Assignment Material

Questions

1. 12-1. Outline the five-step sequence in a decision process.
2. 12-2. Define relevant costs. Why are historical costs irrelevant?
3. 12-3. “All future costs are relevant.” Do you agree? Why?
4. 12-4. Distinguish between quantitative and qualitative factors in decision making.
5. 12-5. Describe two potential problems that should be avoided in relevant-cost analysis.
6. 12-6. “Variable costs are always relevant, and fixed costs are always irrelevant.” Do you agree? Why?
7. 12-7. “A component part should be purchased whenever the purchase price is less than its total manufacturing cost per unit.” Do you agree? Why?
8. 12-8. Define opportunity cost.
9. 12-9. “Managers should always buy inventory in quantities that result in the lowest purchase cost per unit.” Do you agree? Why?
10. 12-10. “Management should always maximize sales of the product with the highest contribution margin per unit.” Do you agree? Why?
11. 12-11. “A branch office or business segment that shows negative operating income should be shut down.” Do you agree? Explain briefly.
12. 12-12. “Cost written off as depreciation on equipment already purchased is always irrelevant.” Do you agree? Why?
13. 12-13. “Managers will always choose the alternative that maximizes operating income or minimizes costs in the decision model.” Do you agree? Why?
14. 12-14. Describe the three steps in solving a linear programming problem.
15. 12-15. How might the optimal solution of a linear programming problem be determined?

Multiple-Choice Questions

1. 12-16. QUALITATIVE AND QUANTITATIVE FACTORS. Which of the following is not a qualitative factor that Atlas Manufacturing should consider when deciding whether to buy or make a part used in manufacturing their product?
   1. a. Quality of the outside producer’s product.
   2. b. Potential loss of trade secrets.
   3. c. Manufacturing deadlines and special orders.
   4. d. Variable cost per unit of the product.
2. 12-17. SPECIAL ORDER, OPPORTUNITY COST. Chade Corp. is considering a special order brought to it by a new client. If Chade determines the variable cost to be $9 per unit, and the contribution margin of the next best alternative of the facility to be $5 per unit, then if Chade has
   1. a. Full capacity, the company will be profitable at $4 per unit.
   2. b. Excess capacity, the company will be profitable at $6 per unit.
   3. c. Full capacity, the selling price must be greater than $5 per unit.
   4. d. Excess capacity, the selling price must be greater than $9 per unit.
3. 12-18. SPECIAL ORDER, OPPORTUNITY COST. In order to determine whether a special order should be accepted at full capacity, the sales price of the special order must be compared to the per unit
   1. a. Contribution margin of the special order.
   2. b. Variable cost and contribution margin of the special order.
   3. c. Variable cost and contribution margin of the next best alternative.
   4. d. Variable cost of current production and the contribution margin of the next best alternative.
4. 12-19. KEEP OR DROP A BUSINESS SEGMENT. Lees Corp. is deciding whether to keep or drop a small segment of its business. Key information regarding the segment include:
5. Contribution margin: 35,000
6.  Avoidable fixed costs: 30,000 
7.  Unavoidable fixed costs: 25,000 
8. Given the information above, Lees should
   1. a. Drop the segment because the contribution margin is less than total fixed costs.
   2. b. Drop the segment because avoidable fixed costs exceed unavoidable fixed costs.
   3. c. Keep the segment because the contribution margin exceeds avoidable fixed costs.
   4. d. Keep the segment because the contribution margin exceeds unavoidable fixed costs.
9. 12-20. RELEVANT COSTS. Ace Cleaning Service is considering expanding into one or more new market areas. Which costs are relevant to Ace’s decision on whether to expand?

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Exercises

1. 12-21. DISPOSAL OF ASSETS. Answer the following questions.
   1. 1. A company has an inventory of 1,250 assorted parts for a line of missiles that has been discontinued. The inventory cost is $72,000. The parts can be either (a) remachined at total additional costs of $28,000 and then sold for $33,500 or (b) sold as scrap for $3,500. Which action is more profitable? Show your calculations.
   2. 2. A truck, costing $103,500 and uninsured, is wrecked its first day in use. It can be either (a) disposed of for $16,500 cash and replaced with a similar truck costing $102,000 or (b) rebuilt for $84,000 and thus be brand-new as far as operating characteristics and looks are concerned. Which action is less costly? Show your calculations.
2. 12-22. RELEVANT AND IRRELEVANT COSTS. Answer the following questions.
   1. 1. Davanit Computers makes 5,600 units of a circuit board, CB76, at a cost of $200 each. Variable cost per unit is $160 and fixed cost per unit is $40. Peach Electronics offers to supply 5,600 units of CB76 for $180. If Davanit buys from Peach, it will be able to save $15 per unit in fixed costs but continue to incur the remaining $25 per unit. Should Davanit accept Peach’s offer? Explain.
   2. 2. LF Manufacturing is deciding whether to keep or replace an old machine. It obtains the following information:

