Quiz 2: The Nature of Costs
Business
Q 1Q 1
Old Turkey Mash
Old Turkey Mash is a whiskey manufactured by distilling grains and corn and then aging the mixture for five years in 50-gallon oak barrels. Distilling requires about a week and aging takes place in carefully controlled warehouses. Before it ages, the whiskey is too bitter to be consumed. Aging mellows the brew (and ultimately the consumer). The cost of the product prior to aging is $100 per barrel (direct plus indirect costs of distilling). In the aging process, each barrel must be inspected monthly and any leaks repaired. Every six months the barrels are rotated and sampled for quality. Costs of direct labor and materials in the aging process (excluding the cost of oak barrels) amount to $50 per barrel per year (all variable). As the whiskey ages, evaporation and leakage cause each 50-gallon barrel to produce only 40 gallons of bottled whiskey. New oak barrels cost $75 each and cannot be reused. After aging, they are cut in half and sold for flowerpots. The revenues generated from sales of the pots just cover the costs of disposing of the used barrels. As soon as the whiskey is aged five years, it is bottled and sold to wholesalers.
While domestic consumption of whiskey is falling, an aggressive international marketing campaign has opened up new international markets. The firm is in the third year of a five-year campaign to double production. Because it takes five years to increase production (an additional barrel of mash produced today does not emerge from the aging process for five years), the firm is adding 100,000 gallons of distilled product each year. Prior to the expansion, 500,000 distilled gallons were produced each year. Distilled output is being increased 100,000 gallons a year for five years until it reaches 1 million gallons. Distilled output is currently 800,000 gallons and is projected to rise to 900,000 gallons next year. The accompanying table describes production, sales, and inventory in the aging process.
Management is quite concerned about the loss that is projected for the third year of the expansion (the current year). The president has scheduled a meeting with the local bank to review the firm's current financial performance. This bank has been lending the firm the capital to finance the production expansion.
Required:
a. Instead of writing off all the warehousing and oak barrel costs, prepare revised income statements for years 1 through 3, treating the warehousing and barrel costs as product costs.
b. Which set of income statements (those given or the ones you prepared) should the president show the bank at the meeting? Justify your answer.
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Essay
Revenue:
It is the amount of receipts generated from the sale of products or services rendered by the company to its customers. It is shown as the sales or service revenue of the company. Various accounting standards have been formed by the authorities for appropriate determination of the amount of revenue.Manufacturing Costs
These are the costs that are incurred up to the stage of final output. It includes the cost of materials, labor, variable and fixed overheads that are incurred in the factory. It does not include the financing cost or selling cost or the administration costs. This is the cost of the product at the point when the product is manufactured in all respects.
a.In the present case, the income statement has been given in which the barrel cost and the warehousing costs are taken as a period cost. It is required to prepare a different set of income statement considering the
Prepare the income statement for three years using MS Excel as follows:
The result of above is as follows:
b.It is observed from the given income statements and the statements prepared above that when the warehousing expenses and barrel costs are taken as a period cost the income statement shows lower profits and loss in the third year but when they are taken as product cost the income statements shows the profit.
It is obvious that the management would like to show the statement which shows higher profits so as to be eligible for more credit from the bank. However, whether this thing will work or not depends upon the banker's point of view. Further, the taxation effect of this change in treatments and the outflow of cash also affects the position.
It is suggested that whether it is legal to keep two sets of the book. If not then the second one should not be even prepared. If it is allowed then both the statements should be made available to the bankers so that they may know the true position of the company's worth and take the decision accordingly.
Q 2Q 2
Darien Industries
Darien Industries operates a cafeteria for its employees. The operation of the cafeteria requires fixed costs of $4,700 per month and variable costs of 40 percent of sales. Cafeteria sales are currently averaging $12,000 per month.
Darien has an opportunity to replace the cafeteria with vending machines. Gross customer spending at the vending machines is estimated to be 40 percent greater than current sales because the machines are available at all hours. By replacing the cafeteria with vending machines, Darien would receive 16 percent of the gross customer spending and avoid all cafeteria costs. How much does monthly operating income change if Darien Industries replaces the cafeteria with vending machines?
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Variable and Fixed Cost
There are two components to the cost of a product from the point of the manufacturer. One is the fixed cost which remains fixed at any level of sales and one is the variable cost which is directly propionate to the level of sales.
If the quantity increases variable cost increases and quantity decreases the variable cost also decreases. Variable costs are relevant cost and fixed cost are irrelevant costs.
The sales from the cafeteria are $12,000 of which 40% is the variable cost. The fixed cost amounts to $4,700. If the vending machine is installed than the company will receive 16% of the sale and there will not be any cost.
Calculate the increase in income due to the installation of vending machines using below equation as follows:
Hence the increase in income is $188.
Calculate the operating income from the cafeteria using the below equation as follows:
Hence the income from the cafeteria is $2,500.
Calculate the income from a vending machine using below equation as follows:
Hence the income from using the vending machine is $2,688.
Q 3Q 3
Montana Pen Company
Montana Pen Company manufactures a full line of premium writing instruments. It has 12 different styles, and within each style, it offers ball point pens, fountain pens, mechanical pencils, and a roller ball pen. Most models also come in three finishes-gold, silver, and black matte. Montana Pen's Bangkok, Thailand, plant manufactures four of the styles. The plant is currently producing the gold clip for the top of one of its pen styles, no. 872. Current production is 1,200 gold no. 872 pens each month at an average cost of 185 baht per gold clip. (One U.S. dollar currently buys 32 baht.)
A Chinese manufacturer has offered to produce the same gold clip for 136 baht. This manufacturer will sell Montana Pen 400 clips per month. If it accepts the Chinese offer and cuts the production of the clips from 1,200 to 800, Montana Pen estimates that the cost of each clip it continues to produce will rise from 185 baht to 212.5 baht per gold clip.
Required:
a. Should Montana Pen outsource 400 gold clips for pen style no. 872 to the Chinese firm?
Provide a written justification of your answer.
b. Given your answer in part ( a ), what additional information would you seek before deciding to outsource 400 gold clips per month to the Chinese firm?
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Opportunity Cost:
It is the income foregone which could have earned if the current task has not opted. Since an opportunity of income is forgiven it is termed as opportunity cost. A famous person once said, "no coming of money is equivalent to going of money".
This refers to that the income you have forgiven is now a cost which should be recovered from the adopted task. If it is not recovered then there is ultimately loss of the amount not recovered.Sales:
It refers to any activity which is undertaken by the entity for selling its products or rendering its services in the market in exchange for money. Sales can be made on two bases i.e. cash or credit basis. The amount of sales is shown in the profit and loss account of the entity as the income of such entity.
a.In the present case, the cost savings for the company on annual basis relating to a contract are provided.
IF the company is planning to take upon a financial year of more than one year then it is the core responsibility of the management to look around the costs which are incurred or the costs are planned to be incurred.
The management should also take into the consideration of matter relating to the savings if any possible in terms of that particular cost. In simple words, the management should work on the opportunity costs that are related to the working of the company.
The managerial person should have reconciled the sales figure of the company with the actual data available and also the differences in the cost should also have been verified with proper evidence.
The company must have used the concept of taking the cash flows according to the discounting technique so that the actual data that pertain to costs occurrence over than a year should have been easily verified.
b.(i)
1.
The given item is appropriate.Reason:
The person is not required to pay the cost of these wages in the future period of time.2.
The given item is inappropriate.Reason:
Since the company is planning to take the financial year of more than one year, therefore the supervisor as appointed by the company should continue the job for two years more.3.
The given item is appropriate.Reason:
The given item is appropriate but up-to some extent of the space which is available to be used on rent basis. Otherwise, the cost will become inappropriate because the managerial person is still using the said space.4.
The given item is inappropriate.Reason:
Since the person appointed by the company in the purchase department is on a temporary basis but the person appointed will continue the job for a longer period of time because the company has selected to take the financial year of more than one year.
5.
The given item is appropriate.Reason:
The given amount of savings will be used or realized by the person from the reduction in costs of the order pertaining to the purchases.
6.
