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Problem 10-23A (continued)
4. Under these circumstances, the company should make the 100,000
boxes of tubes and purchase the remaining 20,000 boxes from the
outside supplier. The costs would:
Cost of making: 100,000 boxes × $1.15 per box .....
$115,000
Cost of buying: 20,000 boxes × $1.35 per box ........
27,000
Total cost ..............................................................
$142,000
Problem 10-24A (45 minutes)
1. Product RG-6 has a contribution margin of $8 per unit ($22 – $14 = $8).
If the plant closes, this contribution margin will be lost on the 16,000
units (8,000 units per month × 2 months) that could have been sold
during the two-month period. However, the company will be able to
avoid some fixed costs as a result of closing down. The analysis is:
Contribution margin lost by closing the plant for
two months ($8 per unit × 16,000 units) ..........
$(128,000)
Costs avoided by closing the plant for two months:
Fixed manufacturing overhead cost ($45,000
per month × 2 months = $90,000) ................
$90,000
Fixed selling costs ($30,000 per month × 10%
× 2 months) ................................................
6,000
96,000
Net disadvantage of closing, before start-up
costs ..............................................................
(32,000)
Add start-up costs .............................................
8,000
Disadvantage of closing the plant .......................
$ (40,000)
No, the company should not close the plant; it should continue to
operate at the reduced level of 8,000 units produced and sold each
month. Closing will result in a $40,000 greater loss over the two-month
period than if the company continues to operate. An additional factor is
the potential loss of goodwill among the customers who need the 8,000
units of RG-6 each month. By closing down, the needs of these
customers will not be met (no inventories are on hand), and their
business may be permanently lost to another supplier.
Problem 10-24A (continued)
Alternative Solution:
Plant
Kept
Open
Plant
Closed
Difference:
Net
Operating
Income
Increase or
(Decrease)
Sales (8,000 units × $22 per
unit × 2).............................
$ 352,000
$ 0
$(352,000)
Variable expenses (8,000 units
× $14 per unit × 2) .............
224,000
0
224,000
Contribution margin ...............
128,000
0
(128,000)
Less fixed costs:
Fixed manufacturing
overhead costs ($150,000
× 2) .................................
300,000
210,000
90,000
Fixed selling costs
($30,000 × 2) ..................
60,000
54,000
*
6,000
Total fixed costs .....................
360,000
264,000
96,000
Net operating loss before
start-up costs ......................
(232,000)
(264,000)
(32,000)
Start-up costs ........................
0
(8,000)
(8,000)
Net operating loss ..................
$(232,000)
$(272,000)
$ (40,000)
*
$30,000 × 90% = $27,000 × 2 = $54,000
Problem 10-24A (continued)
2. Birch Company will not be affected at a level of 11,000 total units sold
over the two-month period. The computations are:
Cost avoided by closing the plant for two months
(see above) .........................................................
$96,000
Less start-up costs .................................................
8,000
Net avoidable costs ................................................
$88,000
Net avoidable costs $88,000
Operate at
11,000
Units for
Two
Months
Close for
Two
Months
Sales (11,000 units × $22 per unit) ..........
$ 242,000
$ 0
Variable expenses (11,000 units × $14
per unit) ..............................................
154,000
0
Contribution margin .................................
88,000
0
Fixed expenses:
Manufacturing overhead ($150,000 and
$105,000, × 2) ..................................
300,000
210,000
Selling ($30,000 and $27,000, × 2)........
60,000
54,000
Total fixed expenses ................................
360,000
264,000
Start-up costs .........................................
0
8,000
Total costs ..............................................
360,000
272,000
Net operating loss ...................................
$(272,000)
$(272,000)
Problem 10-25A (60 minutes)
1.
Debbie
Trish
Sarah
Mike
Sewing
Kit
Direct labor cost per unit ..
$ 3.20
$2.00
$ 5.60
$ 4.00
$ 1.60
Direct labor hours per
unit* (a) .......................
0.40
0.25
0.70
0.50
0.20
Selling price .....................
$13.50
$5.50
$21.00
$10.00
$ 8.00
Variable costs:
Direct materials .............
4.30
1.10
6.44
2.00
3.20
Direct labor ...................
3.20
2.00
5.60
4.00
1.60
Variable overhead ..........
0.80
0.50
1.40
1.00
0.40
Total variable costs ...........
8.30
3.60
13.44
7.00
5.20
Contribution margin (b) ....