1. LF Manufacturing uses straight-line depreciation. Ignore the time value of money and income taxes. Should LF Manufacturing replace the old machine? Explain.
2. 12-23. MULTIPLE CHOICE. (CPA) Choose the best answer.
   1. 1. The Fresno Company manufactures slippers and sells them at $13 a pair. Variable manufacturing cost is $6.50 a pair, and allocated fixed manufacturing cost is $2.00 a pair. It has enough idle capacity available to accept a one-time-only special order of 5,000 pairs of slippers at $8.50 a pair. Fresno will not incur any marketing costs as a result of the special order. What would the effect on operating income be if the special order could be accepted without affecting normal sales: (a) $0, (b) $10,000 increase, (c) $32,500 increase, or (d) $42,500 increase? Show your calculations.
   2. 2. The Portland Company manufactures Part No. 498 for use in its production line. The manufacturing cost per unit for 20,000 units of Part No. 498 is as follows:

1. The Counter Company has offered to sell 20,000 units of Part No. 498 to Portland for $58 per unit. Portland will make the decision to buy the part from Counter if there is an overall savings of at least $20,000 for Portland. If Portland accepts Counter’s offer, $5 per unit of the fixed manufacturing overhead allocated would be eliminated. Furthermore, Portland has determined that the released facilities could be used to save relevant costs in the manufacture of Part No. 575. For Portland to achieve an overall savings of $20,000, the amount of relevant costs that would have to be saved by using the released facilities in the manufacture of Part No. 575 would be which of the following: (a) $100,000, (b) $220,000, (c) $20,000, or (d) $300,000? Show your calculations. What other factors might Portland consider before outsourcing to Counter?
2. 12-24. SPECIAL ORDER, ACTIVITY-BASED COSTING. (CMA, adapted) The Reward One Company manufactures windows. Its manufacturing plant has the capacity to produce 12,000 windows each month. Current production and sales are 10,000 windows per month. The company normally charges $250 per window. Cost information for the current activity level is as follows:

1. Reward One has just received a special one-time-only order for 2,000 windows at $225 per window. Accepting the special order would not affect the company’s regular business or its fixed costs. Reward One makes windows for its existing customers in batch sizes of 100 windows $(100\hspace{0.17em}\text{batches}\times 100\hspace{0.17em}\text{windows\ per\ batch}=\text{10,000}\hspace{0.17em}\text{windows})$. The special order requires Reward One to make the windows in 25 batches of 80 windows.
   1. Required
   2. 1. Should Reward One accept this special order? Show your calculations.
   3. 2. Suppose plant capacity were only 11,000 windows instead of 12,000 windows each month. The special order must either be taken in full or be rejected completely. Should Reward One accept the special order? Show your calculations.
   4. 3. As in requirement 1, assume that monthly capacity is 12,000 windows. Reward One is concerned that if it accepts the special order, its existing customers will immediately demand a price discount of $20 in the month in which the special order is being filled. They would argue that Reward One’s capacity costs are now being spread over more units and that existing customers should get the benefit of these lower costs. Should Reward One accept the special order under these conditions? Show your calculations.
2. 12-25. MAKE VERSUS BUY, ACTIVITY-BASED COSTING. 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 2020 and the expected costs in 2021:

1. Svenson manufactured 8,000 CMCBs in 2020 in 40 batches of 200 each. In 2021, Svenson anticipates needing 10,000 CMCBs. The CMCBs would be produced in 80 batches of 125 each.
2. The Minton Corporation has approached Svenson about supplying CMCBs to Svenson in 2021 at $300 per CMCB on whatever delivery schedule Svenson wants.
   1. Required
   2. 1. Calculate the total expected manufacturing cost per unit of making CMCBs in 2021.
   3. 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? Show your calculations.
   4. 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:

1. On the basis of financial considerations alone, should Svenson make CMCBs or buy them from Minton? Show your calculations.
2. 12-26. INVENTORY DECISION, OPPORTUNITY COSTS. Ever Lawn, a manufacturer of lawn mowers, predicts that it will purchase 228,000 spark plugs next year. Ever Lawn estimates that 19,000 spark plugs will be required each month. A supplier quotes a price of $7 per spark plug. The supplier also offers a special discount option: If all 228,000 spark plugs are purchased at the start of the year, a discount of 4% off the $7 price will be given. Ever Lawn can invest its cash at 10% per year. It costs Ever Lawn $210 to place each purchase order.
   1. Required
   2. 1. What is the opportunity cost of interest forgone from purchasing all 228,000 units at the start of the year instead of in 12 monthly purchases of 19,000 units per order?
   3. 2. Would this opportunity cost be recorded in the accounting system? Why?
   4. 3. Should Ever Lawn purchase 228,000 units at the start of the year or 19,000 units each month? Show your calculations.
   5. 4. What other factors should Ever Lawn consider when making its decision?
3. 12-27.  RELEVANT COSTS, CONTRIBUTION MARGIN, PRODUCT EMPHASIS. The Seashore Stand is a take-out food store at a popular beach resort. Cindy Smith, owner of the Seashore Stand, is deciding how much refrigerator space to devote to four different drinks. Pertinent data on these four drinks are as follows:

1. Smith 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. Required
   2. 1. Calculate the contribution margin per case of each type of drink.
   3. 2. A coworker of Smith’s recommends that she maximize the shelf space devoted to those drinks with the highest contribution margin per case. Do you agree with this recommendation? Explain briefly.
   4. 3. What shelf-space allocation for the four drinks would you recommend for the Seashore Stand? Show your calculations.
2. 12-28 SELECTION OF MOST PROFITABLE PRODUCT. Planet Fit, Inc., produces two basic types of weight-lifting equipment, Model 9 and Model 14. Pertinent data are as follows:

1. The weight-lifting craze suggests that Planet Fit can sell enough of either Model 9 or Model 14 to keep the plant operating at full capacity. Both products are processed through the same production departments.
2. Required
3. Which product should the company produce? Briefly explain your answer.

1. 12-29. THEORY OF CONSTRAINTS, THROUGHPUT MARGIN, RELEVANT COSTS. The Phoenix Corporation manufactures filing cabinets in two operations: machining and finishing. It provides the following information:

1. Each cabinet sells for $100 and has direct material costs of $70 incurred at the start of the machining operation. Phoenix has no other variable costs. Phoenix can sell whatever output it produces. The following requirements refer only to the preceding data. There is no connection between the requirements.
   1. Required
   2. 1. Phoenix is considering using some modern jigs and tools in the finishing operation that would increase annual finishing output by 1,400 units. The annual cost of these jigs and tools is $40,000. Should Phoenix acquire these tools? Show your calculations.
   3. 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 14,000 units and would cost $22,000 per year. Should Phoenix implement the change? Show your calculations.
   4. 3. An outside contractor offers to do the finishing operation for 18,000 units at $20 per unit, double the $10 per unit that it costs Phoenix to do the finishing in-house. Should Phoenix accept the subcontractor’s offer? Show your calculations.
   5. 4. The Henry Corporation offers to machine 5,600 units at $6 per unit, half the $12 per unit that it costs Phoenix to do the machining in-house. Should Phoenix accept Henry’s offer? Show your calculations.
   6. 5. Phoenix produces 1,800 defective units at the machining operation. What is the cost to Phoenix of the defective items produced? Explain your answer briefly.
   7. 6. Phoenix produces 1,800 defective units at the finishing operation. What is the cost to Phoenix of the defective items produced? Explain your answer briefly.
2. 12-30. CLOSING AND OPENING STORES. Rivera Corporation runs two convenience stores, one in Connecticut and one in Rhode Island. Operating income for each store in 2020 is as follows:

1. The equipment has a zero disposal value. In a senior management meeting, Maria Lopez, the management accountant at Rivera Corporation, makes the following comment: “Rivera can increase its profitability by closing down the Rhode Island store or by adding another store like it.”
   1. Required
   2. 1. By closing down the Rhode Island store, Rivera can reduce overall corporate overhead costs by $46,000. Calculate Rivera’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.
   3. 2. Calculate Rivera’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 $23,000 to acquire equipment with a 1-year useful life and zero disposal value). Opening this store will increase corporate overhead costs by $5,000. Is Maria Lopez’s statement about the effect of adding another store like the Rhode Island store correct? Explain.
2. 12-31. CHOOSING CUSTOMERS. Central Printers operates a printing press with a monthly capacity of 4,000 machine-hours. Central has two main customers: Trent Corporation and Jessica Corporation. Data on each customer for January are:

1. Jessica Corporation indicates that it wants Central to do an additional $180,000 worth of printing jobs during February. These jobs are identical to the existing business Central did for Jessica in January in terms of variable costs and machine-hours required. Central anticipates that the business from Trent Corporation in February will be the same as that in January. Central can choose to accept as much of the Trent and Jessica business for February as its capacity allows. Assume that total machine-hours and fixed costs for February will be the same as in January.
2. Required
3. What action should Central take to maximize its operating income? Show your calculations. What other factors should Central consider before making a decision?
4. 12-32. RELEVANCE OF EQUIPMENT COSTS. Janet’s Bakery is thinking about replacing the convection oven with a new, more energy-efficient model. Information related to the old and new ovens follows:

1. Ignore the effect of income taxes and the time value of money.
   1. Required
   2. 1. Which of the costs and benefits above are relevant to the decision to replace the oven?
   3. 2. What information is irrelevant? Why is it irrelevant?
   4. 3. Should Janet’s Bakery purchase the new oven? Provide support for your answer.
   5. 4. Is there any conflict between the decision model and the incentives of the manager who has purchased the “old” oven and is considering replacing it only 2 years later?
   6. 5. At what purchase price would Janet’s Bakery be indifferent between purchasing the new oven and continuing to use the old oven?
2. 12-33. EQUIPMENT UPGRADE VERSUS REPLACEMENT. (A. Spero, adapted) The TechGuide Company produces and sells 7,500 modular computer desks per year at a selling price of $750 each. Its current production equipment, purchased for $1,800,000 and with a 5-year useful life, is only 2 years old. It has a terminal disposal value of $0 and is depreciated on a straight-line basis. The equipment has a current disposal price of $450,000. However, the emergence of a new molding technology has led TechGuide to consider either upgrading or replacing the production equipment. The following table presents data for the two alternatives:

1. All equipment costs will continue to be depreciated on a straight-line basis. For simplicity, ignore income taxes and the time value of money.
   1. Required
   2. 1. Should TechGuide upgrade its production line or replace it? Show your calculations.
   3. 2. Now suppose the one-time equipment cost to replace the production equipment is somewhat negotiable. All other data are as given previously. What is the maximum one-time equipment cost that TechGuide would be willing to pay to replace rather than upgrade the old equipment?
   4. 3. Assume that the capital expenditures to replace and upgrade the production equipment are as given in the original exercise, but that the production and sales quantity is not known. For what production and sales quantity would TechGuide (a) upgrade the equipment or (b) replace the equipment?
   5. 4. Assume that all data are as given in the original exercise. Dan Doria is TechGuide’s manager, and his bonus is based on operating income. Because he is likely to relocate after about a year, his current bonus is his primary concern. Which alternative would Doria choose? Explain.

Problems

1. 12-34. SPECIAL ORDER, SHORT-RUN PRICING. Diamond Corporation produces baseball bats for kids that it sells for $37 each. At capacity, the company can produce 54,000 bats a year. The costs of producing and selling 54,000 bats are as follows:

1. Required

1. Suppose Diamond is currently producing and selling 44,000 bats. At this level of production and sales, its fixed costs are the same as given in the preceding table. Home Run Corporation wants to place a one-time special order for 10,000 bats at $21 each. Diamond will incur no variable selling costs for this special order. Should Diamond accept this one-time special order? Show your calculations.

2. Now suppose Diamond is currently producing and selling 54,000 bats. If Diamond accepts Home Run’s offer, it will have to sell 10,000 fewer bats to its regular customers. (a) On financial considerations alone, should Diamond accept this one-time special order? Show your calculations. (b) On financial considerations alone, at what price would Diamond be indifferent between accepting the special order and continuing to sell to its regular customers at $37 per bat. (c) What other factors should Diamond consider in deciding whether to accept the one-time special order?

1. 12-35.  SHORT-RUN PRICING, CAPACITY CONSTRAINTS. Jersey Acres Dairy, maker of specialty cheeses, produces a soft cheese from the milk of Friesian cows raised on a special corn-based diet. One kilogram of soft cheese, which has a contribution margin of $8, requires 4 liters of milk. A well-known gourmet restaurant has asked Jersey Acres to produce 2,000 kilograms of a hard cheese from the same milk of Friesian cows. Knowing that the dairy has sufficient unused capacity, Ellen Pavotti, owner of Jersey Acres, calculates the costs of making one kilogram of the desired hard cheese:

Required

1. Suppose Jersey Acres can acquire all the Friesian milk that it needs. What is the minimum price per kilogram the company should charge for the hard cheese?

2. Now suppose that the Friesian milk is in short supply. Every kilogram of hard cheese Jersey Acres produces will reduce the quantity of soft cheese that it can make and sell. What is the minimum price per kilogram the company should charge to produce the hard cheese?

1. 12-36.  INTERNATIONAL OUTSOURCING. Riverside Clippers Corp manufactures garden tools in a factory in Taneytown, Maryland. Recently, the company designed a collection of tools for professional use rather than consumer use. Management needs to make a good decision about whether to produce this line in their existing space in Maryland, where space is available or to accept an offer from a manufacturer in Taiwan. Data concerning the decision are as follows:

1. Required

1. Should Riverside Clippers Corp manufacture the 800,000 garden tools in the Maryland facility or purchase them from the supplier in Taiwan? Explain.

2. Riverside Clippers Corp believes that the U.S. dollar may weaken in the coming months against the New Taiwanese Dollar and does not want to face any currency risk. Assume that Riverside Clippers Corp can enter into a forward contract today to purchase 175 NTD for $5.35. Should Riverside Clippers Corp manufacture the 800,000 garden tools in the Maryland facility or purchase them from the Taiwan supplier? Explain.

