Professional Documents
Culture Documents
The Gold Plus Company manufactures medals for winners of athletic events and other contests.
Its manufacturing plant has the capacity to produce 11,000 medals each month. Current
production and sales are 10,000 medals per month. The company normally charges $150 per
medal. Cost information for the current activity level is as follows:
10,000
Variable costs that vary with the number of units produced
Direct materials
Direct manufacturing labor
Variable costs (for setups, materials handling, quality control,
and so on) that vary with number of batches, 200 batches
X $500 per batch
50 batch size
Fixed manufacturing costs
Fixed marketing costs
Total
$350,000
375,000
$35.00
$37.50
100,000
300,000
275,000
$1,400,000
$500.00
$140.00
Gold Plus has just received a special one-time-only order for 1,000 medals at $100 per medal.
Accepting the special order would not affect the company's regular business. Gold Plus
makes medals for its existing customers in batch sizes of 50 medals (200 batches X 50 medals
per batch = 10,000 medals). The special order requires Gold Plus to make the medals in 25
batches of 40 each.
1. Should Gold Plus accept the special one-time only order for 1,000 medals at $100 per medal?
Incremental revenue
$100
Incremental costs
Variable manufacturing costs
Direct materials
($35)
Direct manufacturing labor
($37.50)
Batch setup costs
($500)
Incremental increase in operating income
1,000
1,000
1,000
25
$100,000
($35,000)
(37,500)
(12,500)
(85,000)
$15,000
Gold Plus should accept the one-time-only special order provided that there are no
long-term implications. If accepting the special order would cause the regular
customers to be dissatisfied or to demand lower prices, then Gold Plus will have to
trade off the $15,000 profit increase from accepting the special order against the
operating income that might be lost from regular customers.
2. Suppose plant capacity was only 10,500 medals instead of 11,000 medals each month. The
special order must either be taken in full or be rejected completely. Should Gold Plus accept
the special order?
Batch size
10,500
1,000
9,500
0
Units
10,500
10,000
Batches Req.
50
200
40
50
25
190
500
SP/Costs
Total
(500)
$150.00
($75,000)
500
500
10
$35.00
$37.50
$500.00
17,500
18,750
5,000
($33,750)
1,000
$100.00
$100,000
1,000
1,000
25
($35.00)
($37.50)
($500.00)
($35,000)
(37,500)
(12,500)
15,000
($18,750)
The special order should be rejected because if accepted operating income would decrease
by $18,750.
Note: Even if operating income had increased by accepting the special order, Gold Plus should
consider the effect on its regular customers of accepting the special order. For example, would
selling 500 fewer medals to its regular customers cause these customers to find new suppliers
that might adversely impact Gold Pluss business in the long run.
3. As in requirement 1, assume that monthly capacity is 11,000 medals. Gold Plus is concerned
that if it accepts the special order, its existing customers will immediately demand a price discount
of $10 in the month in which the special order is being filled. They would argue that Gold Plus's
capacity costs are now being spread over more units and that existing customers should get the
benefit of these lower costs. Should Gold Plus accept the special order under these conditions?
Incremental revenue from special order
1,000
$100 $100,000
Incremental costs from special order
Variable manufacturing costs
Direct materials
1,000
($35.00) ($35,000)
Direct manufacturing labor
1,000
($37.50)
(37,500)
Batch setup costs
25 ($500.00)
(12,500)
Incremental increase in operating income from special order
Less decrease in operating income generated from normal sales
Net decrease in operating income if special order is accepted
The special order should, therefore, be rejected
15,000
$15,000
(100,000)
($85,000)
per unit
per unit
per batch
per unit
$135.00
rice discount
Problem 11-20
The Svenson Corporation manufactures cellular modems. It manufactures its own cellular
modem circuit boards (CMCB), an important part of the cellular modem. It reports the
following cost information about the costs of making CMCBs in 2014 and the expected costs
in 2015:
Current Costs
Expected Costs
in 2014
in 2015
$180
$50
$170
$45
$1,600
$1,500
$320,000
$320,000
$800,000
$800,000
Svenson manufactured 8,000 CMCBs in 2014 in 40 batches of 200 each. In 2015, Svenson
anticipates needing 10,000 CMCBs. The CMCBs would be produced in 80 batches of 125 each.
