Accounting for Decision Making Study Set 5

Business

Quiz 2 :

The Nature of Costs

Quiz 2 :

The Nature of Costs

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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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Opportunity Cost:
This refers to the cost of the next best alternative. The decision maker should determine all the possible actions and their net receipts foregone to identify the highest net flow among them.
Therefore, the opportunity cost changes as the set of opportunities changes.
As given, the opportunities available are watching V opera or M concert. Therefore, attending V opera indicates that user is sacrificing M concert. The amount of satisfaction sacrificed by not opting for M concert is the opportunity cost.
Though the user is willing to pay $200 to watch M concert, yet the opportunity cost will be the cost payable to watch the concert, which is $160.
Therefore, the opportunity cost by attending the V opera amounts to
img .

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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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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, "Not 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.The company interrupts the regular programming twice a year. It is considering that raising fund through this is very cheap but does not consider the loss due to the interruption from the regular programming.
If that loss is also added up this cost may not be too cost effective. Hence before considering it cost effective the opportunity cost must be considered because if it is not considered then it might lead to incurring higher cost.

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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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Variable and Fixed Cost
There are two components in cost of a product from the point of the manufacturer. One is the fixed cost which remain 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.
a
The given statement is false. There is no doubt that the total profit would increase but the increase will not be because of the spread of fixed costs among more units.
b
Fixed cost is a sunk cost. When the quantity increases the profit will increase which represents the difference of sale price and the variable cost. Here the concept of marginal profit will apply and not the average profit. Thus the profit will increase whether there is any fixed cost or not. Fixed cost will not affect the profit.

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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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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. img 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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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): img 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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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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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? img img
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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: img 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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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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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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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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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): img 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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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. img (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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Negative Opportunity Costs Can opportunity costs be negative? Give an example.
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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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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: img 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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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. img 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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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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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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