$ 5.20
$1.90
$ 7.56
$ 3.00
$ 2.80
Contribution margin per
DLH (b) ÷ (a) ................
$13.00
$7.60
$10.80
$ 6.00
$14.00
* Direct labor cost per unit ÷ 8 direct labor hours.
2.
Product
DLH Per
Unit
Estimated
Sales
(units)
Total
Hours
Debbie........................
0.40
hours
50,000
20,000
Trish ...........................
0.25
hours
42,000
10,500
Sarah .........................
0.70
hours
35,000
24,500
Mike ...........................
0.50
hours
40,000
20,000
Sewing Kit ..................
0.20
hours
325,000
65,000
Total hours required ....
140,000
3. Because the Mike doll has the lowest contribution margin per labor hour,
its production should be reduced by 20,000 dolls (10,000 excess hours
Problem 10-25A (continued)
An alternative means of deriving this solution is as follows:
Amount of constrained resource available ................
130,000 hours
Less: Constrained resource required for production
of 325,000 units of the Sewing Kit .......................
65,000 hours
Remaining constrained resource available ................
65,000 hours
Less: Constrained resource required for production
of 50,000 units of the Debbie doll .......................
20,000 hours
Remaining constrained resource available ................
45,000 hours
Less: Constrained resource required for production
of 35,000 units of the Sarah doll .........................
24,500 hours
Remaining constrained resource available ................
20,500 hours
Less: Constrained resource required for production
of 42,000 units of the Trish doll ...........................
10,500 hours
Remaining constrained resource available ................
10,000 hours
Less: Constrained resource required for production
of 20,000 units of the Mike doll ...........................
10,000 hours
Remaining constrained resource available ................
0 hours
4. The highest possible contribution margin is the sum of the contribution
margins earned on each of the five products, or $1,574,400:
Sewing
Kit
Debbie
Sarah
Trish
Mike
Unit contribution
margin (a) ..........
$2.80
$5.20
$7.56
$1.90
$3.00
Optimal production
plan (b) ..............
325,000
50,000
35,000
42,000
20,000
Total contribution
margin (a) × (b) .
$910,000
$260,000
$264,600
$79,800
$60,000
Problem 10-25A (continued)
5. Because the additional capacity would be used to produce the Mike doll,
the company should be willing to pay up to $14 per hour ($8 usual rate
profit.
6. Additional output could be obtained in a number of ways including
working overtime, adding another shift, expanding the workforce,
contracting out some work to outside suppliers, and eliminating wasted
labor time in the production process. The first four methods are costly,
Problem 10-26A (60 minutes)
1. The simplest approach to the solution is:
Gross margin lost if the store is closed ............
$(316,800)
Costs that can be avoided:
Sales salaries ...........................................
$70,000
Direct advertising .....................................
51,000
Store rent ................................................
85,000
Delivery salaries .......................................
4,000
Store management salaries
($21,000 – $12,000) ..............................
9,000
Salary of new manager ............................
11,000
General office compensation .....................
6,000
Insurance on inventories ($7,500 × 2/3) ...
5,000
Utilities ....................................................
31,000
Employment taxes ...................................
15,000
*
287,000
Decrease in company profits if the North
Store is closed .........................................
$ (29,800)
*Salaries avoided by closing the store:
Sales salaries ..........................................
$70,000
Delivery salaries ......................................
4,000
Store management salaries ......................
9,000
Salary of new manager ............................
11,000
General office compensation ....................
6,000
Total avoided .............................................
100,000
Employment tax rate ..................................
× 15%
Employment taxes avoided .........................
$15,000
Problem 10-26A (continued)
Alternative Solution:
North
Store
Kept
Open
North
Store
Closed
Difference:
Net
Operating
Income
Increase or
(Decrease)
Sales ...........................................
$720,000
$ 0
$(720,000)
Cost of goods sold .......................
403,200
0
403,200
Gross margin ...............................
316,800
0
(316,800)
Selling and administrative
expenses:
Selling expenses:
Sales salaries ..........................
70,000
0
70,000
Direct advertising ...................
51,000
0
51,000
General advertising .................
10,800
10,800
0
Store rent ..............................
85,000
0
85,000
Depreciation of store fixtures ...
4,600
4,600
0
Delivery salaries .....................
7,000
3,000
4,000
Depreciation of delivery
equipment ...........................
3,000
3,000
0
Total selling expenses ................
231,400
21,400
210,000
Administrative expenses:
Store management salaries .....
21,000
12,000
9,000
Salary of new manager ...........