The Minton Corporation has approached Svenson about supplying 10,000 CMCBs to Svenson in 2015 at
$300 per CMCB on whatever delivery schedule Svenson wants.
1. Calculate the total expected manufacturing cost per unit of making CMCBs in 2015.
Production Level
Variable manufacturing costs
Direct materials cost per unit
Direct manufacturing labor
Batch costs (setups, materials handling and quality control)
Fixed Costs
Avoidable Costs
Unavoidable Costs
Total expected mfg. cost per unit to manufacture 10,000 units
10,000
$120,000
$320,000
$800,000
$170
45
12
32
80
$339
2. Suppose the capacity currently used to make CMCBs will become idle if Svenson purchases
CMCBs from Minton. On the basis of financial considerations alone, should Svenson make
CMCBs or buy them from Minton?
Incremental cost per unit if purchased from Minton
Incremental cost savings per unit by not producing CMCBs internally
Variable manufacturing costs saved by not producing CMCBs internally
Direct materials cost per unit
Direct manufacturing labor
Unit batch costs (setups, materials handling and quality control)
$120,000
Fixed Costs
Avoidable Costs (1)
$320,000
Incremental mfg. costs per unit saved by not producing CMCBs
$300
$170
45
12
32
$259
$41
(1) Note: The unavoidable fixed costs of $800,000 will continue to be incurred regardless of
the decision to make or buy. These costs are therefore, irrelevant to the decision at
hand.
3. Now suppose that if Svenson purchases CMCBs from Minton, its best alternative use of the
capacity currently used for CMCBs is to make and sell special circuit boards (CB3s) to the
Essex Corporation. Svenson estimates the following incremental revenues and costs from
CB3s:
Total expected incremental future revenues
$2,000,000
Total expected incremental future costs
$2,150,000
On the basis of financial considerations alone, should Svenson make CMCBs or buy them from
Minton?
Incremental cost of producing CMCBs internally
Net cost of buying and using freed capacity to produce CB3s
Cost of buying from CMCBs Minton
Net benefit/loss of using freed capacity to produce CB3s.
Incremental revenue associated with CB3s
$2,000,000
Incremental costs associated with CB3s
2,150,000
Net loss associated with producing CB3s
($150,000)
Extra cost per unit to be absorbed by the 10,000 CMCBs
Net cost of buying CMCBs and using freed capacity to produce CB3s.
Disadvantage of buying CMCBs from Minton and producing and selling CB3s
Note: As long as producing CB3s yields a net loss, Svenson should just produce CMCBs.
$259
$300
15
$315
$56
8,000
10,000
80
Cola
Lemonade
$18.80
$20.75
13.80
16.26
7
12
Punch Natural OJ
$26.90
$39.30
20.10
30.10
10
6
Sexton has a maximum front shelf space of 12 feet to devote to the four drinks. She wants a minimum
of 1 foot and a maximum of 6 feet of front shelf space for each drink.
1. Calculate the contribution margin per case of each type of drink.
Cola
Lemonade
$18.80
$20.75
(13.80)
(16.26)
$5.00
$4.49
3
4
Punch Natural OJ
$26.90
$39.30
(20.10)
(30.10)
$6.80
$9.20
2
1
2. A co-worker of Sexton's recommends that she maximize the shelf space devoted to those
drinks with the highest C/M per case. Evaluate this recommendation.
The recommendation fails to take into consideration that "cases sold per foot of shelf space per day"
differs by drink.
