encourage salespersons to promote specific products, Maggie may want to provide
marketing incentives such as higher sales commissions for products contributing the
most to profits. Maggie may also want to educate salespeople about the effects of
constrained resources.

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LO1,2
105. a.
b.
c.

LO1,2
106. a.

Contribution per machine hour is $6 for the Standard chair and $5 for the Premium
chair.
To maximize profits, 240 machine hours should be used to manufacture 120 units of
the Standard chair and 180 machine hours should be used to manufacture 60 units of
the Premium chair. (240 mh + 180 mh = 420 mh available per week.)
If there are 500 machine hours available per week there is excess capacity of 50
machine hours. Demand for both types of chairs can be met and Charlies Chairs
should manufacture 120 Standard chairs and 70 Premium chairs per week. (240 mh +
210 mh = 450 mh used per week.)

The contribution per unit is

$15 for Small ($30 - $8 - $3 - $4),
$18 for Medium ($36 - $10 - $3 - $5), and
$21 for Large ($42 - $12 - $4 - $5).

b.

The contribution per machine hour is

$75 for Small ($15 contribution margin / 0.20 machine hours per unit),
$72 for Medium ($18 / 0.25) and
$70 for Large ($21 / 0.30).

c.

Machine hours required:

Small
(2,500 x 0.20) =
Medium (4,000 x 0.25) =
Large
(3,000 x 0.30) =
Total machine hours required

500 mh
1,000 mh
900 mh
2,400 mh

Since total machine hours required are less than the capacity of 2,500 machine hours,
to maximize profits Novelenes should produce enough to meet projected sales for
each size. That is, Novelenes should produce 2,500 small, 4,000 medium, and 3,000
large cheese heads.
d.

1.

Contribution margin for the special order:

Unit selling price
Unit variable costs ($10 + $3 + $5)
Contribution margin per unit
Machine hours available:
Machine hours required:
Special order (1,000 units x 0.25)
Current demand

Chapter 6

2,500
250
2,400
(2,650)
(150)

Machine hour shortage

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Since the large size has the lowest contribution margin per machine hour, 500
(500 units x .3 mh/unit = 150 mh) units of the large size would not be produced
if the special order was accepted. Therefore, the opportunity cost for the special
order would be $10,500 ($21 contribution per unit x 500 units), the contribution
margin that would be sacrificed when the production and sale of 500 units of
large size cheese heads would be given up.
2.

e.

Novelene will want to consider the impact of this special order on her regular
customers now and in the future. For example, will manufacturing fewer large
cheese heads result in shortages and, therefore, angry customers?

Available machine hours

Machine hours required:
Small (2500 x 0.20) =
Medium (4000 x 0.25) =
Machine hours remaining
Number of the large size that can be
produced is 1,666 units = (500 mh / 0.30 per unit)

2,000
500
1,000
500

The optimal production plan is as follows:

Small size 2500 units, Medium size 4000 units, Large size 1,666 units.
LO1,3
107. a.
b.

The lowest price Backwoods should bid on the 100 table one-time special order is
$5,600 = Variable costs ($80 x .70 x 100 tables), the short-term incremental costs.
The lowest price Backwoods should bid on the long-term hotel chain order is $120 per
table = Full costs $80 + 50% markup, the long-term targeted price.

LO1,3
108. No, Molar Camera should not eliminate Model AE1 from its product line because it
contributes $10,000 toward fixed costs and profits, as shown:
Sales (1,000 units)
Manufacturing costs:
Direct materials
Direct labor
Variable support ($100,000 x 70%)
Contribution margin

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$250,000
140,000
30,000
70,000
$10,000

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LO3,4
109. a.
b.
c.
LO4
110. a.

b.

With the price increase operating profits are expected to decrease by $2,000 = [17,000
units x ($5.00 - $3.00)] - [20,000 units x ($4.80 - $3.00)].
No, I would not recommend the price increase because operating profits are expected
to decline by $2,000.
The demand is elastic because the demand in units decreased with an increase in price.

No, I would not recommend discontinuing the Other Candy product line because this
product line contributes $4,000 toward corporate costs and profits.
$25,000 - $15,000 - $3,000 - $3,000 = $4,000
Without the Other Candy product line, corporate profits would be $4,000 less than
currently reported.
If the Chocolate product line were discontinued, corporate profits would immediately
decrease by $9,000.
$40,000 - $26,000 - $2,000 - $3,000 = $9,000

APPENDIX
111. Total revenue
Total cost

Total profit

=R =PxQ
= P x (600 - 2P)
= 600P - 2P2
= C = $8,000 + $30Q
= $8,000 + $30 * (600 - 2P)
= $8,000 + 18,000 - 60P
= 26,000 - 60P
= R - C = 660P - 2P2 26,000

OPTIMAL PRICE
Differentiating total profit with respect to P and setting it equal to zero, we obtain the
optimal price. P = (660/4) = $165.
CORRESPONDING DEMAND QUANTITY
Substituting P into the demand function, we obtain
Q = 600 (2 x 165) = 270 units.
UNIT PRODUCTION COST
The corresponding cost is
C = $ 8,000 + ($30 x 270) = $16,100.
The unit cost is C/Q = $16,100/270 = $59.63.