11,000
0
11,000
General office compensation ...
12,000
6,000
6,000
Insurance on fixtures and
inventory .............................
7,500
2,500
5,000
Utilities ..................................
31,000
0
31,000
Employment taxes ..................
18,150
3,150
15,000
*
General office—other ..............
18,000
18,000
0
Total administrative expenses ....
118,650
41,650
77,000
Total operating expenses ..............
350,050
63,050
287,000
Net operating income (loss) ..........
$(33,250)
$(63,050)
$ (29,800)
Problem 10-26A (continued)
2. Based on the data in (1), the North Store should not be closed. If the
store is closed, then the company’s overall net operating income will
3. Under these circumstances, the North Store should be closed. The
computations are as follows:
Gross margin lost if the North Store is closed (part 1) .....
$(316,800)
Gross margin gained from the East Store: $720,000 ×
1/4 = $180,000; $180,000 × 45%* = $81,000 ............
81,000
Net operating loss in gross margin .................................
(235,800)
Less costs that can be avoided if the North Store is
closed (part 1) ...........................................................
287,000
Net advantage of closing the North Store .......................
$ 51,200
*The East Store’s gross margin percentage is:
$486,000 ÷ $1,080,000 = 45%
Problem 10-27A (60 minutes)
1. A product should be processed further if the incremental revenue from
the further processing exceeds the incremental costs. The incremental
revenue from further processing of the Grit 337 is:
Selling price of the silver polish, per jar .................
$4.00
Selling price of 1/4 pound of Grit 337 ($2.00 ÷ 4) .
0.50
Incremental revenue per jar .................................
$3.50
Problem 10-27A (continued)
2. Only the cost of advertising and the cost of the production supervisor
are avoidable if production of the silver polish is discontinued.
Therefore, the number of jars of silver polish that must be sold each
month to justify continued processing of the Grit 337 into silver polish
is:
Production supervisor ..........
$3,000
Advertising—direct...............
4,000
Avoidable fixed costs ...........
$7,000
Avoidable fixed costs $7,000
=
Incremental CM per jar $0.70 per jar
= 10,000 jars per month
Therefore, if 10,000 jars of silver polish can be sold each month, the
company would be indifferent between selling it or selling all of the Grit
337 as a cleaning powder. If the sales of the silver polish are greater
than 10,000 jars per month, then continued processing of the Grit 337
into silver polish would be advisable because the company’s total profits
will be increased. If the company can’t sell at least 10,000 jars of silver
polish each month, then production of the silver polish should be
discontinued. To verify this, we show on the next page the total
contribution to profits of sales of 9,000, 10,000, and 11,000 jars of silver
polish, contrasted to sales of equivalent amounts of Grit 337 sold
outright (i.e., 10,000 jars of silver polish would require the use of 2,500
pounds of Grit 337 that otherwise could be sold outright as cleaning
powder, etc.):
Problem 10-27A (continued)
9,000
Jars of
Polish;
or 2,250
pounds
of Grit
337
10,000
Jars of
Polish;
or 2,500
pounds
of Grit
337
11,000
Jars of
Polish;
or 2,750
pounds
of Grit
337
Sales of Silver Polish:
Sales @ $4.00 per jar .........................
$36,000
$40,000
$44,000
Variable expenses:
Production cost of Grit 337 @ $1.60
per pound .......................................
3,600
*
4,000
*
4,400
*
Further processing and selling costs of
the polish @ $2.80 per jar ................
25,200
28,000
30,800
Total variable expenses .........................
28,800
32,000
35,200
Contribution margin ..............................
7,200
8,000
8,800
Avoidable fixed costs:
Production supervisor .........................
3,000
3,000
3,000
Advertising ........................................
4,000
4,000
4,000
Total avoidable fixed costs .....................
7,000
7,000
7,000
Total contribution to common fixed
costs and to profits.............................
$ 200
$ 1,000
$ 1,800
Sales of Grit 337:
Sales @ $2.00 per pound ....................
$ 4,500
$ 5,000
$ 5,500
Variable expenses:
Production cost of Grit 337 @ $1.60
per pound .......................................
3,600
*
4,000
*
4,400
*
Contribution to common fixed costs and
to profits ...........................................
$ 900
$ 1,000
$ 1,100
Problem 10-28A (60 minutes)
1. The $2.80 per drum general overhead cost is not relevant to the
decision because this cost will be the same regardless of whether the
Differential Costs
Per Drum
Total Differential Costs—
60,000 Drums
Make
Buy
Make
Buy
Outside supplier’s price .
