11-1
SOLUTION
1. Easyspread 2.0 has a higher relevant operating income than Easyspread 1.0. Based on this
analysis, Easyspread 2.0 should be introduced immediately:
Easyspread 1.0 Easyspread 2.0
Relevant revenues $165 $215
Relevant costs:
Manuals, diskettes, compact discs $ 0 $38
Total relevant costs 0 38
Relevant operating income $165 $177
Reasons for other cost items being irrelevant are
Easyspread 1.0
• Manuals, diskettes—already incurred
• Development costs—already incurred
• Marketing and administrative—fixed costs of period
Easyspread 2.0
• Development costs—already incurred
• Marketing and administration—fixed costs of period
Note that total marketing and administration costs will not change whether Easyspread 2.0 is
introduced on July 1, 2014, or on October 1, 2014.
2. Other factors to be considered:
a. Customer satisfaction. If 2.0 is significantly better than 1.0 for its customers, a
customer-driven organization would immediately introduce it unless other factors
offset this bias toward “do what is best for the customer.”
b. Quality level of Easyspread 2.0. It is critical for new software products to be fully
debugged. Easyspread 2.0 must be error-free. Consider an immediate release only if
2.0 passes all quality tests and can be supported fully by the salesforce.
c. Importance of being perceived to be a market leader. Being first in the market with a
new product can give Oregano Software a “first–mover advantage,” e.g., capturing an
initial large share of the market that, in itself, causes future potential customers to lean
toward purchasing Easyspread 2.0. Moreover, by introducing 2.0 earlier, Oregano can
get quick feedback from users about ways to further refine the software while its
competitors are still working on their own first versions. Moreover, by locking in early
customers, Oregano may increase the likelihood of these customers also buying future
upgrades of Easyspread 2.0.
d. Morale of developers. These are key people at Oregano Software. Delaying
introduction of a new product can hurt their morale, especially if a competitor then
preempts Oregano from being viewed as a market leader.
11-33 (30 min.) Opportunity costs and relevant costs
11-2
Jason Wu operates Exclusive Limousines, a fleet of 10 limousines used for weddings, proms, and
business events in Washington, D.C. Wu charges customers a flat fee of $250 per car taken on
contract plus an hourly fee of $80. His income statement for May follows:
All expenses are fixed, with the exception of driver wages and benefits and fuel costs, which
are both variable per hour. During May, the company’s limousines were fully booked. In June, Wu
expects that Exclusive Limousines will be operating near capacity. Shelly Worthington, a
prominent Washington socialite, has asked Wu to bid on a large charity event she is hosting in late
June. The limousine company she had hired has canceled at the last minute, and she needs the
service of five limousines for four hours each. She will only hire Exclusive Limousines if they
take the entire job. Wu checks his schedule and finds that he only has three limousines available
that day.
Required:
1. If Wu accepts the contract with Worthington, he would either have to (a) cancel two prom
contracts each for 1 car for 6 hours or (b) cancel one business event for three cars contracted
for two hours each. What are the relevant opportunity costs of accepting the Worthington
contract in each case? Which contract should he cancel?
2. Wu would like to win the bid on the Worthington job because of the potential for lucrative
future business. Assume that Wu cancels the contract in part 1 with the lowest opportunity
cost, and assume that the three currently available cars would go unrented if the company does
not win the bid. What is the lowest amount he should bid on the Worthington job?
3. Another limousine company has offered to rent Exclusive Limousines two additional cars for
$300 each per day. Wu would still need to pay for fuel and driver wages on these cars for the
Worthington job. Should Wu rent the two cars to avoid canceling either of the other two
contracts?
11-3
SOLUTION
1. If Wu cancels the two prom contracts, the opportunity cost of accepting the Worthington job
would be $886.40, as follows:
Lost revenue (2 × $250) + (12 hrs. × $80)
$1,460.00
Less variable costs
Driver wages and benefits* ($35 × 12 hrs.)
420.00
Fuel costs** ($12.80 × 12 hrs.)
153.60
Opportunity cost
$ 886.40
*Driver wages and benefits are $35/hour ($43,750 ÷ 1,250 hours)
** Fuel costs are $12.80/hour ($16,000 ÷ 1,250 hours)
If Wu cancels the business event contract, the opportunity cost would be $943.20, as
follows:
Lost revenue (3 × $250) + (6 hrs. × $80)
$1,230.00
Less variable costs
Driver wages and benefits* ($35 × 6 hrs.)