Cola
Lemonade
Punch Natural OJ
7
12
10
6
Cases sold per foot of shelf space per day
3. What recommendation would you make?
Cola
Lemonade
$18.80
$20.75
(13.80)
(16.26)
$5.00
$4.49
7
12
$35.00
$53.88
1 Foot
Minimum
Allowed
Punch Natural OJ
$26.90
$39.30
(20.10)
(30.10)
$6.80
$9.20
10
6
$68.00
$55.20
4 Feet
6 Feet
Remaining Maximum
Amount
Allowed
1 Foot
Minimum
Allowed
Revenues
Operating Costs
Cost of Goods Sold
Lease rent (renewable each year)
Labor costs (paid on an hourly basis)
Equipment depreciation
Utilities (electricity, heating)
Allocated corporate overhead
Total operating costs
Operating Income
Connecticut
Store
$1,070,000
Rhode Island
Store
$860,000
$750,000
90,000
42,000
25,000
43,000
50,000
$1,000,000
$70,000
$660,000
75,000
42,000
22,000
46,000
40,000
$885,000
($25,000)
The equipment has a zero disposal value. In a senior management meeting, Maria Lopez, the
management accountant at Sanchez Corporation, makes the following comment, "Sanchez
can increase its profitability by closing down the Rhode Island store or by adding another
store like it."
1. By closing down the Rhode Island store, Sanchez can reduce overall corporate overhead costs
by $44,000. Calculate Sanchez's operating income if it closes the Rhode Island store. Is Maria
Lopez's statement about the effect of closing the Rhode Island store correct?
Explain. Yes, see below.
Relevant Cost
Total Rev./Cost
Current situation
Revenues
Operating Costs
Cost of Goods Sold
Lease rent (renewable each year)
Labor costs (paid on an hourly basis)
Equipment depreciation
Utilities (electricity, heating)
Allocated corporate overhead
Total operating costs
Operating Income
Irrelevant
Approach
Approach
Connecticut
Store
$1,070,000
Rhode Island
Store
$860,000
Both
Stores
$1,930,000
$750,000
90,000
42,000
25,000
43,000
50,000
$1,000,000
$70,000
$660,000
75,000
42,000
22,000
46,000
40,000
$885,000
($25,000)
$1,410,000
165,000
84,000
47,000
89,000
90,000
$1,885,000
$45,000
Connecticut
Store
$1,070,000
Rhode Island
Store
$0
Both
Stores
$1,070,000
$750,000
90,000
42,000
25,000
$0
0
0
22,000
$750,000
90,000
42,000
47,000
43,000
50,000
$1,000,000
$70,000
0
(4,000)
$18,000
($18,000)
$7,000
43,000
46,000
$1,018,000
$52,000
$7,000
2. Calculate Sanchez's operating income if it keeps the Rhode Island store open and opens
another store with revenues and costs identical to the Rhode Island store (including a
cost of $22,000 to acquire equipment with a one-year useful life and zero disposal value).
Opening this store will increase corporate overhead costs by $4,000. Is Maria Lopez's
statement about the effect of adding another store like the Rhode Island store correct?
Explain. Yes, see below.
Current situation
Revenues
Operating Costs
Cost of Goods Sold
Lease rent (renewable each year)
Labor costs (paid on an hourly basis)
Equipment depreciation
Utilities (electricity, heating)
Allocated corporate overhead
Total operating costs
Operating Income
Irrelevant
Irrelevant
Connecticut
Store
$1,070,000
Rhode Island
Store
$860,000
$750,000
$90,000
$42,000
$25,000
$43,000
$50,000
$1,000,000
$70,000
$660,000
$75,000
$42,000
$22,000
$46,000
$40,000
$885,000
($25,000)
Incremental
Irrelevant
Irrelevant
Connecticut
Store
$1,070,000
Rhode Island
Revenues
Operating Costs
Cost of Goods Sold
$750,000
Lease rent (renewable each year)
90,000
Labor costs (paid on an hourly basis)
42,000
Equipment depreciation
25,000
Utilities (electricity, heating)
43,000
Allocated corporate overhead
50,000
Total operating costs
$1,000,000
Operating Income
$70,000
Net benefit obtained by adding a Rhode Island type store.