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CRITICAL THINKING/ESSAY
LO1
112. What considerations other than cost need to be evaluated for one-time special orders?
Solution: Firms also need to consider the strategic implications such as the impact on
current customers when these customers hear that another customer was offered a
discounted price, and the impact on the competition and if they might choose to meet the
discounted price.
LO1
113. An activity-based costing system allocates fixed manufacturing costs to various product
lines. When should these allocated costs be used to evaluate short-term pricing decisions?
Solution: Allocated costs should only be used to evaluate short-term pricing decisions if they
are variable in the short run and differ among the alternatives being considered.
LO1,2
114. For short-term pricing decisions, what costs are relevant when there is available surplus
capacity? When there is no available surplus capacity?
Solution: For both situations the relevant costs are the incremental costs. However, when
there is limited capacity the incremental costs will be greater because they will include the
costs of adding capacity or the opportunity costs of alternative manufacturing choices.
LO2
115. When there is inadequate capacity, under what conditions may a firm consider accepting a
one-time special order?
Solution: When the incremental revenues exceed the incremental costs, a special order
should be considered.
LO1,3
116. Under what conditions might a manufacturing firm sell a product for less than its long-term
price? Why?
Solution: The price for a short-term order may be less than the price offered to a long-term
customer. If a firm has excess capacity, it is more profitable for the firm to accept a special
order for a price below the long-run price than it is to let the capacity sit idle. In addition,
the firm may use this strategy for market penetration and to obtain greater market share.
LO1,3
117. Why is the evaluation of short-term pricing decisions different from the evaluation of longterm pricing decisions?
Solution: Since capacities made available for many production and support activities cannot
be altered easily in the short run, managers need to pay attention to whether surplus capacity
is available for additional production or whether the available capacity limits production
alternatives. By contrast, in the long run, 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.

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LO2,3
118. Under what conditions will a firm become a price-setter? A price-taker?
Solution: A firm will be a price-setter when it is in an industry with relatively little
competition, it holds a large share of the market, and it can exercise leadership. A firm will
be a price-taker when it is one of a large number of firms in an industry, it holds a small
market share in an industry with a price-setter firm, or it competes in an industry where
there is little to distinguish products from each other.
LO3
119. Vlasic has a large market share of the pickle industry. What influences how Vlasic
determines its prices?
Solution: Since Vlasic holds a large share of the market, it can set the prices for the pickle
industry based on customer price acceptance.
LO3
120. Clark Manufacturing offers two product lines IN2 and EL5. The demand of the IN2 product
line is inelastic, while the demand of the EL5 product line is very elastic. If Clark initiates a
price increase for both product lines, how will customer demand change? How will the price
increase affect operating profits?
Solution: For the inelastic product line, when prices are increased demand will stay
approximately the same and profits would be expected to increase.
For the elastic product line, the increased price will result in decreased demand (i.e., lower
sales volume). Whether a profit or a loss results from this change will depend on the amount
of decreased demand and the amount of the increased contribution margin due to the
increase in price.
LO3
121. What factors may influence the level of markups?
Solution: Factors affecting the level of markups include the strength of demand, the
elasticity of demand, and the intensity of competition. In addition, strategic reasons also
may influence the level of markups. For instance, a firm may either choose a low markup to
penetrate the market and win market share from established products of its competitors, or
employ a high markup if it employs a skimming strategy for a market segment in which
some customers are willing to pay higher prices for the privilege of owning the product.
LO3
122. When is full-cost information useful for pricing decisions?
Solution: Full costs are used for pricing decisions under the following circumstances:
1) Contracts for the development and production of new customized products, including
contracts with governmental agencies, specify prices as full costs plus a markup;
2) Prices set in regulated industries like electric utilities also are based on full costs;
3) 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, because with the flexibility it has in
adjusting the level of commitment for all activity resources, most costs become variable in
the long run; and
4) 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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LO3
123. Explain how price markups relate to the strength of demand, the elasticity of demand, and
the intensity of competition.
Solution: The stronger the demand, the higher the markup will be. 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.
LO4
124. Vlasic has a large market share of the pickle industry. Dean Foods holds a much smaller
share of the pickle market. What influences how Dean Foods determines its prices?
Solution: Firms with smaller market share like Dean Foods will set prices similar to Vlasic,
the price setter for the pickle market.
LO4
125. Vlasic has a large market share of the pickle industry. Dean Foods holds a much smaller
share of the pickle market. What are the possible consequences if Dean Foods raises the
price of their pickles? Lowers the price of their pickles?
Solution: If Dean Foods raise their pickle prices they would lose market share because
customers will simply purchase a competitors pickles at the lower price.
If Dean Foods lowers their pickle prices, Vlasic would probably respond by also lowering
prices. This could lead to a price war and decreased profits for everyone in the industry. In
this situation, smaller firms are usually the losers because they cannot sustain losses over an
extended period of time and as a result may be forced out of business.
LO4
126. Is a company that competes in commodities such as corn and wheat a price-taker or a pricesetter? Why?
Solution: A price-taker. In industries where it is difficult to differentiate one firms products
from another firms products, prices are influenced by the supply and demand of the market,
and all firms are price-takers.
LO4
127. A hotel in Orlando, Florida, experiences peak periods and slower times. How should prices
be adjusted during peak periods? During slow times?
Solution: During peak periods the hotel can justify increased prices because of full capacity
conditions, whereas in slower periods when there is excess capacity, the hotel may want to
lower prices to fill the excess capacity.
LO4
128. What options may be considered when long-run market prices are below full costs?
Solution: 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,
or dropping these unprofitable products.

AKY 4E Test Bank

Chapter 6

Page 32

Schoenebeck