The company has the capacity to produce 80,000 units. The product regularly sells for £90. A
wholesaler has offered to pay £75 each for 2,000 units.
If Bridge’s special order is accepted, the effect on operating income would be a
a.
£20,000 decrease.
b.
£52,000 increase.
c.
£14,000 increase.
d.
none of the above.
60. The Dot Company manufactures two products: X and Y. The contribution margin per unit is
determined as follows:
X
Y
Sales
£130
£80
Variable costs
__70
_38
Contribution margin
£ 60
£42
Total demand for Product X is 16,000 units and for Product Y is 8,000 units. Machine hours is a scarce
resource. During the year, 42,000 machine hours are available. Product X requires 6 machine hours per
unit, while Product Y requires 3 machine hours per unit.
How many units of Products X and Y should Dot Company produce?
Product X Product Y
a.
16,000 -0-
b.
8,000 4,000
c.
7,000 -0-
d.
3,000 8,000
Product Y: 8,000 units 3 machine hours =
Product X: 3,000 units 6 machine hours =
Total
42,000 machine hours
61. Caddo Ltd. produces two products using the same manufacturing equipment. Information about the
two products is as follows:
Alpha
Beta
Incremental revenue (2,000 units £75)
Less: Incremental costs
[2,000 units (£15 + £22 + £12)]
Incremental profit
Sales
£15
£35
Variable costs
£5
£10
Machine hours required
0.5
2.0
Demand (units)
30,000
10,000
Demand (machine hours)
15,000
20,000
If Caddo can produce only one of the products in the next period, which product should be produced?
a.
Alpha should be produced because it requires less machine hours.
b.
Beta should be produced because it generates more revenue.
c.
Beta should be produced because it generates more contribution margin per unit.
d.
none of the above
62. WJE Company has only 4,000 machine hours available each month. The following information on the
company’s three products is available:
Product
AA
Product
BB
Product
CC
Contribution margin per unit
£10
£13
£5
Machine hours per unit
2
1.5
0.5
If demand exceeds the available capacity, in what sequence should orders be filled to maximize the
company’s profits?
a.
Product AA first, Product BB second, and Product CC third
b.
Product BB first, Product AA second, and Product CC third
c.
Product CC first, Product BB second, and Product AA third
d.
Product CC first, Product AA second, and Product BB third
63. The theory of constraints focuses on
a.
throughput.
b.
inventory.
c.
operating expenses.
d.
all of the above.
64. Throughput is calculated as
a.
Sales revenue – Unit-level variable cost.
b.
Sales revenue – Total manufacturing cost.
c.
Unit-level cost + Batch-level cost + Facilities-level cost.
d.
Unit-level cost + Nonunit-level cost.
65. Application of the theory of constraints will improve all of the following EXCEPT
a.
net income.
b.
debt-to-equity ratio.
c.
cash flow.
d.
return on investment.
SHORT ANSWER
1. What is a sunk cost? Under what circumstances are sunk costs relevant to a decision? Construct an
example of a sunk cost. Briefly discuss why you think financial reports for investors and managerial
reports for mangers may or may not differ in their treatment of sunk costs.
2. What is an opportunity cost? Under what circumstances are opportunity costs relevant to a decision?
Construct an example of an opportunity cost. Briefly discuss why you think financial reports for
investors and managerial reports for mangers may or may not differ in their treatment of opportunity
costs.
3. Describe the Theory of Constraints and discuss some of its implications for management.
PROBLEM
1. Junior Company currently buys 30,000 units of a part used to manufacture its product at £40 per unit.
Recently the supplier informed Junior Company that a 20 per cent increase will take effect next year.
Junior has some additional space and could produce the units for the following per-unit costs (based on
30,000 units):
Direct materials
£16
Direct labour
12
Variable overhead
12
Fixed overhead
_10
Total
£50
If the units are purchased from the supplier, £200,000 of fixed costs will continue to be incurred. In
addition, the plant can be rented out for £20,000 per year if the parts are purchased externally.
Required:
Should Junior Company buy the part externally or make it internally?