The given item is inappropriate.Reason:
The person has taken the costs relating to the freight on the inward basis in the cost of material and the other person has included the costs relating to the delivery of the products in the selling price.
7.
The given item is appropriate.Reason:
The amount of difference occurring to the company in terms of costs which are included in the manufacturing costs and the purchasing of the products should be maintained and taken by the management in the analysis of the person.
8.
The given item is appropriate.Reason:
The person appointed as a junior engineer in the company will also be counted in the staff of the company.
9.
The given item is appropriate.Reason:
The inspector appointed for checking the quality of the products will also be taken as a staff member of the company.
10.
The given item is appropriate.Reason:
The increase in the value of the stock pertaining to the safety purposes will represent some extra burden of the cost to the person.
(ii)
1.
The given amount is correct.
Reason:
The given cost is related to the person appointed as technicians and they will not work for the said in future.
2.
The given amount is incorrect.
Reason:
The given costs will also be incurred by M in future and the amount that will be included in the analysis of W will be computed by subtracting the extra benefits given to the staff from their salary.
3.
The given amount is incorrect.
Reason:
The amount which relates to the space available at outside of the rented area shall be taken into consideration. The cost amount that relates to the plant will still be continued. The cost of the rental space shall be computed by multiplying 1,000 with a rate of $9.50 and the resultant amount comes out to be $9,500.
4.
The given amount is incorrect.
Reason:
There will no benefit to the company in the savings on cost due to the appointment of the clerk in the purchasing department unless and until the appointed clerk brings some additional in the said purchasing department.
5.
The given amount is correct as per the information provided in the question.
6.
The given amount is incorrect.
Reason:
The amount of any extra cost incurred by the person or any savings made that are related to the expense of freight will not be shown in the said item.
7.
The given amount is incorrect.
Reason:
The correct amount shall be $2,975,000. The resultant amount is being computed by multiplying 100,000 with the difference of $60 and $30.25. The amount of $30.25 is the sum total of direct material i.e. $24 and variable overhead i.e. $6.25. The amount of overheads in the nature of fixed will be occurring for the company in the long run.
8.
The given amount is correct as per the information provided in the question.
9.
The given amount is correct as per the information provided in the question.
10.
The given amount is incorrect.
Reason:
Compute the correct amount with the help of MS-Excel as follows:
The result of the above calculation is as follows:
Therefore the correct amount of additional cost comes out to be $4,800.
c.
The person shall consider the below-mentioned information of the other party before making any decision:
1. The actual performance of the company shall be taken into consideration i.e. the financial position and stability of the accounts shall be checked in details.
2. The creditworthiness or rating should be checked.3. The person shall also check the ability of the company for meeting the deliveries on time and providing the best quality products to the customers.
4. The increment that shall be done in future at the prices of the product as manufactured by the company.
5. The level of production shall also be taken into consideration.
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Essay
Q 5Q 5
NPR
In its radio fund-raising campaign, National Public Radio (NPR) stated, "On-air radio membership campaigns are the most cost-effective means we have for raising the funds necessary to bring you the type of programming you expect." NPR is commercial-free, member-supported radio. Most of its operating funds come from private individuals, corporations, and foundations. Twice a year, it interrupts its regularly scheduled programming for fund-raising pledge campaigns where listeners are encouraged to call in and make pledges. Critically evaluate the passage quoted above.
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Q 6Q 6
Silky Smooth Lotions
Silky Smooth lotions come in three sizes: 4, 8, and 12 ounces. The following table summarizes the selling prices and variable costs per case of each lotion size.
Fixed costs are $771,000. Current production and sales are 2,000 cases of 4-ounce bottles; 4,000 cases of 8-ounce bottles; and 1,000 cases of 12-ounce bottles. Silky Smooth typically sells the three lotion sizes in fixed proportions as represented by the preceding sales amounts.
Required:
How many cases of 4-, 8-, and 12-ounce lotion bottles must be produced and sold for Silky Smooth to break even, assuming that the three sizes are sold in fixed proportions?
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Q 7Q 7
P. Max Department Stores
J.P. Max is a department store carrying a large and varied stock of merchandise. Management is considering leasing part of its floor space for $72 per square foot per year to an outside jewelry company that would sell merchandise. Two areas currently in use are being considered: home appliances (1,000 square feet) and televisions (1,200 square feet). These departments had annual profits of $64,000 for appliances and $82,000 for televisions after allocated fixed occupancy costs of $7 per square foot were deducted. Allocated fixed occupancy costs include property taxes, mortgage interest, insurance, and exterior maintenance for the department store.
Required:
Considering all the relevant factors, which department should be leased and why?
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Q 8Q 8
Vintage Cellars
Vintage Cellars manufactures a 1,000-bottle wine storage system that maintains optimum temperature (55-57 °F) and humidity (50-80 percent). The system has a backup battery for power failures and can store red and white wines at different temperatures. The following table depicts how average cost varies with the number of units manufactured and sold (per month):
Required:
a. Prepare a table that computes the total cost and marginal cost for each quantity between 1and 10 units.
b. What is the relation between average cost and marginal cost?
c. What is the opportunity cost of producing one more unit if the company is currently producing and selling four units?
d. Vintage Cellars sells the units for $9,000 each. This price does not vary with the number of units sold. How many units should Vintage manufacture and sell each month?
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Q 9Q 9
ETB
ETB plans to manufacture a slim bamboo hard case for the Apple iPad, which will be sold for $65. ETB estimates that it can produce and sell between 3,000 and 5,000 bamboo cases a month. The following data summarize ETB's cost structure at various output (sales) levels:
Required:
a. What monthly production (sales) level minimizes the average cost of the bamboo iPad case?
b. How many bamboo iPad cases should ETB produce monthly?
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Q 10Q 10
Taylor Chemicals produces a particular chemical at a fixed cost of $1,000 per day. The following table displays how marginal cost varies with output (in cases):
Required:
a. Given the preceding data, construct a table that reports total cost and average cost at various output levels from 1 to 10 cases.
b. At what quantity is average cost minimized?
c. Does marginal cost always intersect average cost at minimum average cost? Why?
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Q 11Q 11
Emrich Processing is a small custom stainless steel parts processor. Customers send new and used stainless steel parts to Emrich for cleaning in various acid baths to remove small imperfections or films on the surface. These parts are used in a variety of applications, ranging from nuclear reactors to chemical and medical applications. Depending on the foreign substance to be removed, Emrich chooses the acid bath mixture and process.
Such chemical cleaning operations require highly skilled technicians to handle the dangerous acids. Environmental Protection Agency (EPA) and Occupational Safety and Health Administration (OSHA) regulations are closely followed. Once the part is treated in the proper chemical bath using other chemicals, a benign waste solution results that can be disposed of via the city sewer system.
On May 12, Emrich ordered a 50-gallon drum of a specialty acid known as GX-100 for use in a May 15 job. It used 25 of the 50 gallons in the drum. The 50 gallons cost $1,000. GX-100 has a shelf life of 30 days after the drum is opened before it becomes unstable and must be discarded. Because of the hazardous nature of GX-100 and the other chemicals Emrich uses, Emrich works closely with Environ Disposal, a company specializing in the disposal of hazardous wastes. At the time of ordering
the GX-100, Emrich anticipated no other orders in the May-June time period that could use the remaining 25 gallons of GX-100. Knowing it would have 25 gallons remaining, it built $1,000 into the cost of the job to cover the cost of the GX-100 plus an additional $400 to cover the cost of having Environ dispose of the remaining 25 gallons.
On June 1, a customer called and asked for a price bid for a rush job to be completed on June 5. This job will use 25 gallons of GX-100. Emrich is preparing to bid on this order. What cost amount for the GX-100 must be considered in preparing the bid? Justify your answer.
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Q 12Q 12
You won a free ticket to see Verdi's Aida opera. The ticket has no resale value, but since you enjoy Verdi operas, you would be willing to pay $30 for the ticket had you not received it for free. Madonna is performing on the same night. There is absolutely nothing else you can do that night other than either attending the Verdi opera or the Madonna concert. Tickets to the Madonna concert cost $160. On any given day, you would be willing to pay up to $200 to see Madonna because you are such a big fan. Assume there are no other costs of seeing either the Verdi opera or Madonna. What is the opportunity cost of attending the Verdi opera?