3. What are some of the qualitative factors that Riverside Clippers Corp should consider when deciding whether to outsource the garden tools manufacturing to Taiwan?

1. 12-37. RELEVANT COSTS, OPPORTUNITY COSTS. Mitch McCalister, the general manager of Time Sprint, must decide when to release the new version of Time Sprint’s fitness watch, TS-12. Development of TS-12 is complete, but the product has not yet been produced. The product can be shipped starting July 1, 2020.
2. The major problem is that Time Sprint has overstocked the previous version of its fitness watch, TS-11. McCalister knows that once TS-12 is introduced, Time Sprint will not be able to sell any more units of TS-11. Rather than just throwing away the inventory of TS-11, McCalister is wondering whether it might be better to continue to sell TS-11 for the next 3 months and introduce TS-12 on October 1, 2020, when the inventory of TS-11 will be sold out.
3. The following information is available:

1. Development cost per unit for each product equals the total costs of developing the watch divided by the anticipated unit sales over the life of the product. Marketing and administrative costs are fixed costs in 2020, incurred to support all marketing and administrative activities of Time Sprint and are allocated to products on the basis of the budgeted revenues of each product. The preceding unit costs assume TS-12 will be introduced on October 1, 2020.
   1. Required
   2. 1. On the basis of financial considerations alone, should McCalister introduce TS-12 on July 1, 2020, or wait until October 1, 2020? Show your calculations, clearly identifying relevant and irrelevant revenues and costs.
   3. 2. What other factors might McCalister consider in making a decision?
2. 12-38. OPPORTUNITY COSTS AND RELEVANT COSTS. Sandy’s Paint Shop paints exterior surfaces for commercial and residential customers. It charges $175 per hour for a crew of painters. For March 2020, Sandy expects the crew to operate at 80% of capacity, 160 hours of the 200 hours available that month.
3. Operating income for March 2020 is anticipated to be as follows:

1. Jenny’s Pizza has approached Sandy to paint its storefronts for $150 per hour. The job needs to be done in March 2020 and is expected to take 60 hours of the crew time. It is not expected to change fixed painting costs. There are no marketing or additional administrative costs associated with the Jenny job. Sandy must either take the entire job or none of it.
   1. Required
   2. 1. Should Sandy’s Paint Shop accept the special order? Show your calculations.
   3. 2. Perry’s Paint Shop has offered to provide paint and a crew to Sandy for $125 per hour if she needs help in March 2020. Should Sandy (a) accept the special order and reject Perry’s offer, (b) accept the special order and accept Perry’s offer or (c) reject the special order. Show your calculations.
   4. 3. What other factors should Sandy consider in choosing among the three alternatives in requirement 2?
2. 12-39. OPPORTUNITY COSTS. (H. Schaefer, adapted) The Wild Orchid Corporation is working at full production capacity producing 13,000 units of a unique product, Everlast. Manufacturing cost per unit for Everlast is as follows:

1. Manufacturing overhead cost per unit is based on variable cost per unit of $8 and fixed costs of $78,000 (at full capacity of 13,000 units). Marketing cost per unit, all variable, is $4, and the selling price is $52.
2. 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 Stronglast and share half of the marketing cost per unit.
   1. Required
   2. 1. What is the opportunity cost to Wild Orchid of producing the 3,500 units of Stronglast? (Assume that no overtime is worked.)
   3. 2. 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. Chesapeake would charge Wild Orchid $36 per unit to manufacture Everlast. On the basis of financial considerations alone, should Wild Orchid accept the Chesapeake offer? Show your calculations.
   4. 3. Suppose Wild Orchid had been working at less than full capacity, producing 9,500 units of Everlast, at the time the Apex offer was made. Calculate the minimum price Wild Orchid should accept for Stronglast under these conditions. (Ignore the previous $40 selling price.)
3. 12-40. MAKE OR BUY, UNKNOWN LEVEL OF VOLUME. (A. Atkinson, adapted) Denver Engineering manufactures small engines that it sells to manufacturers who install them in products such as lawn mowers. The company currently manufactures all the parts used in these engines but is considering a proposal from an external supplier who wishes to supply the starter assemblies used in these engines.
4. The starter assemblies are currently manufactured in Division 3 of Denver Engineering. The costs relating to the starter assemblies for the past 12 months were as follows:

1. Over the past year, Division 3 manufactured 150,000 starter assemblies. The average cost for each starter assembly is $\mathrm{\$10\hspace{0.17em}}(\mathrm{\$}\text{1,500,000}÷\text{150,000})\mathrm{.}$ 
2. Further analysis of manufacturing overhead revealed the following information. Of the total manufacturing overhead, only 25% is considered variable. Of the fixed portion, $300,000 is an allocation of general overhead that will remain unchanged for the company as a whole if production of the starter assemblies is discontinued. A further $200,000 of the fixed overhead is avoidable if production of the starter assemblies is discontinued. The balance of the current fixed overhead, $100,000, is the division manager’s salary. If Denver Engineering discontinues production of the starter assemblies, the manager of Division 3 will be transferred to Division 2 at the same salary. This move will allow the company to save the $80,000 salary that would otherwise be paid to attract an outsider to this position.
   1. Required
   2. 1. Tutwiler Electronics, a reliable supplier, has offered to supply starter-assembly units at $8 per unit. Because this price is less than the current average cost of $10 per unit, the vice president of manufacturing is eager to accept this offer. On the basis of financial considerations alone, should Denver Engineering accept the outside offer? Show your calculations. (HINT: Production output in the coming year may be different from production output in the past year.)
   3. 2. How, if at all, would your response to requirement 1 change if the company could use the vacated plant space for storage and, in so doing, avoid $100,000 of outside storage charges currently incurred? Why is this information relevant or irrelevant?
3. 12-41. MAKE VERSUS BUY, ACTIVITY-BASED COSTING, OPPORTUNITY COSTS. The Allen Company produces chairs. This year’s expected production is 30,000 units. Currently, Allen makes the upholstery for the chairs in its factory. Allen’s management accountant reports the following costs for the upholstery for the 30,000 chairs:

1. Allen has received an offer from an outside vendor to supply the upholstery for the chairs Allen requires at $23 per chair.
   1. Required
   2. 1. Assume that if the outside vendor supplies the upholstery, the facility where the upholstery is currently made will remain idle. On the basis of financial considerations alone, should Allen accept the outside vendor’s offer at the anticipated volume of 30,000 chairs? Show your calculations.
   3. 2. For this question, assume that if the upholstery is purchased outside, the available unused facilities will be used to make pillows to match the chairs. Each pillow sells for $25 with a variable cost of $15. No other costs would change and the company expects to sell 10,000 pillows. On the basis of financial considerations alone, should Allen make or buy the upholstery for their chairs, assuming that 30,000 chairs are produced (and sold)? Show your calculations.
   4. 3. The sales manager at Allen is concerned that the estimate of 30,000 chairs may be high and believes that only 24,000 chairs will be sold. Production will be cut back, freeing up work space. This space can be used to make 10,000 pillows whether Allen buys the upholstery or makes it in-house. On the basis of financial considerations alone, should Allen purchase the upholstery from the outside vendor? Show your calculations.
2. 12-42. PRODUCT MIX, CONSTRAINED RESOURCE. Wechsler Company produces three products: A130, B324, and C587. All three products use the same direct material, Brac. Unit data for the three products are as follows: 

1. The demand for the products far exceeds the direct materials available to produce the products. Brac costs $9 per pound, and a maximum of 5,000 pounds is available each month. Wechsler must produce a minimum of 200 units of each product. 
   1. Required
   2. 1. How many units of product A130, B324, and C587 should Wechsler produce?
   3. 2. What is the maximum amount Wechsler would be willing to pay for another 1,200 pounds of Brac?
2. 12-43. PRODUCT MIX, SPECIAL ORDER. (N. Melumad, adapted) Gormley Precision Tools makes cutting tools for metalworking operations. It makes two types of tools: A6, a regular cutting tool, and EX4, a high-precision cutting tool. A6 is manufactured on a regular machine, but EX4 must be manufactured on both the regular machine and a high-precision machine. The following information is available: 

1. Additional information includes the following:
   1. a. Gormley faces a capacity constraint on the regular machine of 50,000 hours per year.
   2. b. The capacity of the high-precision machine is not a constraint.
   3. c. Of the $1,100,000 budgeted fixed overhead costs of EX4, $600,000 are lease payments for the high-precision machine. This cost is charged entirely to EX4 because Gormley uses the machine exclusively to produce EX4. The company can cancel the lease agreement for the high-precision machine at any time without penalties.
   4. d. All other overhead costs are fixed and cannot be changed.
   5. Required
   6. 1. What product mix—that is, how many units of A6 and EX4—will maximize Gormley’s operating income? Show your calculations.
   7. 2. Suppose Gormley can increase the annual capacity of its regular machines by 15,000 machine-hours at a cost of $300,000. Should Gormley increase the capacity of the regular machines by 15,000 machine-hours? By how much will Gormley’s operating income increase or decrease? Show your calculations.
   8. 3. Suppose that the capacity of the regular machines has been increased to 65,000 hours. Gormley has been approached by Clark Corporation to supply 20,000 units of another cutting tool, V2, for $240 per unit. Gormley must either accept the order for all 20,000 units or reject it totally. V2 is exactly like A6 except that its variable manufacturing cost is $130 per unit. (It takes 1 hour to produce one unit of V2 on the regular machine, and variable marketing cost equals $20 per unit.) What product mix should Gormley choose to maximize operating income? Show your calculations.
2. 12-44. THEORY OF CONSTRAINTS, THROUGHPUT MARGIN, AND RELEVANT COSTS. Washington Industries manufactures electronic testing equipment. Washington also installs the equipment at customers’ sites and ensures that it functions smoothly. Additional information on the manufacturing and installation departments is as follows (capacities are expressed in terms of the number of units of electronic testing equipment):