If purchased externally:
Purchase price (30,000 £40 1.20)
Fixed costs
Rent received
Net cost to purchase
If produced internally:
Cost to produce (30,000 £50)
2. Rippey Ltd. manufactures a single product with the following unit costs for 5,000 units:
Direct materials
£ 60
Direct labour
30
Factory overhead (40% variable)
90
Selling expenses (60% variable)
30
Administrative expenses (20% variable)
__15
Total per unit
£225
Recently, a company approached Rippey Ltd. about buying 1,000 units for £225. Currently, the
models are sold to dealers for £412.50. Rippey’s capacity is sufficient to produce the extra 1,000 units.
No additional selling expenses would be incurred on the special order.
Required:
a.
What is the profit earned by Rippey Ltd. on the original 5,000 units?
b.
Should Rippey accept the special order if its goal is to maximize short-run profits? How much
will income be affected?
c.
Determine the minimum price Rippey would want to receive in order to increase profits by
£7,500 on the special order.
d.
When making a special order decision, what nonquantitative aspects of the decision should
Rippey Ltd. consider?
3. The operations of Grant Ltd. are divided into the Fix Division and the Roach Division. Projections for
the next year are as follows:
Fix
Roach
Division
Division
Total
Sales
£60,000
£ 40,000
£100,000
Variable costs
_20,000
__15,000
__35,000
Contribution margin
£40,000
£ 25,000
£ 65,000
Sales (5,000 £412.50)
Less: costs (5,000 £225)
Net income
b.
Yes, profit will increase by:
Increase in sales (1,000 £225)
Less:
Increase in direct materials (1,000 £60)
Increase in direct labour (1,000 £30)
Increase in var. overhead (1,000 £90 0.40)
Increase in var. selling (1,000 £30 0.60)
Increase in var. adm. (1,000 £15 0.20)
Increase in profits
£60 + £30 + (£90 0.40) + (£30 0.60) + (£15 0.20) + (£7,500/1,000) = £154.50 per unit
d.
What is the impact on regular customers?
Do we have the capacity to produce the extra units?
Will we lose some regular customers?
Will we be violating the Robinson-Patman Act?
Direct fixed costs
_12,500
__30,000
__42,500
Segment margin
£27,500
£ (5,000)
£ 22,500
Allocated common costs
_10,000
___7,500
__17,500
Operating income (loss)
£17,500
£(12,500)
£ 5,000
Required:
a.
Determine operating income for Grant Ltd. as a whole if the Roach Division is dropped.
b.
Should the Roach Division be eliminated?
4. The management of James Industries has been evaluating whether the company should continue
manufacturing a component or buy it from an outside supplier. A £200 cost per component was
determined as follows:
Direct materials
£ 15
Direct labour
40
Variable manufacturing overhead
10
Fixed manufacturing overhead
__35
Total
£100
James Industries uses 4,000 components per year. After Light, SA., submitted a bid of £80 per
component, some members of management felt they could reduce costs by buying from outside and
discontinuing production of the component. If the component is obtained from Light, SA., James’s
unused production facilities could be leased to another company for £50,000 per year.
Required:
a.
Determine the maximum amount per unit James should pay an outside supplier.
b.
Indicate if the company should make or buy the component and the total monetary difference
in favor of that alternative.
c.
Assume the company could eliminate production supervisors with salaries totaling £30,000 if
the component is purchased from an outside supplier. Indicate if the company should make or
buy the component and the total monetary difference in favor of that alternative.
a.
£77.50 [£15 + £40 + £10 + (£50,000/4,000)]
Sales
Variable costs
Contribution margin
Direct fixed costs
Segment margin
(£10,000 + £7,500)
Operating income
Outside supplier’s price
Direct materials
(£15 4,000)
(£40 4,000)
(£10 4,000)
Fixed manufacturing overhead
Rental revenue
Totals
Direct materials
Variable manufacturing overhead
Rental revenue
(£80 4,000)
(£15 4,000)
Direct labour
Variable manufacturing overhead
(£10 4,000)
(£35 4,000)
(£140,000 – £30,000)
Totals
The analysis could be done including only avoidable fixed costs:
Outside supplier’s price
Direct materials
(£15 4,000)
(£40 4,000)
Variable manufacturing overhead
5. Scott Company has an annual capacity of 18,000 units. Budgeted operating results for 2011 are as
follows:
Revenues (16,000 units @ £60)
£960,000
Variable costs:
Manufacturing
£384,000
Selling
_128,000
_512,000
Contribution margin
£448,000
Fixed costs:
Manufacturing
£160,000
Selling and administrative
_120,000
_280,000
Operating income
£168,000
A foreign wholesaler wants to buy 1,000 units at a price of £40 per unit. All fixed costs would remain
within the relevant range. Variable selling costs on the special order would be the same as variable
selling costs for regular orders.