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Q 13Q 13
Dod Electronics manufactures various RFID (radio-frequency identification) chips for medical device companies. The RFID chips track the location and movement of medical personnel. A nonmedical device company, Xtron Systems, has approached Dod Electronics for a one-time special order of 10,000 RFID chips. The RFID chip that Xtron is seeking to purchase is virtually identical to Dod's existing RFID chip model FQ4503. The Dod manufacturing cell that produces model FQ4503 currently is producing 60,000 FQ4503 chips for medical customers and has excess capacity to run the 10,000 special order without disrupting Dod's regular production/delivery schedule. Xtron will purchase the chips for $38 per chip. If Dod accepts this special order, assume that it will have NO impact on the pricing of Dod's existing FQ4503 contracts/customers. Dod's average cost of producing its current level of 60,000 RFID chips is $35 per chip. Management does not know precisely what it will cost to produce the extra 10,000 chips for Xtron.
Required:
a. Management is very confident that the average cost of FQ4503 chips is falling at their current production level of 60,000. Should Dod accept Xtron's offer to purchase the 10,000 chips for $38 per chip? Explain the logic supporting your answer.
b. Management is very confident that the average cost of FQ4503 chips is rising at their current production level of 60,000. Should Dod accept Xtron's offer to purchase the 10,000 chips for $38 per chip? Explain the logic supporting your answer.
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Q 14Q 14
Gino Potestio, owner of Napoli Pizzeria, is evaluating leasing an espresso/cappuccino machine. A number of patrons have inquired about espresso and cappuccino beverages. Napoli currently does not offer these beverages. Gino believes adding these beverages will increase the demand for his pizzas. A good espresso/cappuccino machine can be leased for $300 month. Each
espresso/cappuccino will sell for $3 and the coffee and milk will average $1 per serving. No additional labor cost is needed because the restaurant staff has enough idle time to prepare and serve the espresso/cappuccino. Gino estimates that the machine will add about $75 of additional pizza profits per month.
Required:
a. How many espresso/cappuccino beverages must Napoli sell to break even?
b. Gino doesn't want to offer espresso/cappuccino beverages unless he makes at least $1,000 per month after taxes including the additional sales of pizzas from adding espresso/cappuccino beverages. Napoli's income tax rate is 35 percent. How many servings of espresso/cappuccino must Gino sell to meet his after tax profit goal?
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Q 15Q 15
JLT Systems sells and installs a firewall program to protect mobile apps from hacking an e-tailer's servers. Each sale and installation requires JLT to incur a variable cost to sell and install the JLT firewall. JLT has a linear cost structure meaning that JLT has a fixed cost each month and a variable cost per sale and installation that does not vary with the number of sales and installs. At 200 sales and installs per month, JLT's average cost is $2,700 per sale and install. JLT incurs fixed costs of $400,000 per month.
Required:
a. What is JLT's variable cost per sale and install?
b. JLT Systems sets the price for its firewall software at the market price of $2,000 per sales and installation. Being a small competitor in this market, JLT is a price taker, and varying the number of JLT sales and installs does not affect the market price of $2,000. JLT Systems wants to show an after-tax profit of $18,000 per month and has an income tax rate of 40 percent. How many sales and installs per month does JLT need to make to achieve its after-tax profit goals?
c. Instead of being a price taker as in part b, now assume that JLT faces the following demand schedule.
(JLT's demand curve is represented by the equation: P = 2600 ? 2Q)
What is JLT Systems' profit maximizing number of sales and installs of its firewall software per month?
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Q 16Q 16
Volume and Profits
Assuming the firm sells everything it produces and assuming that variable cost per unit does not change with volume, total profits are higher as volume increases because fixed costs are spread over more units.
Required:
a. True or false?
b. Explain your answer in part ( a ).
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Q 17Q 17
American Cinema shows first-run movies. It pays the company distributing the movies a fixed fee of $1,000 per week plus a percentage of the gross box office receipts. In the first two weeks a movie is released, the theater pays the fixed fee of $1,000 per week plus 90 percent of gross box office receipts to the distributor. If the theater keeps the movie for weeks 3 and 4, the theater pays the distributor $1,000 per week plus 80 percent of its gross box office receipts received during those two weeks. American Cinema charges $6.50 per ticket for all movies, including those shown for two weeks and those shown for four weeks.
American Cinema must decide what movies to show and for how many weeks to show each movie (either two weeks only or four weeks) before the movie is released. For most movies, the audience demand is higher in the first two weeks than in the next two weeks.
American Cinema is evaluating two similar comedies. The first one, Paris Is for Lovers, is scheduled for release on October 1. The second comedy, I Do, is scheduled for release on October 14. American Cinema has decided to rent Paris Is for Lovers but must decide whether to run it for four weeks or to run it for two weeks and then replace it with I Do. Based on all the information
about the stars in the movie, production costs, and prerelease publicity, management expects the two movies will have the same demand in the first two weeks and will have the same (lower) demand in weeks 3 and 4.
Required:
a. The only movie being released on October 14 is I Do. How should management go about deciding whether to rent Paris for four weeks or to rent it for two weeks and then replace it with I Do ? In other words, provide American Cinema management with a decision-making rule to use in choosing between renting Paris for four weeks or just two weeks. American Cinema's tax rate is zero. Be sure to justify your advice with clearly described analysis.
b. How does your answer in part ( a ) change if American Cinema's income tax rate is 30 percent?
c. American Cinema's average movie patron purchases soda, popcorn, and candy that yields profits of $2 after supplies and labor. How does profit on these concession items affect your answer to part ( a )? (Ignore taxes.)
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Q 18Q 18
Home Auto Parts
Home Auto Parts is a large retail auto parts store selling the full range of auto parts and supplies for doit-yourself auto repair enthusiasts. The store is arranged with three prime displays in the store: front door, checkout counters, and ends of aisles. These display areas receive the most customer traffic and contain special stands that display the merchandise with attractive eye-catching designs. Each display area is set up at the beginning of the week and runs for one week. Three items are scheduled next week for special display areas: Texcan Oil, windshield wiper blades, and floor mats. The accompanying table provides information for the three promotional areas scheduled to run next week:
Based on past experience, management finds that virtually all display-area sales are made by impulse buyers. The display items are extra purchases by consumers attracted by the exhibits. Before the store manager sets up the display areas, the distributor for Armadillo car wax visits the store. She says her firm wants its car wax in one of the three display areas and is prepared to offer
the product at a unit cost of $2.50. At a retail price of $2.90, management expects to sell 800 units during the week if the wax is on special display.
Required:
a. Home Auto has not yet purchased any of the promotion items for next week. Should management substitute the Armadillo car wax for one of the three planned promotion displays? If so, which one?
b. A common practice in retailing is for the manufacturer to give free units to a retail store to secure desirable promotion space or shelf space. The Armadillo distributor decides to sweeten the offer by giving Home Auto 50 free units of car wax if it places the Armadillo wax on display. Does this change your answer to part ( a )?
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Q 19Q 19
Stahl produces and sells a single product and faces an inelastic demand curve, meaning it can sell as many units as it wants without affecting the selling price. Stahl has a cost structure consisting of fixed costs that are incurred each month, and a variable cost of $12 per unit produced that is independent of (i.e., does not vary with) the number of units produced. Stahl's income tax rate is 30 percent, and its break-even quantity is 24,000 units each month. If Stahl produces 30,000 units during the month, it has an after-tax net income of $33,600. Calculate Stahl's selling price and monthly fixed costs.
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Q 20Q 20
Affording a Hybrid
With gasoline prices at $3.00 per gallon, consumers are flocking to purchase hybrid vehicles (with a combination of gasoline and electric motors) that get 50 miles per gallon of gasoline. The monthly payment on a three-year lease of a hybrid is $499 compared to $399 per month on a conventional, equivalent traditional gasoline car that gets 25 miles per gallon. Both vehicles require a one-time $1,500 payment for taxes, license, and dealer charges. Both vehicles have identical lease terms for the residual value, maximum number of miles allowed without penalty, and so forth.