Store (Current)
$860,000
$660,000
75,000
42,000
22,000
46,000
40,000
$885,000
($25,000)
approach
New
Store
$860,000
$660,000
$75,000
$42,000
$22,000
$46,000
$4,000
$849,000
$11,000
$11,000
Incremental
Approach
($860,000)
($660,000)
($75,000)
($42,000)
$0
($46,000)
($44,000)
($867,000)
$7,000
n and opens
posal value).
Total Rev./Cost
Both
Stores
$1,930,000
$1,410,000
165,000
84,000
47,000
89,000
90,000
$1,885,000
$45,000
Total Rev./Cost
All
Stores
$2,790,000
$2,070,000
240,000
126,000
69,000
135,000
94,000
$2,734,000
$56,000
$11,000
$56,000
Trent
Julie
Both
Corporation Corporation Corporations
$210,000
$140,000
$350,000
84,000
85,000
169,000
$126,000
$55,000
$181,000
102,000
68,000
170,000
$24,000
($13,000)
$11,000
3,000
1,000
4,000
Trent
Julie
Both
Corporation Corporation Corporations
$210,000
$140,000
$350,000
84,000
85,000
169,000
$126,000
$55,000
$181,000
3,000
1,000
$42
$55
$70
$140
4,000
$224,000
140
1,600
1,600
2,400
$70
$168,000
Trent
Julie
Both
Corporation Corporation Corporations
$168,000
$224,000
$392,000
0.40
67,200
136,000
203,200
0.60
$100,800
$88,000
$188,800 (1)
170,000
$18,800
Trent
Julie
Both
Corporation Corporation Corporations
2,400
1,600
4,000
$42
$55
$100,800
$88,000
$188,800
Sample LP Problem
Information Technology, Inc., assembles and sells two products:
printers and desktop computers. Customers can purchase
either (1) a computer or (2) a computer plus a printer. The
printers are not sold without the computer. The result is that
the quantity of printers sold is equal to or less than the quantity
of desktop computers sold. The contribution margins are $200
per printer and $100 per computer.
Each printer requires 6 assembly-hours on production line 1
and 10 assembly-hours on production line 2. Each computer
requires 4 assembly-hours on production line 1 only. (Many of
the components for each computer are preassembled by
external vendors.) Production line 1 has 24 assembly-hours
available per day. Production line 2 has 20 assembly-hours
available per day.
Let P represent units of printers and C represent units of desktop
computers. The production manager must decide on the optimal
mix of printers and computers to manufacture.
1. Formulate the production manager's problem in a LP format.
Let P = the number printers (only sold with computers)
Let C = the number computers
Objective function
Maximize: $200 P + $100 C
Subject to the following constraints:
1
Sales Constraint
P<=C
2
Assembly Line 1
6P + 4C < = 24 hours
3
Assembly Line 2
10P + 0C < = 20 hours
4
Non-negativity
P > = 0; C > = 0
Plot: Equality relationships
1
Sales Constraint P = C
P C
0 0 Point 1
9 9 Point 2
2
Assembly Line 1 6P + 4C = 24 hours
P C
0 6 Point 1
4 0 Point 2
3
Assembly Line 2 10P + 0C = 20 hours
10P = 20 hours
P C
P=2
2 0 Point 1
2 9 Point 2
4
Non-negativity
P = 0; C = 0
5
Objective function
200 P + 100 C = Z
Objective Function
Assembly Line 2 C
8
C
O
M
P
U
T
E
R
S
7
6
Assembly Line 1
Constraint
5
4
3
Feasible
Solution
Area
Set Z = 800 (an easy to plot assumed value)
Then plot: 200 P + 100 C = 800
2
1
P C
0 8 Point 1
4 0 Point 2
P C
0 7 Point 1
3.5 0 Point 2
Z = 800
Z = 700
P=2
6 P + 4 C = 24
6 (2) + 4 C = 24
12 + 4 C = 24
4 C = 12
C=3
$200 P + $100 C = Z
$200(2) + $100(3) = Z
$400 + $300 = Z
$700 = Z
3
P R
Assembly Line 1
Constraint
4
5
6
N T E R S
$10
2
14 (1)
$26
$8
6
$78,000
$4
$52
A customer, the Apex Company, has asked Wild Orchid to produce 3,500 units of
Stronglast, a modification of Everlast. Stronglast would require the same manufacturing
processes as Everlast. Apex has offered to pay Wild Orchid $40 for a unit of Everlast
and share 1/2 of the marketing cost per unit.