Required:
a.
Determine the effect on operating income if the company produces the special order.
b.
Should the company produce the special order?
c.
Determine operating income if the customer had wanted a special order of 3,000 units and the
company produced the special order.
d.
Should the company produce the 3,000-unit special order?
e.
Discuss any nonquantitative factors the company might want to consider when making the
decision.
£8,000 increase
Incremental revenue (£40 1,000)
Incremental costs:
Variable manufacturing (£24 1,000)
Variable selling (£8 1,000)
Incremental contribution margin
b.
Yes, the company should produce the special order.
£164,000
(£10 4,000)
Avoidable fixed manufacturing overhead
Rental revenue
Totals
6. Bonilla Ltd., which produces one product, had the following income statement for a recent month:
Bonilla Ltd.
Income Statement
For the Month of April 2011
Sales
£30,000
Cost of goods sold
_27,000
Gross profit
£ 3,000
Selling and administrative
__2,500
Net income
£ 500
There were no beginning or ending inventories of work-in-process or finished goods. Bonilla’s
manufacturing costs were as follows:
Direct materials (1,200 units £5)
£ 6,000
Direct labour (1,200 units £8)
9,600
Variable overhead (1,200 units £4.50)
5,400
Fixed overhead
__6,000
Total
£27,000
Average cost per unit
£ 22.50
Revenues:
(16,000 £60)
(15,000 £60)
(3,000 £40)
Variable costs:
Manufacturing:
(16,000 £24)
(18,000 £24)
Selling:
(16,000 £8)
(18,000 £8)
Contribution margin
Fixed costs:
Manufacturing
Selling and administrative
_(120,000)
Operating income
Nonquantitative considerations might include:
The possibility of repeat business with the special-order customer.
Increasing the selling price on subsequent special orders.
The reliability of regular customer repeat business.
Selling and administrative expenses are all fixed.
Bonilla has just received a special order from a firm in Canada to purchase 800 units at £20 each. The
order will not affect the selling price to regular customers.
Required:
a.
Prepare a differential analysis of the relevant costs and revenues associated with the decision
to accept or reject the special order, assuming Bonilla has excess capacity.
b.
Determine the net advantage or disadvantage (profit increase or decrease) of accepting the
order, assuming Bonilla does not have excess capacity.
7. Vance Company manufactures a product that has the following unit costs: direct materials, £15; direct
labour, £12; variable overhead, £8; and fixed overhead, £12. Fixed selling costs are £1,500,000 per
year. Variable selling costs of £4 per unit cover the transportation cost. Although production capacity
is 800,000 units per year, the company expects to produce only 650,000 units next year. The product
normally sells for £70 each. A customer has offered to buy 50,000 units for £45 each. The customer
will pay the transportation charge on the units purchased.
Required:
a.
What is the incremental cost to Vance Company for the special order?
b.
What is the effect on Vance’s income if the special order is accepted?
£1,750,000 50,000 units (£15 + £12 + £8)
b.
£500,000 increase
8. Majestic Company manufactures a product that has the following unit costs: direct materials, £5; direct
labour, £7; variable overhead, £3; and fixed overhead, £5. Fixed selling costs are £200,000 per year.
Variable selling costs of £1 per unit cover the transportation cost. Although production capacity is
80,000 units per year, the company expects to produce only 65,000 units next year. The product
normally sells for £30 each. A customer has offered to buy 10,000 units for £18 each. The customer
will pay the transportation charge on the units purchased.