210.00
Fuel costs** ($12.80 × 6 hrs.)
76.80
Opportunity cost
$ 943.20
*Driver wages and benefits are $35/hour ($43,750 ÷ 1,250 hours)
** Fuel costs are $12.80/hour ($16,000 ÷ 1,250 hours)
Wu should cancel the prom contracts because the opportunity cost would be lower by $56.80
($943.20 – $886.40).
2. If Wu cancels the two prom contracts, opportunity cost equals $886.40. In addition, variable
costs of the 20-hour Worthington job would be (20 hrs. × $35) + (20 hrs. × $12.80) = $956.
Therefore, the minimum amount Wu would bid is $1,842.40 ($886.40 + $956).
3. Yes, it would be in Wu’s best interest to lease the additional cars for a total of $600 because it
is less than the opportunity cost of $886.40.
11-34 (20 min.) Opportunity costs.
(H. Schaefer, adapted) The Wild Orchid Corporation is working at full production capacity
producing 13,000 units of a unique product, Everlast. Manufacturing cost per unit for Everlast is:
11-4
Manufacturing overhead cost per unit is based on variable cost per unit of $8 and fixed costs of
$78,000 (at full capacity of 13,000 units). Marketing cost per unit, all variable, is $4, and the selling
price is $52.
A customer, the Apex Company, has asked Wild Orchid to produce 3,500 units of Stronglast,
a modification of Everlast. Stronglast would require the same manufacturing processes as Everlast.
Apex has offered to pay Wild Orchid $40 for a unit of Stronglast and share half of the marketing
cost per unit.
Required:
1. What is the opportunity cost to Wild Orchid of producing the 3,500 units of Stronglast?
(Assume that no overtime is worked.)
2. The Chesapeake Corporation has offered to produce 3,500 units of Everlast for Wild Orchid
so that Wild Orchid may accept the Apex offer. That is, if Wild Orchid accepts the Chesapeake
offer, Wild Orchid would manufacture 9,500 units of Everlast and 3,500 units of Stronglast
and purchase 3,500 units of Everlast from Chesapeake. Chesapeake would charge Wild Orchid
$36 per unit to manufacture Everlast. On the basis of financial considerations alone, should
Wild Orchid accept the Chesapeake offer? Show your calculations.
3. Suppose Wild Orchid had been working at less than full capacity, producing 9,500 units of
Everlast, at the time the Apex offer was made. Calculate the minimum price Wild Orchid
should accept for Stronglast under these conditions. (Ignore the previous $40 selling price.)
SOLUTION
1. The opportunity cost to Wild Orchid of producing the 3,500 units of Stronglast is the
contribution margin lost on the 3,500 units of Everlast that would have to be forgone, as computed
below:
Selling price
Variable costs per unit:
Direct materials
Direct manufacturing labor
Variable manufacturing overhead
Variable marketing costs
Contribution margin per unit
Contribution margin for 3,500 units ($28 3,500 units)
$ 52
$10
2
8
4 24
$ 28
$98,000
11-5
The opportunity cost is $98,000. Opportunity cost is the maximum contribution to
operating income that is forgone (rejected) by not using a limited resource in its next-best
alternative use.
2. Contribution margin from manufacturing 3,500 units of Stronglast and purchasing 3,500
units of Everlast from Chesapeake is $105,000, as follows:
Manufacture
Stronglast
Purchase
Everlast
Total
Selling price
Variable costs per unit:
Purchase costs
Direct materials
Direct manufacturing labor
Variable manufacturing costs
Variable marketing overhead
Variable costs per unit
Contribution margin per unit
Contribution margin from selling 3,500 units
of Stronglast and 3,500 units of Everlast
($18 3,500 units; $12 3,500 units)
$ 40
–
10
2
8
2
22
$ 18
$63,000
$ 52
36
4
40
$ 12
$42,000
$105,000
As calculated in requirement 1, Wild Orchid’s contribution margin from continuing to
manufacture 3,500 units of Everlast is $98,000. Accepting the Apex Company and Chesapeake
offer will benefit Wild Orchid by $7,000 ($105,000 – $98,000). Hence, Wild Orchid should accept
the Apex Company and Chesapeake Corporation’s offers.