Required:
a. Calculate how many miles the consumer must drive per year to make the hybrid the economical choice over the conventional gasoline-only vehicle.
b. How does your answer to part ( a ) change if the price of gasoline is $4.00 per gallon?
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Q 21Q 21
Easton Diagnostics
Easton Diagnostics is a large medical testing laboratory that services a four-county region. Easton runs a van that picks up specimens from clinics and hospitals and takes them to the Easton laboratory where various tests are conducted. Easton currently has a large chemical blood analysis system. This system runs a battery of standard tests for which Easton is reimbursed $750 per blood sample. The cost structure of the current blood analysis system consists of annual fixed costs (lease payment of $1.6 million, supervisory costs of $400,000, and occupancy costs of $100,000) and variable costs per blood sample (direct labor, including transporting the blood samples, technicians, and so forth of
$175, direct materials of $125, and a royalty fee of $150). [ Note: The current equipment is leased for $1.6 million per year plus $150 (royalty) for every blood sample analyzed.]
A competing vendor has approached Easton Diagnostics with a comparable system that performs the same set of tests. The reliability and quality of both the proposed and the existing systems are the same. The competing vendor is willing to lower the annual lease payment to $1.2 million but raise the royalty fee by $30 per blood sample to $180. Both the existing and proposed leases have the same contractual terms in all other respects. If Easton adopts the competing vendor's proposal, the current fee it charges ($750) and the direct labor costs per blood sample ($175) are unaffected. However, the proposed equipment adds $10 per blood sample analyzed to direct materials.
Required:
a. How does Easton Diagnostic's break-even point for standard blood tests change if the competing vendor's proposal is accepted?
b. Easton Diagnostic currently analyzes 10,300 blood samples per year, and this number has remained constant over the past few years. Moreover, Easton management does not foresee any growth in the number of standard blood tests it performs. Make a recommendation to management as to whether Easton should stay with its existing blood analysis equipment or accept the competing vendor's proposal. Justify your recommendation. (Assume that there are no cancellation payments on the existing equipment and there are no costs of converting from the existing equipment to the new equipment other than the costs described in the problem.)
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Q 22Q 22
Spa Salon
The Spa Salon is a full-service day spa specializing in massage and manicures. One out of every three massage clients also purchases a manicure. Last month, Spa Salon did 90 massages and 30 manicures and reported the following net loss:
After reviewing the income statement for last month, the owner was quite upset about the net loss. She thought the spa was making money.
Required:
How many massages and manicures does Spa Salon have to conduct each month to break even, assuming that the prices and the variable costs of massages and manicures remain the same as last month's, as do the fixed costs?
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Q 23Q 23
Manufacturing Cost Classification
A company makes DVD players and incurs a variety of different costs. Place a check in the appropriate column if the cost is a product cost or a period cost. Further, classify each product cost as direct materials, direct labor, or manufacturing overhead.
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Q 24Q 24
Australian Shipping
In the 1800s, Australia was a colony of England and most of its trade was with England. Australia primarily exported agricultural products such as wheat and imported manufactured goods such as steel, machinery, and textiles. The volume of trade measured in British pounds (£) was roughly equal in the sense that exports equaled imports. (Imports were slightly larger as there were net
positive investments being made in Australia.) However, in cubic feet of cargo being shipped, exports to England exceeded imports. A British pound (£) of wheat required more cubic feet than £1 of manufactured goods. Hence, an imbalance of shipping existed. Numerous ships would carry agricultural products to England but return to Australia empty because no cargo of manufactured goods existed.
Large sail-powered ships required substantial ballast (weight) in the hold to keep the ship sailing properly, especially in rough seas. Before leaving England empty, the ships would purchase stone from local quarries for ballast. However, once in Australia, the stone had no market value, and in fact had to be hauled from the harbor area.
Consider the following facts for a particular ship in England with a shipment of Australian cargo for England.
1. The ship has contracted to sail to Australia and return with a cargo of Australian wheat. The ship has no cargo scheduled for London to Sydney.
2. The wheat-shipping contract calls for paying the captain and crew £4,900 for the round trip. The wheat seller will arrange for and pay Australian dock hands £250 to load the wheat in Sydney, and the wheat purchaser will arrange for and pay English dock hands to unload the wheat in London. The ship's crew does not load or unload the cargo.
3. To sail to Australia, the ship requires 10 tons of ballast. (1 ton = 2,000 pounds)
4. Stone can be quarried in England, transported to the docks, and loaded as ballast for £40 per ton. In Sydney, the stone can be unloaded and hauled away for £15 per ton.
5. Wrought iron bars of 10-foot lengths can also be used as ship ballast. Wrought iron bars can be purchased in England at £1.20 per bar. Each bar weighs 20 pounds. Wrought iron bars sell for £0.90 per bar in Sydney. The cost of loading the wrought iron in London is £15 per ton, and the cost of unloading it and transporting it to the Sydney market is £10 per ton.
Required:
a. Write a memo to the ship's captain describing what actions he should take with respect to using stone or wrought iron as ballast. Assume that interest rates are zero and all prices and quantities are known with certainty. Support your recommendation with a clearly labeled financial analysis.
b. Why do you think the price of wrought iron is lower in Sydney than in London?
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Essay
Q 25Q 25
iGen3
The Xerox DocuColor iGen3 digital production press is a high-volume, on-demand, full-color printer capable of producing up to 6,000 impressions (pages) per hour. It weighs nearly 3 tons, stretches 30 feet long, and holds more than 40 pounds of dry ink. It sells for over $500,000, and its principal market is print shops that produce mail order catalogs (e.g., L.L.Bean). Xerox offers two leasing options for the iGen3. Option A requires a three-year agreement with a monthly lease fee of $10,000 plus $0.01 per impression. Option B (also a three-year agreement) does not include a monthly lease fee but requires a charge of $0.03 per impression.
ColorGrafix is a print shop considering leasing the iGen3 to begin producing customized mailorder catalogs. Besides leasing the iGen3, ColorGrafix estimates that it will have to buy ink for the iGen3 at a cost of $0.02 per impression and hire an operator to run the iGen3 to produce the customized catalogs at a cost of $5,000 per month. ColorGrafix estimates that it can charge $0.08 per impression for customized color catalogs. ( Note: The customer provides the paper stock on which the color impressions are printed.)
Required:
a. If ColorGrafix leases the iGen3 and chooses Option A, how many impressions per month will ColorGrafix have to sell and produce to break even?
b. If ColorGrafix leases the iGen3 and chooses Option B, how many impressions per month will ColorGrafix have to sell and produce to break even?
c. Should ColorGrafix choose Option A or Option B? Explain why.
d. ColorGrafix is a fairly new firm (only three years old) and has a substantial amount of debt that was used to help start the company. ColorGrafix has positive net cash flow after servicing the debt, but the owners of ColorGrafix have not felt it wise to withdraw any cash from the business since its inception, except for their salaries. ColorGrafix expects to sell and produce 520,000 impressions per month. Which lease option would you recommend ColorGrafix choose? Explain why.
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Essay
Q 26Q 26
Adapt Inc.
You work for the strategy group of Adapt Inc., a firm that designs and manufactures memory cards for digital cameras. Your task is to gather intelligence about Adapt's key competitor, DigiMem, a privately held company. Your boss has asked you to estimate DigiMem's fixed costs. Industry sources, such as trade associations, provide the following information on DigiMem:
Required:
a. Using the preceding data, estimate DigiMem's annual fixed costs.
b. Why might your boss be interested in knowing DigiMem's fixed costs?