3,500
$40
0.5
1. What is the opportunity cost to Wild Orchid of producing the 3,500 units of Stronglast?
(Assume that no overtime is worked.)
The opportunity cost to Wild Orchid of producing the 3,500 units of Stronglast is the C/M
lost on the 3,500 units of Everlast that would have to be forgone, as computed below:
Selling price
Variable cost per unit:
Direct materials
Direct mfg. Labor
Variable mfg. Overhead
Variable marketing
Contribution margin per unit
Units of Everlast that must be forgone
Total opportunity cost of producing Stronglast
$52
($10)
(2)
(8)
(4)
(24)
$28
3,500
$98,000
Additional Data
The Chesapeake Corporation has offered to produce 3,500 units of Everlast for
Wild Orchid so that Wild Orchid may accept the Apex offer. That is, if Wild Orchid
accepts the Chesapeake offer, Wild Orchid would manufacture 9,500 units of Everlast
and 3,500 units of Stronglast and purchase 3,500 units of Everlast from Chesapeake.
Cheaspeake would charge Wild Orchid $36 per unit to manufacture Stronglast.
$36
2. On the basis of financial considerations alone, should Wild Orchid accept the
Chesapeake offer?
Contribution margin from sale of Stronglast produced by Wild Orchid to Apex
$42
(24)
$18
3,500
$63,000
(24)
$28
9,500
$266,000
$371,000
$52
Net benefit of accepting Chesapeake's offer and producing Stronglast for Apex
Alternative calculation of net benefit
$7,000
$7,000
3. Assume current production of only 9,500 units of Everlast. What is minimum selling
price Wild Orchid would accept from Apex Co. for Stronglast?
9,500
Since there is enough excess capacity for Wild Orchid to produce Stronglast without
giving up any normal customers, then the minimal acceptable selling price would
be slightly higher than its incremental unit cost:
3,500
Minimum selling price
Variable cost per unit which will be incurred by Wild Orchid:
Direct materials
Direct mfg. Labor
Variable mfg. Overhead
Var. marketing (Wild Orchid's portion; 1/2 to be paid by Apex)
Contribution margin per unit
$22
($10)
(2)
(8)
(2)
(22)
$0
**
FMOH are irrelevant because they will not increase because of the production
and sale of Stronglast. Incremental fixed costs are zero.
**
$52
($10)
(2)
(8)
(4)
(24)
$28
13,000
$364,000
$364,000
$70
$30
Required:
1. Pierce is considering using some modern jigs and tools in the finishing
operation that would increase annual finishing output by 1,150 units. The
annual cost of these jigs and tools is $35,000. Should Pierce acquire
these tools?
Finishing is a bottleneck.
Modern jigs and tools would relax the bottleneck by 1,150 units.
Benefit of modern jigs and tools:
Additional contribution margin generated
$46,000
Incremental fixed costs associated with tools
(35,000)
Net advantage of buying modern jigs and tools
$11,000
Recommendation: Buy modern jigs and tools
2. The production manager of the Machining Department has submitted a
proposal to do faster setups that would increase the annual capacity of
the Machining Department by 9,000 units and cost $4,000 per year.
Should Pierce implement the change?