3. The minimum price would be any price greater than $22, the sum of the incremental costs
of manufacturing and marketing Stronglast as computed in requirement 2. This follows because,
if Wild Orchid has surplus capacity, the opportunity cost = $0. For the short-run decision of
whether to accept Apex’s offer, fixed costs of Wild Orchid are irrelevant. Only the incremental
costs need to be covered for it to be worthwhile for Wild Orchid to accept the Apex offer.
11-35 (30–40 min.) Make or buy, unknown level of volume.
(A. Atkinson, adapted) Denver Engineering manufactures small engines that it sells to
manufacturers who install them in products such as lawn mowers. The company currently
manufactures all the parts used in these engines but is considering a proposal from an external
supplier who wishes to supply the starter assemblies used in these engines.
The starter assemblies are currently manufactured in Division 3 of Denver Engineering. The
costs relating to the starter assemblies for the past 12 months were as follows:
11-6
Over the past year, Division 3 manufactured 150,000 starter assemblies. The average cost for each
starter assembly is $10($1,500,000 ÷ 150,000).
Further analysis of manufacturing overhead revealed the following information. Of the total
manufacturing overhead, only 25% is considered variable. Of the fixed portion, $300,000 is an
allocation of general overhead that will remain unchanged for the company as a whole if
production of the starter assemblies is discontinued. A further $200,000 of the fixed overhead is
avoidable if production of the starter assemblies is discontinued. The balance of the current fixed
overhead, $100,000, is the division manager’s salary. If Denver Engineering discontinues
production of the starter assemblies, the manager of Division 3 will be transferred to Division 2 at
the same salary. This move will allow the company to save the $80,000 salary that would otherwise
be paid to attract an outsider to this position.
Required:
1. Tutwiler Electronics, a reliable supplier, has offered to supply starter-assembly units at $8 per
unit. Because this price is less than the current average cost of $10 per unit, the vice president
of manufacturing is eager to accept this offer. On the basis of financial considerations alone,
should Denver Engineering accept the outside offer? Show your calculations. (Hint:
Production output in the coming year may be different from production output in the past year.)
2. How, if at all, would your response to requirement 1 change if the company could use the
vacated plant space for storage and, in so doing, avoid $100,000 of outside storage charges
currently incurred? Why is this information relevant or irrelevant?
SOLUTION
1. The variable costs required to manufacture 150,000 starter assemblies are
Direct materials $400,000
Direct manufacturing labor 300,000
Variable manufacturing overhead 200,000
Total variable costs $900,000
The variable costs per unit are $900,000 ÷ 150,000 = $6.00 per unit.
Let X = number of starter assemblies required in the next 12 months.
The data can be presented in both “all data” and “relevant data” formats:
All Data
Relevant Data
Alternative
1:
Make
Alternative
2:
Buy
Alternative
1:
Make
Alternative
2: Buy
Variable manufacturing costs
Fixed general manufacturing overhead
Fixed overhead, avoidable
Division 2 manager’s salary
Division 3 manager’s salary
Purchase cost, if bought from
Tutwiler Electronics
Total costs
$ 6X
300,000
200,000
80,000
100,000
–
$680,000
+ $ 6X
–
$300,000
–
100,000
–
8X
$400,000
+ $ 8X
$ 6X
–
200,000
80,000
100,000
–
$380,000
+ $ 6X
–
–
–
$100,000
–
8X
$100,000
+ $ 8X
The number of units at which the costs of make and buy are equivalent is
All data analysis: $680,000 + $6X = $400,000 + $8X
2X = 280,000
X = 140,000
or
Relevant data analysis: $380,000 + $6X = $100,000 + $8X
2X = 280,000
X = 140,000
Assuming cost minimization is the objective, then
• If production is expected to be less than 140,000 units, it is preferable to buy units from
Tutwiler.
• If production is expected to exceed 140,000 units, it is preferable to manufacture
internally (make) the units.
• If production is expected to be 140,000 units, Denver should be indifferent between
buying units from Tutwiler and manufacturing (making) the units internally.