1. Washington manufactures only 250 units per year because the installation department has only enough capacity to install 250 units. The equipment sells for $55,000 per unit (installed) and has direct material costs of $30,000. All costs other than direct material costs are fixed. The following requirements refer only to the preceding data. There is no connection between the requirements.
   1. Required
   2. 1. Washington’s engineers have found a way to reduce equipment manufacturing time. The new method would cost an additional $500 per unit and would allow Washington to manufacture 30 additional units a year. Should Washington implement the new method? Show your calculations.
   3. 2. Washington’s designers have proposed a change in direct materials that would increase direct material costs by $2,000 per unit. This change would enable Washington to install 285 units of equipment each year. If Washington makes the change, it will implement the new design on all equipment sold. Should Washington use the new design? Show your calculations.
   4. 3. A new installation technique has been developed that will enable Washington’s engineers to install seven additional units of equipment a year. The new method will increase installation costs by $145,000 each year. Should Washington implement the new technique? Show your calculations.
   5. 4. Washington is considering how to motivate workers to improve their productivity (output per hour). One proposal is to evaluate and compensate workers in the manufacturing and installation departments on the basis of their productivities. Do you think the new proposal is a good idea? Explain briefly.
2. 12-45.  THEORY OF CONSTRAINTS, CONTRIBUTION MARGIN, SENSITIVITY ANALYSIS. Mpharm Industries manufactures pharmaceutical products in two departments: mixing and tablet-making. Additional monthly information on the two departments follows. Each tablet contains 0.5 gram of direct materials.

1. The mixing department makes 200,000 grams of direct materials mixture (enough to make 400,000 tablets) because the tablet-making department has only enough capacity to process 400,000 tablets. All direct material costs of $156,000 are incurred in the mixing department. The tablet-making department manufactures only 390,000 tablets from the 200,000 grams of mixture processed; 2.5% of the direct materials mixture is lost in the tablet-making process. Each tablet sells for $1. All costs other than direct material costs are fixed costs. The following requirements refer only to the preceding data. There is no connection between the requirements.
   1. Required
   2. 1. An outside contractor makes the following offer: If Mpharm will supply the contractor with 10,000 grams of mixture, the contractor will manufacture 19,500 tablets for Mpharm (allowing for the normal 2.5% loss of the mixture during the tablet-making process) at $0.12 per tablet. Should Mpharm accept the contractor’s offer? Show your calculations.
   3. 2. Another company offers to prepare 20,000 grams of mixture a month from direct materials Mpharm supplies. The company will charge $0.07 per gram of mixture. Should Mpharm accept the company’s offer? Show your calculations.
   4. 3. Mpharm’s engineers have devised a method that would improve quality in the tablet-making department. They estimate that the 10,000 tablets currently being lost would be saved. The modification would cost $7,000 a month. Should Mpharm implement the new method? Show your calculations.
   5. 4. Suppose that Mpharm also loses 10,000 grams of mixture in its mixing department. These losses can be reduced to zero if the company is willing to spend $9,000 per month in quality-improvement methods. Should Mpharm adopt the quality-improvement method? Show your calculations.
   6. 5. What are the benefits of improving quality in the mixing department compared with improving quality in the tablet-making department?
2. 12-46. CLOSING DOWN DIVISIONS. Ainsley Corporation has four operating divisions. The budgeted revenues and expenses for each division for 2020 follow:

1. Further analysis of costs reveals the following percentages of variable costs in each division:

1. Closing down any division would result in savings of 40% of the fixed costs of that division.
2. Top management is very concerned about the unprofitable divisions (A and B) and is considering closing them for the year.
   1. Required
   2. 1. Calculate the increase or decrease in operating income if Ainsley closes division A.
   3. 2. Calculate the increase or decrease in operating income if Ainsley closes division B.
   4. 3. What other factors should the top management of Ainsley consider before making a decision?
3. 12-47. DROPPING A PRODUCT LINE, SELLING MORE TOURS. Norman City Tour, offers two types of guided tours, basic and deluxe. Operating income for each tour type in 2020 follows:

1. The equipment has a zero disposal value. Guide wages, supplies, and vehicle fuel are variable costs with respect to the number of tours. Administrative salaries are fixed costs with respect to the number of tours. Brad Barrett, Norman City Tour’s president, is concerned about the losses incurred on the deluxe tours. He is considering dropping the deluxe tour and offering only the basic tour.
   1. Required
   2. 1. If the deluxe tours are discontinued, one administrative position could be eliminated, saving the company $50,000. Assuming no change in the sales of basic tours, what effect would dropping the deluxe tour have on the company’s operating income?
   3. 2. Refer back to the original data. If Norman City Tour drops the deluxe tours, Barrett estimates that sales of basic tours would increase by 50%. He believes that he could still eliminate the $50,000 administrative position. Equipment currently used for the deluxe tours would be used by the additional basic tours. Should Barrett drop the deluxe tour? Explain.
   4. 3. What additional factors should Barrett consider before dropping the deluxe tours?
2. 12-48. OPTIMAL PRODUCT MIX. (CMA adapted) Della Simpson, Inc., sells two popular brands of cookies: Della’s Delight and Bonny’s Bourbon. Della’s Delight goes through the mixing and baking departments, and Bonny’s Bourbon, a filled cookie, goes through the mixing, filling, and baking departments.
3. Michael Shirra, vice president for sales, believes that at the current price, Della Simpson can sell all of its daily production of Della’s Delight and Bonny’s Bourbon. Both cookies are made in batches of 3,000. In each department, the time required per batch and the total time available each day are as follows:

1. Revenue and cost data for each type of cookie are as follows:

1. Required

1. Using D to represent the batches of Della’s Delight and B to represent the batches of Bonny’s Bourbon made and sold each day, formulate Shirra’s decision as an LP model.

2. Compute the optimal number of batches of each type of cookie that Della Simpson, Inc., should make and sell each day to maximize operating income.

1. 12-49. DROPPING A CUSTOMER, ACTIVITY-BASED COSTING, ETHICS. Justin Anders is the management accountant for Carey Restaurant Supply (CRS). Sara Brinkley, the CRS sales manager, and Justin are meeting to discuss the profitability of one of the customers, Donnelly’s Pizza. Justin hands Sara the following analysis of Donnelly’s activity during the last quarter, taken from CRS’s activity-based costing system:

1. Sara looks at the report and remarks, “I’m glad to see all my hard work is paying off with Donnelly’s. Sales have gone up 10% over the previous quarter!”
2. Justin replies, “Increased sales are great, but I’m worried about Donnelly’s margin, Sara. We were showing a profit with Donnelly’s at the lower sales level, but now we’re showing a loss. Gross margin percentage this quarter was 40%, down five percentage points from the prior quarter. I’m afraid that corporate will push hard to drop them as a customer if things don’t turn around.”
3. “That’s crazy,” Sara responds. “A lot of that overhead for things like order processing, deliveries, and sales calls would just be allocated to other customers if we dropped Donnelly’s. This report makes it look like we’re losing money on Donnelly’s when we’re not. In any case, I am sure you can do something to make its profitability look closer to what we think it is. No one doubts that Donnelly’s is a very good customer.”
   1. Required
   2. 1. Assume that Sara is partly correct in her assessment of the report. Upon further investigation, it is determined that 10% of the order processing costs and 20% of the delivery costs would not be avoidable if CRS were to drop Donnelly’s. Would CRS benefit from dropping Donnelly’s? Show your calculations.
   3. 2. Sara’s bonus is based on meeting sales targets. Based on the preceding information regarding gross margin percentage, what might Sara have done last quarter to meet her target and receive her bonus? How might CRS revise its bonus system to address this?
   4. 3. Should Justin rework the numbers? How should he respond to Sara’s comments about making Donnelly’s look more profitable?
4. 12-50. EQUIPMENT REPLACEMENT DECISIONS AND PERFORMANCE EVALUATION. Susan Smith manages the Wexford plant of Sanchez Manufacturing. A representative of Darnell Engineering approaches Smith about replacing a large piece of manufacturing equipment that Sanchez uses in its process with a more efficient model. While the representative made some compelling arguments in favor of replacing the 3-year-old equipment, Smith is hesitant. Smith is hoping to be promoted next year to manager of the larger Detroit plant, and she knows that the accrual-basis net operating income of the Wexford plant will be evaluated closely as part of the promotion decision. The following information is available concerning the equipment-replacement decision:

1. Sanchez uses straight-line depreciation on all equipment. Annual depreciation expense for the old machine is $180,000 and will be $270,000 on the new machine if it is acquired. For simplicity, ignore income taxes and the time value of money.
   1. Required
   2. 1. Assume that Smith’s priority is to receive the promotion and she makes the equipment-replacement decision based on the next 1-year’s accrual-based operating income. Which alternative would she choose? Show your calculations.
   3. 2. What are the relevant factors in the decision? Which alternative is in the best interest of the company over the next 2 years? Show your calculations.
   4. 3. At what cost would Smith be willing to purchase the new equipment? Explain.