Machining already has excess capacity and is therefore not a bottleneck
operation. Increasing its capacity further will not increase throughput contribution.
Therefore, there is no benefit from spending $4,000 to increase the Machining
Department's capacity by 9,000 units.
Recommendation: Do not implement the change to do faster setups.
3. An outside contractor offers to do the finishing operation for 9,500 units
at $9 per unit, triple the $3 per unit that it costs Pierce to do the finishing
in-house. Should Pierce accept the subcontractor's offer?
Finishing is a bottleneck operation.
Accepting the outside contractor's offer will increase output by 9,500 units.
Advantage of accepting
Additional Throughput CM from increased sales
$380,000
Cost of outside finishing
(85,500)
Net advantage of accepting the offer
$294,500
Recommendation: Accept the offer.
4. The Hammond Corporation offers to machine 5,000 units at $3 per unit, half
the $6 per unit that it costs Pierce to do the machining in-house. Should
**
$51,000
68,000
$119,000
No Defects
1,700 Defects
$6,300,000
$2,700,000
$3,600,000
$6,181,000
$2,700,000
$3,481,000
$119,000
** Note that the direct material cost is irrelevant; whether the units are defective or good
the direct material costs will be incurred.
Alternative calculation: 1,700 X $70 =
$119,000
$119,000
Chatty
Chelsey
$39
Talking
Tanya
$50
Total
Available
36,000
$8
8,500
15
20
$12
The following requirements refer only to the preceeding data. There is no connection
between the requirements.
1. If there were enough demand for either doll, which doll would TT produce?
How many of these dolls would it make and sell?
Chatty
Chelsey
Molding Department Requirements
Maximum production possible (dolls)
Assembly Department Requirements
Maximum production possible (dolls)
Combined Department Requirements
Overall maximum production possible (dolls)
Talking
Tanya
18,000
12,000
34,000
25,500
18,000
12,000
$39
$50
(16)
(3)
(24)
(4)
$20
$22
$360,000
$264,000
Dolls
18,000
0
Model
Chatty Chelsey
Talking Tanya
2. If TT sells three Chatty Chelseys for each Talking Tanya, how many dolls of
each type would it produce and sell? What would be the TCM?
Constraint Checking:
From "1." above:
Molding Department Requirements
Molding materials used
Assembly Department Requirements
Labor hours used
Chatty
Chelsey
Talking
Tanya
Total
Available
Excess
Resources
36,000
36,000
4,500
8,500
4,000
3
3X
2
6X
1
X
3
3X
36,000
12,000
$240,000
4,000
$88,000
$328,000
3. If TT sells three Chatty Chelseys for each Talking Tanya, how much would production
and contribution margin increase if the molding department could buy 900 more pounds
of materials for $8 per pound?
Chatty
Talking
Total
Chelsey
Tanya
Available
Sales Mix Requirement in Dolls
3
1
Let X = units of Talking Tanya produced
X
Let 3X = units of Chatty Chelsey produced
3X
DM needed per doll (pounds)
2
3
DM needed given 3:1 sales mix
6X
3X
Material constraint
6X + 3X = 36,000
36,900
3:1 Sales mix production
12,300
4,100
TCM
$246,000
$90,200
$336,200
Increase in contribution margin
$8,200
ADDED
3. If TT sells three Chatty Chelseys for each Talking Tanya, how much would production
and contribution margin increase if the molding department could buy 900 more pounds
of materials for $10 per pound?
900
$10
3
3X
2
6X
1
X
3
3X
36,900
12,300
$246,000
4,100
$90,200
$336,200
(328,000)
$8,200
(1,800)
Proof:
Sales
Molding material costs
(8.0488)
Assembly department labor
Operating income with extra material
Old operating income
Increase in contribution margin
$6,400
Chatty
Chelsey
$479,700
(198,000)
(36,900)
$244,800
Talking
Tanya
$205,000
(99,000)
(16,400)
$89,600
Total
$684,700
(297,000)
(53,300)
$334,400
(328,000)
$6,400
(297,000)
$334,400
4. If TT sells three Chatty Chelseys for each Talking Tanya, how much would production
and contribution margin increase if the assembly department could get 65 more labor
hours at $12 per hour?