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Essay
Q 27Q 27
Tesla Motors
You work in the long-run strategic planning group of a large automotive firm and are tasked with following the development of electric vehicles. Your firm has electric cars in development but has not yet decided to enter the battery-powered car market. One company you follow is Tesla Motors, founded by Silicon Valley engineers, that specializes in high-performance luxury electric vehicles. A recent article in The Wall Street Journal, entitled "Tesla Motors Approaches Crossroad," describes Tesla's current and expected operating performance. Last quarter, Tesla lost $49 million when it was making 200 cars a week. To break even, Tesla needs to make 400 cars a week. Tesla operates its plant 50 weeks out of the year and is shut down for the remainder of the days in the year for holidays and planned maintenance. While the list price of a Tesla ranges between $60,000 and $100,000
depending on battery capacity and other options, the average price is $75,000.
Required:
a. What is the variable cost of a Tesla automobile and what are Tesla's quarterly fixed costs?
b. Why would your firm be interested in knowing about Tesla's fixed and variable cost structure?
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Essay
Q 28Q 28
Oppenheimer Visuals
Oppenheimer Visuals manufactures state-of-the-art flat-panel plasma display screens that large computer companies like Dell and Gateway assemble into flat-panel monitors. Oppenheimer produces just the display panels, not any of the electronics, cases, or stands needed to make a complete unit. It is about to launch a new product employing TN polarized glass with a unique microscopic groove pattern. Two different technologies exist that can produce the unique groove pattern. One technology has a fixed cost of $34,000 per day and a variable cost of $200 per panel. The second technology has a fixed cost of $16,000 per day and a variable cost of $400 per panel. The fixed costs of the two technologies consist entirely of three-year leases for equipment to produce the panels. Both technologies are equally reliable and produce panels of equal quality. The only difference between the two technologies is their cost structures.
Because Oppenheimer holds a patent on the new YN polarized glass flat-panel displays, it has some market power and expects to sell the new display panels to computer companies based on the following demand schedule:
In other words, if Oppenheimer sets the price per panel at $760, it expects to sell 60 panels per day. If it sets the price at $560, it expects to sell 110 panels per day.
Required:
a. To maximize firm value, should Oppenheimer Visuals choose technology 1 or technology 2 to manufacture the new flat-panel display?
b. Given the technology choice you made in part ( a ), what price should Oppenheimer charge for the new flat-panel display?
c. Using Oppenheimer Visuals as an example, explain what is meant by the often used expression, "All costs are variable in the long run."
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Essay
Q 29Q 29
Eastern University Parking
Eastern University faces a shortage of parking spaces and charges for parking. For nearby parking (e.g., behind the business school), faculty and staff pay $180 per year. Parking in lots Z and B, which are north and south of the campus and involve about a 10-minute walk to the business school, costs $124 per year. In setting these prices, the university seeks to recover the costs of parking and to manage the queue of people wishing to park on campus. The current $180 and $124 fees cover the costs of surface spaces.
Lots Z and B have lower fees to compensate people for the longer walks and to encourage them to park in outlying lots. University officials say this fee structure, when multiplied by the number of parking stickers of each type sold, covers the cost of running the parking office and building new spaces. The cost of providing a parking space consists of costs of construction of the space, maintenance, and security. The construction cost is the annual amount required to repay the cost of grading, draining, and asphalting the space. Maintenance includes snow removal, line painting, fixing the gates after the arms are broken by irate faculty members searching for a space, and patching the asphalt. Security costs include all costs of the parking officers who ticket the cars of staff and students parked illegally.
The university recently evaluated a proposal to construct an enclosed, multifloor parking facility. Design estimates place the construction cost at $12,000 per enclosed space. The equivalent cost of a surface space is $900. The university uses a 10 percent cost of capital. (Assume that this is an appropriate interest rate.) To compensate the university for the cost of the capital involved in building parking garages, parking fees would have to be at least $1,200 per space per year, as opposed to $90 per space per year for the surface space. Because the university does not believe that faculty, staff, and students are willing to pay more than $1,200 per year for a covered parking space, no plans exist to build a parking building.
Required:
Critically evaluate Eastern University's costing of parking permits. What do you think accounts for the university administration's reluctance to build a parking garage?
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Essay
Q 30Q 30
GRC
GRC currently manufactures and sells computer-controlled gear-cutting machines used by automobile companies to produce gears for car and truck transmissions and differentials. GRC has decided to produce gear-cutting machines that wind-powered, electric-generating turbine companies (e.g., Siemens and General Electric) will purchase to manufacture gear sets used in their turbines. Because of the tremendous torque generated by the 160-foot blades on the windmills, the gears in the electric power generators must be able to withstand unusually large forces. GRC has designed a gear-cutting machine to produce gears that can withstand such forces.
The following table describes the demand curve for the number of wind-powered turbine gear-cutting machines GRC expects to sell per year.
( Note: The demand curve in the table can be represented as P = 500 - 20Q.)
GRC can produce its new gear-cutting machines for wind-powered turbines using one of two technologies. One technology (HI Automation) involves more capital investment but results in lower variable costs. The other technology (LO Automation) requires less capital investment but results in higher variable costs. The following table summarizes how the average costs of the two technologies vary with different production levels of wind-powered turbine gear-cutting machines.
In other words, if five wind-powered turbine gear-cutting machines are produced, the average cost of each machine is $365 using the Hi Automation technology but only $295 if the Low Automation technology is used. On the other hand, if 10 machines are produced, the Hi Automation technology is less expensive ($245) than the Low Automation technology ($285). ( Note: The average cost estimates above include the annual lease cost of the automation technology.)
Required:
a. Should GRC purchase the Hi Automation or the Low Automation technology? Justify your answer with convincing supporting analyses.
b. Given your choice of production technology (Hi or Low Automation) in part ( a ), what price should GRC set for its gear-cutting machines for wind-powered turbines and how many machines will GRC expect to sell at this price?
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Essay
Q 31Q 31
Mastich Counters
Mastich Counters manufactures a material used to fabricate kitchen counters. It is a very durable, high-fashion, and expensive product that is installed in luxury homes. The manufacturing process is complicated and requires highly skilled employees, supervisors, and engineers. Mastich employs 450 people in its manufacturing operation. Most of the production employees are cross-functionally trained to perform several manufacturing tasks.
The firm's vacation policy gives employees three hours of paid vacation for every week of work. An employee who works 52 weeks accrues 156 hours or 3.9 weeks (156 ÷ 40) of paid vacation. In the past, Mastich allowed employees unlimited accumulation of vacation time. Some longtime employees had accumulated six months of vacation. When they retired from the firm, they continued to be paid for six months after leaving.
Management decided that allowing employees unlimited accumulation of vacation was costing the firm too much money when they left. Not only were the employees who left being paid, but so were their replacements. To correct this problem, management instituted a policy that an employee could not accumulate more than 156 hours of vacation. Once an employee's accumulated vacation exceeded 156 hours, these additional hours would not be added to his or her account. In addition, employees with more than 156 hours of accrued vacation had two years from the date of the policy change to bring their balance down to the maximum 156 hours. After the two-year phase-in period, the "take it or lose it" policy was strictly enforced.
While there was much grumbling about the "take it or lose it" policy, after the two-year phase-in period, the following comments were collected at a focus group held by the personnel department to assess the new policy:
• Manager A: "In some cases it has been very beneficial. Some of our people in high-stress positions were burned out. These people never took all their vacation. One woman took every Friday off for six months to use her excess vacation time. For the four days she worked, she was like a new person-refreshed, invigorated, and enthused."
• Manager B: "Well, that may be true, but this new policy, especially during the phase-in period, has been hell on our staffing. Some days, especially around weekends and holidays, we've had 30 percent of the plant on vacation. What impact do you think this has had on our production schedule and quality programs?"
• Manager C: "I have looked at the data and very few employees lose any accrued vacation. Fewer than 1 percent of the accrued vacation hours were lost last year after the phase-in period because employees did not use them."
Required:
Evaluate the costs and benefits of the new policy that limits accumulated vacation to 156 hours.
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Essay
Q 32Q 32
Prestige Products
Prestige manufactures a line of female cosmetics, including lipsticks, face creams, eyeliners, and so forth. Prestige manufactures its own products to maintain proprietary information and to assure high-quality standards. They have just developed a new exfoliating masque face cream in a unique tube and applicator that they expect to sell for $12.00 per unit. To manufacture the new face cream, Prestige will have to lease new equipment. Only two companies manufacture the necessary equipment for producing the face cream, a German company and a Swedish company. The following table lists the two alternative production technologies that Prestige can use to produce the new face cream.