Required:
a.
What is the incremental cost per unit to Majestic Company for the special order?
b.
What is the effect on Majestic’s income if the special order is accepted?
9. Solomon Company manufactures 20,000 components per year. The manufacturing cost per unit of the
components is as follows:
Direct materials
£10
Direct labour
14
Variable overhead
6
Fixed overhead
__8
Total unit cost
£38
Assume that the fixed overhead reflects the cost of Solomon’s manufacturing facility. This facility
cannot be used for any other purpose. An outside supplier has offered to sell the component to
Solomon for £32.
Required:
a.
What is the effect on income if Solomon purchases the component from the outside supplier?
b.
Assume that Solomon can avoid £50,000 of the total fixed overhead costs if it purchases the
components. Now what is the effect on income if Solomon purchases the component from the
outside supplier?
£40,000 decrease
Make:
(20,000 components £10)
(20,000 components £14)
(20,000 components £6)
Total cost to make
Buy:
a.
£15 (£5 + £7 + £3)
b.
£30,000 increase
(10,000 units £18)
(10,000 units £15)
Incremental profit
10. Mills SA. manufactures 50,000 components per year. The manufacturing cost per unit of the
components is as follows:
Direct materials
£12
Direct labour
13
Variable overhead
5
Fixed overhead
_10
Total unit cost
£40
An outside supplier has offered to sell the component to Mills SA. for £35.
Required:
a.
What is the effect on income if Mills SA. purchases the component from the outside supplier?
b.
Assume that Mills SA. can avoid £700,000 of the total fixed overhead costs if it purchases the
components. Now what is the effect on income if Mills SA. purchases the component from the
outside supplier?
£250,000 decrease
Make:
(50,000 components £13)
(50,000 components £5)
Total cost to make
Buy:
(50,000 components £35)
£1,750,000 – £1,500,000 = £250,000 decrease in income
Purchase price (20,000 components £32)
£640,000 – £600,000 = £40,000 decrease in income
b.
£10,000 increase
Make:
(20,000 components £10)
(20,000 components £14)
(20,000 components £6)
Avoidable fixed overhead
Total cost to make
Buy:
Purchase price (20,000 components £32)
£640,000 – £650,000 = £10,000 increase in income
11. The Dash Company manufactures two products: A and B. Information about the products is as
follows:
Product A
Product B
Revenue per unit
£150
£125
Variable costs per unit
__80
__70
Contribution margin per unit
£ 70
£ 55
Total demand
15,000 units
12,000 units
Machine hours per unit
.5 MH
.25 MH
There are 5,000 machine hours available during the quarter.
Required:
a.
Which of the products should Dash Company produce if it can only produce one of the
products?
b.
Assume that Dash Company uses half of the hours available to produce Product A and half of
the hours available to produce Product B. What is Dash‘s total contribution margin?
c.
Assume that Dash Company produces the product mix that will maximize profit. What is
Dash’s total contribution margin?
margin per machine hour.
Product A: £70 per unit/.5 MH per unit = £140 per MH
Product B: £55 per unit/.25 MH per unit = £220 per MH
b.
£900,000
Product A: 2,500 MH => 5,000 units
(5,000 £70)
Product B: 2,500 MH => 10,000 units
(10,000 £55)
Total contribution margin
£940,000
Make:
(50,000 components £12)
(50,000 components £13)
(50,000 components £5)
Avoidable fixed overhead
Total cost to make
Buy:
Purchase price (50,000 components £35)
£1,750,000 – £2,200,000 = £450,000 increase in income
12. The Bilko Company manufactures two products: widgets and gadgets. Information about the products
is as follows:
Widgets
Gadgets
Revenue per unit
£200
£150
Variable costs per unit
_110
__90
Contribution margin per unit
£ 90
£ 60
Total demand
20,000 units
20,000 units
Direct labour hours per unit
1.5 DLH
1.2 DLH
There are 40,000 direct labour hours available during the year.
Required:
a.
Which of the products should Bilko Company produce if it can only produce one of the
products?
b.
Assume that Bilko Company uses half of the hours available to produce widgets and half of
the hours available to produce gadgets. What is Bilko’s total contribution margin?
c.