Constraint Checking:
From "3." above:
Production & Sales
DM needed per doll (pounds)
DL needed per doll (minutes)
Molding Department Requirements
Molding materials used
Assembly Department Requirements
Labor hours used
Chatty
Chelsey
Talking
Tanya
Total
Available
Excess
Resources
12,000
2
15
4,000
3
20
36,000
8,500
24,000
12000
36,000
3,000 1333.33333
8,500
4,167
85%
60%
Top management is very concerned about the unprofitable divisions (A and B) and is considering
closing them for the year. Closing down any division would result in a savings of 40% of the fixed
costs of that division.
40%
1&2. Calculate the change in operating income if Division A or B are closed.
Lost sales
Saved variable costs
COGS (90%)
Selling G & A Expenses (50%)
Saved fixed costs (40%)
Change in operating income
A
B
($504,000) ($948,000)
396,000
48,000
36,800
($23,200)
Keep open
744,000
101,250
114,900
$12,150
Close
3. What other factors should the top management consider before making such a decision?
Before deciding to close Division B, management should consider the role that the Division's
product line plays relative to other product lines. For instance, if the product manufactured by
Division B attracts customers to the company, then dropping Division B may have a detrimental
effect on the revenues of the remaining divisions.
Management may also want to consider the impact on the morale of the remaining employees
if Division B is closed. Talented employees may become fearful of losing their jobs and seek
employment elsewhere.
$15
4
2
5
$26 one kilogram
Required:
1. Suppose Ohio Acres Diary can acquire all the Holstein milk that it needs.
What is the minimum price per kilogram it should charge for the hard cheese?
The minimum price is the sum of all of the variable costs.
The fixed costs are not relevant because they are not dependent
on production volume.
$21
2. Now suppose that the Holstein milk is in short supply. Every kilogram of hard
cheese produced by Colorado Mountains Dairy will reduce the quantity of soft
cheese that it can make and sell. What is the minimum price per kilogram it
should charge to produce the hard cheese?
One kilogram of hard cheese requires 10 liters of milk.
One kilogram of soft cheese requires 4 liters of milk.
Every kilogram of hard cheese produced requires that 2.5 (10/4) kilograms of
soft cheese to be foregone.
Each kilogram of soft cheese generates $8 of contribution margin.
Therefore, every kilogram of hard cheese produced must generate at least
$8 X 2.5 = $20 of contribution margin.
$20
The minimum price per kilogram for hard cheese is equal to:
(1) the VC necessary to produce 1 kilogram of hard cheese, plus
(2) the foregone CM sale of 2 kilograms of soft cheese
Minimum price per kilogram for hard cheese
Alternative solution approach based on CM per unit of limiting resource:
Soft Cheese:
$8
4
$2.00 CM per limiting resource
$21
20
$41
Revenues
Disbursements
Purchase of machinery
Cash machine operating costs
Other cash operating costs
Net cash disbursements
Net cash inflow
Revenues
Disbursements
Purchase of machinery ("old")
Cash machine operating costs
Other cash operating costs
Buy newer machine
Salvage from sale of "old"
Net cash disbursements
Net cash inflow
Net benefit of buying newer machine
$15,000
110,000
$125,000
$25,000
$15,000
110,000
$125,000
$25,000
$15,000
110,000
$125,000
$25,000
$9,000
110,000
$9,000
110,000
$9,000
110,000
$119,000
$31,000
$119,000
$31,000
$119,000
$31,000
($10,000)
$6,000
$6,000
$6,000
1b. Prepare a statement of income for each of the 4 years under each alternative. Assume straight-line
depreciation. What is the cumulative difference in operating income for the 4 years taken together?