$18.00
$1,080,000
Direct materials ............
$10.35
$621,000
Direct labor
($6.00 × 70%) ..........
4.20
252,000
Variable overhead
($1.50 × 70%) ..........
1.05
63,000
Supervision ..................
0.75
45,000
Equipment rental* ........
2.25
*
135,000
Total cost .....................
$18.60
$18.00
$1,116,000
$1,080,000
Difference in favor of buying ................................
$0.60
$36,000
*
$135,000 per year ÷ 60,000 drums = $2.25 per drum.
Problem 10-28A (continued)
2. a. Notice that unit costs for both supervision and equipment rental
decrease with the greater volume because these fixed costs are
spread over more units.
Differential
Cost Per Drum
Total Differential Cost—
75,000 Drums
Make
Buy
Make
Buy
Outside supplier’s price ....
$18.00
$1,350,000
Direct materials ...............
$10.35
$776,250
Direct labor .....................
4.20
315,000
Variable overhead ............
1.05
78,750
Supervision ($45,000 ÷
75,000 drums) ..............
0.60
45,000
Equipment rental
($135,000 ÷ 75,000
drums) .........................
1.80
135,000
Total cost ........................
$18.00
$18.00
$1,350,000
$1,350,000
Difference .......................
$0
$0
The company would be indifferent between the two alternatives if
75,000 drums were needed each year.
Problem 10-28A (continued)
b. Again, notice that the unit costs for both supervision and equipment
rental decrease with the greater volume of units.
Differential
Costs Per Drum
Total Differential Cost—
90,000 Drums
Make
Buy
Make
Buy
Outside supplier’s price ....
$18.00
$1,620,000
Direct materials ...............
$10.35
$931,500
Direct labor .....................
4.20
378,000
Variable overhead ............
1.05
94,500
Supervision ($45,000 ÷
90,000 drums) ..............
0.50
45,000
Equipment rental
($135,000 ÷ 90,000
drums) .........................
1.50
135,000
Total cost ........................
$17.60
$18.00
$1,584,000
$1,620,000
Problem 10-28A (continued)
3. Other factors that the company should consider include:
a. Will volume in future years increase, or will it remain constant at
60,000 units per year? (If volume increases, then renting the new
equipment becomes more desirable, as shown in the computations
above.)
Case (45 minutes)
1. As much yarn as possible should be processed into sweaters. Products
should be processed further so long as the added revenues from further
processing are greater than the added costs. In this case, the added
revenues and costs are:
Per Sweater
Added revenue ($30.00 – $20.00) .......
$10.00
Added costs:
Buttons, thread, lining ......................
$2.00
Direct labor .....................................
5.80
7.80
Added contribution margin ..................
$ 2.20
Thus, the company will gain $2.20 in contribution margin for each
spindle of yarn that is further processed into a sweater. The fixed
manufacturing overhead costs are not relevant to the decision because
they will be the same regardless of whether the yarn is sold or
processed further. In addition, we must omit the $16.00 cost of
manufacturing the yarn because this cost will be incurred whether the
yarn is sold as is or is used in sweaters.
2. The lowest price the company should accept is $27.80 per sweater. The
simplest approach to this answer is:
Present selling price per sweater .........
$30.00
Less added contribution margin being
realized on each sweater sold ...........
2.20
Minimum selling price per sweater .......
$27.80
A more involved approach to the same answer is to reason as follows:
If the wool yarn is sold outright, then the company will realize a
contribution margin of $9.40 per spindle:
Per Spindle
Selling price ..........................
$20.00
Variable expenses:
Raw wool ...........................
$7.00
Direct labor ........................
3.60
10.60
Contribution margin ...............
$ 9.40
Case (continued)
This $9.40 is an opportunity cost. The price of the sweaters must be
high enough to cover this opportunity cost. In addition, the company
must be able to cover all of its variable costs from the time the raw wool
is purchased until the sweater is completed. Therefore, the minimum
price is:
Variable costs of producing a spindle of yarn:
Raw wool ...................................................
$7.00
Direct labor ................................................
3.60
$10.60
Added variable costs of producing a sweater:
Buttons, etc. ...............................................
2.00
Direct labor ................................................
5.80
7.80
Total variable costs ........................................
18.40
Opportunity cost—contribution margin if the
yarn is sold outright ....................................
9.40
Minimum selling price per sweater ..................
$27.80