The German equipment has an annual capacity of 215,000 units per year, whereas the Swedish equipment can produce up to 380,000 units per year. Both companies require Prestige Products to sign a five-year, non-cancelable lease for the annual lease payment ($500,000 for the German equipment and $900,000 for the Swedish equipment). The variable costs include the labor and material ($8 if the German equipment is used and $6 if the Swedish equipment is used).
Required:
a. Calculate the break-even point if Prestige were to lease the German equipment.
b. Calculate the break-even point if Prestige were to lease the Swedish equipment.
c. Which equipment (German or Swedish) should Prestige lease (and why)?
d. Suppose that Prestige management expects to sell 180,000 masques per year. Calculate the average cost (fixed plus variable cost) of the German and Swedish equipment at 180,000 units.
e. What is operating leverage and what is the relation between operating leverage and firm value?
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Essay
Q 33Q 33
JLE Electronics
JLE Electronics is an independent contract manufacturer of complex printed circuit board assemblies.
Computer companies and other electronics firms engage JLE to assemble their boards. Utilizing
computer-controlled manufacturing and test machinery and equipment, JLE provides manufacturing
services employing surface mount technology (SMT) and pin-through-hole (PTH) interconnection technologies. The customer purchases the subcomponents and pays JLE a per-board fee to assemble the components. JLE has a new one-of-a-kind, state-of-the-art board assembly line. The line can be operated 20 hours per day, seven days a week, in each three-week (21-day) period. Four customers have asked that their boards be manufactured on this line over the next three-week period. The following table summarizes the number of units of each board requested, the price JLE will charge for each board, JLE's variable and fixed cost per board, and the number of assembly line minutes each board requires. Fixed cost per board is the allocated cost of property taxes, fire insurance, accounting, depreciation, and so forth.
Make the following assumptions:
• The four customer orders can be produced only on the new JLE line.
• If JLE rejects an order, future orders from that customer are not affected.
• There is no setup or downtime between orders.
• Customers are willing to have any number of boards produced by JLE up to the number of
units specified in the preceding table. For example, customer A has requested 2,500 boards
in the 21-day period, but would accept a smaller number.
• The four customers comprise the entire set of potential customers who would want to use
the new JLE line in the next 21-day period.
Required:
Which customer orders should be accepted? In other words, complete the following table:
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Essay
Q 34Q 34
com
News.com is a website that offers users access to current national and international news stories. News.com does not charge users a fee for accessing the site, but rather charges advertisers $0.05 per hit to the website. A "hit" is a user that logs on the website.
News.com is considering two alternate ISPs that will link News.com's computer system to the World Wide Web-NetCom and Globalink. These firms are identical in access speeds and the number of users able to connect to the site per minute. Both ISPs are equally reliable. NetCom proposes to charge $3,000 per month plus $0.01 per hit to News.com. Globalink proposes to charge $2,000 per month plus $0.02 per hit. Assume that the only costs News.com incurs are the access fees charged by the ISP.
Required:
a. Calculate the number of hits to its website needed to break even if News.com uses NetCom.
b. Calculate the number of hits to its website needed to break even if News.com uses Globalink.
c. Which ISP do you recommend that News.com use? Explain why.
d. Monthly demand (in number of hits) for News.com is expected to be either 50,000 if the economy is slumping or 150,000 if the economy is booming, each equally probable. Which ISP should News.com choose and why?
P 2-33: Rowe Waste Removal (A)
Free
Essay
Q 35Q 35
Rowe Waste Removal (A)
Rowe Waste Removal now only collects garbage from private residences (houses) because it does not own trucks with the capability of lifting and emptying garbage dumpsters used by apartment complexes. Rowe currently is reassessing this decision. To lease, license, insure, and get the various permits to operate a refuse collection truck with a fork-lift capable of emptying a dumpster costs $54,000 per month. This includes the cost of the driver, fuel, and oil. Rowe prices each apartment complex based on the number of apartment units in the complex based on a standard of 25 units. The following table indicates how Row expects the number of apartment customers to vary with the price (per 25 apartment units)
(Table is based on the demand curve: P = 2000 - 4.4 Q. )
In other words, if Rowe wants 100 apartment customers, it will set the price at $1,560 per 25 units per month. If an apartment has 50 units, then at this price point, this apartment complex pays $3,120 (2 × $1,560) per month. Since garbage is collected once per week at each apartment complex, the single truck has the capacity to handle up to 145 25-unit apartment complexes per month.
Rowe uses a landfill in the county to dispose of the waste. The landfill charges $1,750 per truck load of garbage the size Rowe would acquire. Rowe estimates that 10 apartment complexes (each with 25 units) will fill the truck once and will require dumping at the landfill. And, Rowe will remove the refuse at each 25-unit complex exactly four times per month. Each 25-unit apartment complex requires Rowe to lease a dumpster that can be lifted and emptied by its fork-lift-equipped garbage truck. Rowe can lease these dumpsters for $200 per month per 25-unit dumpster.
Required:
a. What is Rowe's monthly fixed cost of adding an apartment-complex refuse disposal service to its existing residential services? And what is Rowe's monthly variable cost of servicing each 25-unit apartment complex?
b. Given the demand curve Rowe expects to face in the apartment refuse collection business, what price should it choose to maximize profits, and how much profit will it make at this price?
c. Based on the profit maximizing price computed in part ( b ), what is the break-even point at this price?
d. After preparing the analysis in part ( b ), Rowe discovers it has forgotten to include an additional cost of $72,000 per year to cover the cost of the new person needed to contact potential apartment complexes, sign contracts for waste removal, and manage the apartment refuse collection business. After incorporating the $72,000 cost of the manager to market and manage the apartment collection business, how do your answers to parts ( b ) and ( c ) change? In other words, what price should Rowe set to maximize profits, how much profit will Rowe make at this price, and what is the break-even point at this new price?
e. Discuss why your answers in parts ( a ) and ( c ) are either the same or differ from your answers in part ( d ).
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Essay
Q 36Q 36
Littleton Imaging
Dr. Na Gu plans to open a radiology office that provides CAT scans. She can lease the CAT scanner for $1,200 per month plus $45 for each imaging session. In addition to the $45 lease cost per imaging session, Dr. Gu must purchase film for each session at a cost of $55. She plans to charge $250 for each session. Dr. Gu has identified a suitable office that she can rent for $1,400 per month. The monthly cost of a receptionist is $2,400 and two radiology technicians are $3,200 each per month. Office furnishings, phones, and office equipment cost $600 per month. She expects that her salary will be $15,000 per month.
Required:
a. How many imaging sessions per month must Littleton Imaging conduct in order for the office to break even?
b. How many imaging sessions per month must Littleton Imaging conduct in order for the office to yield an after-tax profit of $5,000 if the tax rate is 40 percent?
c. Dr. Gu expects that the office will perform 200 imaging sessions per month. How much must she charge per session to break even?
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Essay
Q 37Q 37
Candice Company
Candice Company has decided to introduce a new product that can be manufactured by either of two methods. The manufacturing method will not affect the quality of the product. The estimated manufacturing costs of the two methods are as follows:
Candice's market research department has recommended an introductory unit sales price of $30. The incremental selling expenses are estimated to be $500,000 annually plus $2 for each unit sold, regardless of manufacturing method.
Required:
a. Calculate the estimated break-even point in annual unit sales of the new product if Candice
Co. uses
(i) Manufacturing method A.
(ii) Manufacturing method B.
b. Which production technology should the firm use and why?
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Essay
Q 38Q 38
Cost Behavior Patterns
For each of the following questions draw a graph that depicts how costs vary with volume. Completely label each graph and axis.
a. Plant XXX works a 40-hour week. Management can vary the number of employees. Currently, 200 employees are being paid $10 per hour. The plant is near capacity. To increase output, a second 40-hour shift is being considered. To attract employees to the second shift, a 20 percent wage premium will be offered. Plot total labor costs as a function
of labor hours per week.
b. Plant YYY has a contract with the Texas Gas Company to purchase up to 150 million cubic feet of natural gas per month for a flat fee of $1.5 million. Additional gas can be purchased for $0.0175 per cubic foot. Plant YYY manufactures aluminum cans. One thousand cans require 10 cubic feet of gas. Plot total gas costs as a function of can production.
c. Use the same facts as in ( b ), but plot the gas cost per can as a function of can production.