Year 1
Revenues
Expenses
Depreciation of "old" machine
Cash machine operating costs
Other cash operating costs
Total Expenses
Operating Income
Revenues
Expenses (and Losses)
Loss on disposal of "old"
Cash machine operating costs
Other cash operating costs
Depreciation of newer machine
Total expenses/losses
Operating Income
Net benefit of buying newer machine
$150,000
$150,000
$150,000
$150,000
$5,000
15,000
110,000
$130,000
$20,000
$5,000
15,000
110,000
$130,000
$20,000
$5,000
15,000
110,000
$130,000
$20,000
$5,000
15,000
110,000
$130,000
$20,000
$9,000
110,000
6,000
$125,000
$25,000
$9,000
110,000
6,000
$125,000
$25,000
$9,000
110,000
6,000
$125,000
$25,000
($7,000)
$5,000
$5,000
$5,000
Revenues
Disbursements
Purchase of machinery
$15,000
110,000
$125,000
$25,000
$15,000
110,000
$125,000
$25,000
$15,000
110,000
$125,000
$25,000
9,000
110,000
24,000
(8,000)
1,135,000
($985,000)
$9,000
110,000
$9,000
110,000
$9,000
110,000
119,000
$31,000
119,000
$31,000
119,000
$31,000
($10,000)
$6,000
$6,000
$6,000
1b revisited.
Revenues
Expenses
Depreciation of "old" machine
Cash machine operating costs
Other cash operating costs
Total expenses
Operating income
$250,000
15,000
110,000
$375,000
($225,000)
$250,000
15,000
110,000
$375,000
($225,000)
$250,000
15,000
110,000
$375,000
($225,000)
$250,000
15,000
110,000
$375,000
($225,000)
Revenues
Expenses (and Losses)
Loss on disposal of "old"
Cash machine operating costs
Other cash operating costs
Depreciation of newer machine
Total expenses
Operating Income
$992,000
9,000
110,000
6,000
$1,117,000
($967,000)
9,000
110,000
6,000
$125,000
$25,000
9,000
110,000
6,000
$125,000
$25,000
9,000
110,000
6,000
$125,000
$25,000
($742,000)
$250,000
$250,000
$250,000
3. Is there any conflict between the decision model and the incentives of the manager who has
just purchased the "old" machine and is considering replacing it a day later?
Decision model is based upon relevant items -- those expected future items that will differ among
alternatives.
Difference in total cash machine operating costs
Cost of new machine
Salvage of old machine
Advantage of buying newer machine
$24,000
($24,000)
8,000
(16,000)
$8,000
Incentives -- income measures are often the principal means of performance evaluation.
Replacement requires recognition of large loss in the replacement year, which can be avoided
by not replacing. Management compensation plans often are disfunctional causing equipment
decisions to be deferred or avoided despite being good for the company as a whole.
polishing cars at
e costs $20,000.
life and a zero
achine that
chine will cost
ly $10,000, minus
e and zero terminal
00 annually,
under each
sh Flow Analysis
Total
$600,000
$20,000
60,000
440,000
$520,000
$80,000
h Flow Analysis
Total
$600,000
$20,000
36,000
440,000
24,000
(8,000)
$512,000
$88,000
$8,000
ssume straight-line
ars taken together?
come Analysis
Total
$600,000
$20,000
60,000
440,000
$520,000
$80,000
come Analysis
Total
$600,000
$12,000
36,000
440,000
24,000
$512,000
$88,000
$8,000
sh Flow Analysis
Total
$600,000
$1,000,000
60,000
440,000
$1,500,000
($900,000)
h Flow Analysis
Total
$600,000
$1,000,000
36,000
440,000
24,000
(8,000)
1,492,000
($892,000)
$8,000
come Analysis
Total
$600,000
$1,000,000
60,000
440,000
$1,500,000
($900,000)
come Analysis
Total
$600,000
$992,000
36,000
440,000
24,000
$1,492,000
($892,000)
$8,000
er who has
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