Assume that Bilko Company produces the product mix that will maximize profit. What is
Bilko’s total contribution margin?
Widgets:
£90 per unit/1.5 DLH per unit
= £60 per DLH
Gadgets:
£60 per unit/1.2 DLH per unit
= £50 per DLH
b.
£2,199,930
Widgets:
20,000 DLH
=> 13,333 units
(13,333 £90)
Gadgets:
20,000 DLH
=> 16,666 units
(16,666 £60)
Total contribution margin
£2,299,980
requirement a, produce Product B first.
From
12,000 units .25 MH per unit = 3,000 MH to produce Product B
Use remaining 2,000 MH available to produce Product A.
2,000 MH/.5 MH per unit = 4,000 units of Product A
Product A (4,000 units £70)
Product B (12,000 units £55)
Total contribution margin
13. Terrazo Ltd. produces three kinds of ceramic tile that are used in home and office construction. Details
of each type of tile are as follows:
Type I
Type II
Type III
Price per unit
£40
£60
£100
Unit variable cost
£10
£28
£ 48
Machine hours required
.2
.5
1.25
Terrazo has 30,000 machine hours available for production.
Required:
Assume that Terrazo can sell all of each type of tile that it produces.
a.
Determine the amount of each type of tile that Terrazo should produce.
b.
Determine Terrazo’s contribution margin using your decision in requirement a.
c.
Assume that the demand for each type of tile is limited to 20,000 units each. Determine
the amount of each type of tile that Terrazo should produce.
d.
Determine Terrazo’s contribution margin using your decision in requirement b.
Type I: (£40 – £10)/.2 = £150 per machine hour
Type II: (£60 – £28)/.5 = £64 per machine hour
Type III: (£100 – £48)/1.25 = £41.60 per machine hour
Type I: 150,000 units (30,000 machine hours/.20)
£4,500,000 (150,000 units £30)
Type I: 20,000 units
Type II: 20,000 units
Type III: 12,800 units
Type I: 20,000 units .2 =
Type II: 20,000 units .5 =
Type III: 12,800 units 1.25 =
From requirement a, produce widgets first.
20,000 units 1.5 DLH per unit = 30,000 DLH to produce widgets
Use remaining 10,000 DLH available to produce gadgets.
10,000 DLH/1.2 DLH per unit = 8,333 units of gadgets
(20,000 units £90)
(8,333 units £60)
Total contribution margin
14. KnitWorks Ltd. produces three kinds of yarn. Details of each type of yarn are as follows:
Type I
Type II
Type III
Price per unit
£200
£250
£100
Unit variable cost
£150
£100
£ 60
Machine hours required
0.5
2.0
0.1
KnitWorks has 15,000 machine hours available for production.
Required:
Assume that KnitWorks can sell all of each type of yarn that it produces.
a.
Determine the amount of each type of yarn that KnitWorks should produce.
b.
Assume that the demand for each type of yarn is limited to 10,000 units each. Determine the
amount of each type of yarn that KnitWorks should produce.
c.
Assume that the demand for each type of yarn is limited to 10,000 units each. Determine
KnitWorks’ contribution margin.
Contribution margin per scarce unit of resource:
Type I: (£200 – £150)/0.5 = £100 per machine hour
Type II: (£250 – £100)/2.0 = £75 per machine hour
Type III: (£100 – £60)/0.1 = £400 per machine hour
Type III: 150,000 units (15,000 machine hours/0.1)
b.
Type III: 10,000 units
Type I: 10,000 units
Type II: 4,500 units
Type III: 10,000 units 0.1 =
Type I: 10,000 units 0.5 =
Type II: 4,500 units 2.0 =
15,000 hours
£1,575,000
Type III: 10,000 units £40 =
Type I: 10,000 units £50 =
Type II: 4,500 units £150 =
d.
£1,905,600
Type I: 20,000 units £30 =
Type II: 20,000 units £32 =
Type III: 12,800 units £52 =
£1,905,600
ESSAY
1. Describe the theory of constraints (TOC) and how it can be used to manage inventory.