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Essay
Q 39Q 39
Royal Holland Line
Royal Holland is a cruise ship company. It currently has six ships and plans to add two more. It offers luxury passenger cruises in the Caribbean, Alaska, and the Far East. Management is currently addressing what to do with an existing ship, the S.S. msterdam, when she is replaced by a new ship.
The S.S. Amsterdam was built 20 years ago for $100 million. For accounting purposes, she was assumed to have a 20-year life and hence is now fully depreciated. To replace the S.S. Amsterdam would cost $500 million, but her current market value is $371,250,000. The Holland Line can borrow or lend money at 10 percent.
The S.S. Amsterdam is now sailing the Caribbean and will be replaced next year by a new ship. The S.S. Amsterdam might be moved to the Mediterranean for a new seven-day Greek island tour. A seven-day cruise would depart Athens Sunday night, stop at four ports before returning to Athens Sunday morning, and prepare for a new cruise that afternoon. The S.S. Amsterdam can carry as many as 1,500 passengers. The accompanying data summarize the operating cost for this seven-day cruise.
Required:
a. Assuming the seven-day Greek island cruise can be priced at an average of $1,620, calculate the break-even number of passengers per cruise using the data provided.
b. What major cost component is not included in management's estimates?
c. If you were to include the omitted cost component identified in part ( b ), recalculate the break-even point for the S.S. Amsterdam 's Greek island cruise.
d. Passengers purchase beverages, souvenirs, and services while on the ship. The ship makes money on the purchases. If the ship line has a margin of 50 percent on all such on-board purchases, how much would the average passenger have to purchase for the break-even point to be 900 passengers?
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Essay
Q 40Q 40
Roberts Machining
Roberts Machining specializes in fabricating metal racks that hold electronic equipment such as telephone switching units, power supplies, and so forth. Roberts designs and produces the metal stamping dies used to fabricate the racks. It is currently fabricating several racks for GTE. A new rack, the 1160, is scheduled to begin production. The die used to fabricate this rack cost Roberts $49,000 to design and build. This die was completed last week, and production of the 1160 is scheduled to begin next week. Rack 1160 is a specialized custom product only for GTE. GTE and Roberts have a one-year contract whereby Roberts agrees to manufacture and GTE agrees to purchase a fixed number of 1160 racks over the next 12 months for a fixed price per rack. The 1160 rack will not be produced beyond one year. This contract generates profits of $358,000 (after deducting the die's cost
of $49,000). Roberts's accounting system recorded all expenditures for the 1160 die as a fixed asset with a one-year life. If this die is scrapped today or in one year's time, it has a scrap value of $6,800. Easton, another metal fabricator, has offered to buy the 1160 die from Roberts for $588,000 and will supply 1160 racks to GTE. GTE has agreed to this supplier substitution. Roberts estimates that if it sells the 1160 tools and dies to Easton, it will lose a current cash equivalent of $192,000 of future profits that would have been generated from GTE and similar customers, but now this business will go to Easton. (Ignore all tax effects.)
Required:
a. List all the alternatives in Roberts's opportunity set with respect to the 1160 die.
b. Calculate the net cash flows associated with each alternative in Roberts's opportunity set listed in part ( a ).
c. What is the opportunity cost of each alternative in the opportunity set listed in part ( a )?
d. What action should Roberts take with respect to the 1160 die?
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Essay
Q 41Q 41
Fuller Aerosols
Fuller Aerosols manufactures six different aerosol can products (room deodorants, hair sprays, furniture polish, and so forth) on its fill line. The fill line mixes the ingredients, adds the propellant, fills and seals the cans, and packs the cans in cases in a continuous production process. These aerosol products are then sold to distributors. The following table summarizes the weekly operating data for each product.
Required:
a. Calculate the break-even volume for each product.
b. Suppose the aerosol fill line can operate only 70 hours per week. Which products should be manufactured?
c. Suppose the aerosol fill line can operate only 50 hours per week. Which products should be manufactured?
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Essay
Q 42Q 42
Happy Feet
Dr. Lucy Zang, a noted local podiatrist, plans to open a retail shoe store specializing in hard-to-find footwear for people with feet problems such as bunions, flat feet, mallet toes, diabetic feet, and so forth. Because of the wide variety of foot ailments and shoe sizes needed, Dr. Zang estimates that she would have to stock a large inventory of shoes, perhaps as much as $1.5 million (at her cost). She found a 4,000-square-foot store in a popular mall that provides adequate retail space and storage for her inventory. Store improvements including carpeting, lighting, shelving, computer terminals, and so forth, require an additional $0.2 million investment. Initial advertising, hiring expenses, legal fees, and working capital are projected to add another $0.1 million of initial investment. To finance this $1.8 million investment, Dr. Zang and her family will invest $0.4 million, and the balance of the
$1.4 million will be borrowed from a bank.
The mall charges rent of $40 per square foot per year, payable in equal monthly installments, plus 3 percent of her retail sales. So, to rent the 4,000-square-foot store, the annual rent is $160,000, or $13,333 per month PLUS 3 percent of her sales. Besides the rent, Dr. Zang estimates other monthly expenses for labor, utilities, and so on to be $38,000. These expenses will not vary
with the amount of shoe sales. She plans to mark up the shoes 100 percent, so a pair of shoes she buys wholesale for $110 will be sold at retail for $220. Based on her research, she expects monthly retail sales to be $150,000, but in any given month, total sales can be $80,000 or $220,000 with equal probability.
Dr. Zang talks to her local banker and lays out her business plan; the banker tells her the bank would make a three-year interest-only loan at 10 percent interest, with the principal of $1.4 million due in three years (or it could be refinanced). The high interest rate of 10 percent was caused by the rather large risk of default due to the substantial fixed costs in the business plan. The
banker explains that the monthly rent ($13,333), other expenses ($38,000), and interest ($11,667), or $63,000, require the shoe store to generate a fairly large minimum level of sales to pay these expenses.
Required:
a. Calculate the amount of sales the Happy Feet store must do each month to break even.
b. After calculating the break-even point in part ( a ), Dr. Zang still believes that her Happy Feetstore can be commercially successful and provide a valuable service to her patients. She goes back to the mall leasing agent and asks if the mall would take a lower fixed monthly rental amount and a larger percentage fee of her sales. The mall leasing agent (who happens to have
sore feet and believes the Happy Feet store will drive new customers to his mall) says the mall would accept a rental fee of $1,000 per month plus 12.5 percent of her monthly sales. While Dr. Zang likes the idea of dropping her monthly rent from $13,333 to $1,000, she feels that raising the percentage of sales from 3 percent to 12.5 percent is a bit steep. But she goes back
to the bank and presents the revised rental agreement. The banker says the bank would lower the annual interest rate from 10 percent to 9 percent if Dr. Zang accepts the new lease agreement.
Both the original lease and the new lease are for three years and can be renegotiated at the end of the three years. Should Dr. Zang accept the new lease agreement ($1,000 per month plus 12.5 percent) or the original lease terms ($13,333 per month plus 3 percent)? Support your recommendation with both a written analysis and a quantitative analysis backing up your recommendation.
( Hint: First, conduct an analysis comparing the two options, using the expected monthly sales of $150,000. Second, conduct an analysis comparing the two options, using the two extreme sales of $80,000 and $220,000.)
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Essay
Q 43Q 43
Digital Convert
Digital Convert (DC) is a three-year-old startup company with most of its capital coming from banks and personal investments by the founders. DC manufactures a high-resolution scanner (MXP35). At the heart of the MXP35 is a photoelectric light sensor that converts light into digital pixels. DC currently produces the MXP35 for $480 (variable cost) per unit and incurs virtually no fixed manufacturing costs. All of its equipment is leased, and the leases are structured whereby DC only pays for the actual units produced. DC operates out of a building that is provided free by New York State for entrepreneurial startups. New York State also pays utilities, taxes, insurance, and administrative costs. DC does have fixed financing costs to service its existing loans, and these financing costs consume most of its profits from sales of the MXP35.
DC faces the following monthly demand schedule for the MXP35 (where price is the wholesale price DC receives):
The equation of the demand curve for the preceding table is P = $2,000 - 38 Q. In other words, if DC wants to sell 20 MXP35s per month, it would charge a wholesale price of $1,240 per unit.
Required:
a. Given DC's current cost structure of $480 variable cost and zero fixed costs, what is its profit-maximizing price-quantity combination for MXP35?
b. DC learns of a new manufacturing process for their photoelectric light sensor that lowers the variable cost from $480 per unit to $100 per unit. But the equipment must be leased for $7,000 per month for 24 months. If DC leases the new equipment, then over the next 24 months DC commits to paying $7,000 each month. If DC installs the new equipment, what is the price-quantity combination that maximizes profits? (Assume the quality and quantity of sensors produced by the existing and new technologies are identical.)
c. Before deciding to adopt the new photoelectric light sensor production technology, DC does some further research into its cost of financial distress. While the demand curve DC faces represents its normal demand, random monthly variation can cause demand to shift up or down unexpectedly. Given its existing bank loans, its variable costs of $480 per unit, no fixed manufacturing costs, and its small cash balances, DC faces a 15 percent chance of defaulting on its loans sometime over the next 24 months. If DC defaults on its loans, the owners of DC estimate the costs of default (legal costs, bank fees, lost sales, and so forth) to be $500,000. With the additional fixed leasing cost of the new sensor manufacturing technology, the owners of DC predict that the likelihood of defaulting on their fixed monthly commitments (bank loans and the $7,000 equipment lease) increases to 25 percent over the next 24 months. Prepare an analysis supporting your recommendation as to whether DC should adopt the new sensor manufacturing process or stay with their current manufacturing technology. (To simplify your analysis, assume a zero discount rate.)
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Q 44Q 44
APC Electronics
APC is a contract manufacturer of printed circuit board assemblies that specializes in manufacturing and test engineering support of complex printed circuit boards for companies in the defense and medical instruments industries. The assembly process begins with raw printed circuit boards, into which preprogrammed robotic machines insert various integrated circuits and other components, and then these parts are soldered onto the board. The board is then tested before shipment to the customer.
Four separate assembly lines, each with roughly the same type of equipment, are used to assemble the circuit boards. Before running a particular board assembly, the insertion equipment must be loaded with the correct components, and the equipment programmed and tested before production begins. Setup time varies between 3 to 6 hours depending on the complexity of the board being assembled. Setup labor costs APC $40 per hour, and technicians assembling and testing the completed boards cost $28 per hour. Not every assembly line can manufacture every type of board. Some lines have older insertion and testing equipment inappropriate for more complex assemblies. The assignment of boards to assembly lines depends on the number and complexity of the component insertions, the type of soldering to be applied, and the testing required.
Each assembly line has an hourly cost consisting of the accounting depreciation on the equipment (straight line) and occupancy costs (factory depreciation, taxes, insurance, and utilities). Occupancy costs are fixed with respect to volume changes. Direct labor to set up and test the line as well as the direct labor to manufacture the complete board assemblies and the testing of each board is tracked separately to each batch of boards. The following table summarizes the costs of operating each line and the annual number of hours each line is expected to run assembling boards (excluding setup and testing time).
The equipment depreciation cost varies widely across the two lines because some of the lines (especially
Line III) have older machines, some of which are fully depreciated.
Required:
a. Calculate the hourly cost of operating each of the four lines.
b. One of APC's customers, Healthtronics, has requested a special order for one of its boards APC currently builds. Healthtronics needs 150 boards by next week. These boards have to be run on Line I because that is the only one with the specialized soldering capability needed for these boards. Healthtronics will ship APC the raw boards and components to be inserted, so APC will not have to buy any of the parts. Setup time is expected to be four hours, and run time for these boards is expected to be 30 hours. Three technicians, each working 30 hours, are needed to staff Line I while the Healthtronics boards are being assembled and tested. Healthtronics splits the production of this particular board between APC and another contract manufacturer. So, if APC refuses this special offer, the customer will take the work to the other manufacturer. APC does not expect refusing this order to
adversely affect Healthtronics' demand for future APC work. If APC accepts the special order, the line will be set up next Monday during the day. The job will start Monday afternoon and be finished by Wednesday. Sixteen of the 30 hours of run time will be during an evening shift when the technicians are paid time and a half, or $42 an hour ($28 × 1.5). Calculate the cost APC will record as cost of goods sold when it ships the special order to Healthtronics.
c. Assume that accepting this special order from Healthtronics does not adversely affect the delivery schedules of any of APC's other customers. What is APC's out-of-pocket cash flow of accepting this Healthtronics special order?
d. Instead of assuming no other APC customers' deliveries are affected by accepting the special order from Healthtronics as in part ( c ), assume that another APC customer, SonarTech, will be affected. SonarTech's boards are currently running on Line I. They will have to be pulled from the line (two hours of tear-down time using setup technicians to unload the automatic parts feeders and return the parts to the storeroom), and Line I will have to be set up and tested as described in part ( b ). Healthtronics boards are run as in part ( b ). Then on Wednesday, six hours of setup time is needed to unload the remaining Healthtronics parts and reload and retest the SonarTech parts. To partially catch up on the SonarTech job, 14 hours of line run time that would have been done during the day is shifted to the evening, when the four technicians needed to run the SonarTech boards are paid time and a half ($42 per hour). Instead of shipping all the SonarTech boards in one shipment, two overnight shipments will be made-the first occurring when the first half is produced, and the second batch when the order is completed, costing an additional $2,300 of freight. SonarTech is willing to have its boards delayed a few days, as long as it can receive the boards in two overnight shipments. But Sonar-Tech is unwilling to pay the additional freight. What is the opportunity cost of accepting the Healthtronics special order?
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Q 45Q 45
Amy's Boards
Amy Laura is opening a snowboard rental store. She rents snowboards for skiing on a weekly basis for $75 per week, including the boots. The skiing season is 20 weeks long. Laura can buy a snowboard and boots for $550, rent them for a season, and sell them for $250 at the end of the season.
The store rent is $7,200 per year. During the off-season, Laura sublets the store for $1,600. Salaries, advertising, and office expenses are $26,000 per year.
On average, 80 percent of the boards in any given week are rented. After each rental, the boards must be resurfaced and the boots deodorized. Labor (not included in the $26,000 per year.
On average, 80 percent of the boards in any given week are rented. After each rental, the boards must be resurfaced and the boots deodorized. Labor (not included in the $26,000) and materials to prepare the board and boots to be re-rented cost $7.
Required:
a. How many boards must Laura purchase in order to break even?
b. Suppose that Laura purchases 50 boards. What profit does she expect?
c. Laura purchases 50 boards. What fraction of her boards must she rent each week to break even (including covering the cost of the boards)?
d. Explain why the percentage utilization you calculated in part ( c ) differs from the expected rental rate of 80 percent.
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Essay
Q 46Q 46
Blue Sage Mountain
Blue Sage Mountain produces hinged snowboards. The price charged affects the quantity sold. The following equation captures the relation between price and quantity each month:
Selling price = $530 ?.2 × Quantity sold
In other words, if they wish to sell 500 boards a month, the price must be $430 ($530 ?.2 × 500). Fixed costs of producing the boards are $70,000 a month and the variable costs per board are $90.
Required:
a. Prepare a table with quantities between 100 and 2,000 boards in increments of 100 that calculates the price, total revenue, total costs, and profits for each quantity-price combination.
b. Determine the profit-maximizing quantity-price combination.
c. Fixed costs fall from $70,000 a month to $50,000 a month. Should Blue Sage change its pricing decision?
d. Variable costs fall from $90 per unit to $50 per unit. Should Blue Sage change its pricing decision?
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