2. The information on the storage cost, which is avoidable if self-manufacture is discontinued,
is relevant; these storage charges represent current outlays that are avoidable if self-manufacture
is discontinued. Assume these $100,000 charges are represented as an opportunity cost of the make
alternative. The costs of internal manufacture that incorporate this $100,000 opportunity cost are
All data analysis: $780,000 + $6X
Relevant data analysis: $480,000 + $6X
Alternatively stated, we would add the following line to the table shown in requirement 1
causing the total costs line to change as follows:
All Data
Relevant Data
Alternative 1:
Alternative 2:
Alternative 1:
Alternative 2:
Make
Buy
Make
Buy
11-8
Outside storage charges
$100,000
$0
$100,000
$0
Total costs
$780,0001 + 6X
$400,000 + 8X
$480,0002 + 6X
$100,000 + 8X
1$780,000 = $680,000 + $100,000 2$480,000 = $380,000 + $100,000
The number of units at which the costs of make and buy are equivalent is
All data analysis: $780,000 + $6X = $400,000 + $8X
2X = 380,000
X = 190,000
Relevant data analysis: $480,000 + $6X = $100,000 + $8X
2X = 380,000
X = 190,000
If production is expected to be less than 190,000, it is preferable to buy units from Tutwiler. If
production is expected to exceed 190,000, it is preferable to manufacture the units internally.
11-36 (30 min.) Make versus buy, activity-based costing, opportunity costs.
The Lexington Company produces gas grills. This year’s expected production is 20,000 units.
Currently, Lexington makes the side burners for its grills. Each grill includes two side burners.
Lexington’s management accountant reports the following costs for making the 40,000 burners:
Lexington has received an offer from an outside vendor to supply any number of burners Lexington
requires at $14.80 per burner. The following additional information is available:
a. Inspection, setup, and materials-handling costs vary with the number of batches in which the
burners are produced. Lexington produces burners in batch sizes of 1,000 units. Lexington will
produce the 40,000 units in 40 batches.
b. Lexington rents the machine it uses to make the burners. If Lexington buys all of its burners
from the outside vendor, it does not need to pay rent on this machine.
Required:
11-9
1. Assume that if Lexington purchases the burners from the outside vendor, the facility where the
burners are currently made will remain idle. On the basis of financial considerations alone,
should Lexington accept the outside vendor’s offer at the anticipated volume of 40,000
burners? Show your calculations.
2. For this question, assume that if the burners are purchased outside, the facilities where the
burners are currently made will be used to upgrade the grills by adding a rotisserie attachment.
(Note: Each grill contains two burners and one rotisserie attachment.) As a consequence, the
selling price of grills will be raised by $48. The variable cost per unit of the upgrade would be
$38, and additional tooling costs of $160,000 per year would be incurred. On the basis of
financial considerations alone, should Lexington make or buy the burners, assuming that
20,000 grills are produced (and sold)? Show your calculations.
3. The sales manager at Lexington is concerned that the estimate of 20,000 grills may be high
and believes that only 16,000 grills will be sold. Production will be cut back, freeing up work
space. This space can be used to add the rotisserie attachments whether Lexington buys the
burners or makes them in-house. At this lower output, Lexington will produce the burners in
32 batches of 1,000 units each. On the basis of financial considerations alone, should Lexington
purchase the burners from the outside vendor? Show your calculations.
SOLUTION
1. Relevant costs under buy alternative:
Purchases, 40,000 $14.80 $592,000
Relevant costs under make alternative:
Direct materials $320,000
Direct manufacturing labor 160,000
Variable manufacturing overhead 80,000
Inspection, setup, materials handling 8,000
Machine rent 12,000
Total relevant costs under make alternative $580,000
The allocated fixed plant administration, taxes, and insurance will not change if Weaver
makes or buys the burners. Hence, these costs are irrelevant to the make-or-buy decision. The
analysis indicates that it is less costly for Weaver to make rather than buy the burners from the
outside supplier.
2. Relevant costs under the make alternative:
Relevant costs (as computed in requirement 1) $580,000
Relevant costs under the buy alternative:
Costs of purchases (40,000 $14.80) $592,000
Additional tooling costs 160,000
Additional contribution margin from using the space
where the burners were made to upgrade the grills by
adding rotisserie attachments, 20,000 ($48 – $38) (200,000)
Total relevant costs under the buy alternative $552,000
11-10
Weaver should buy the side burners from an outside vendor and use its own capacity to
upgrade its grills.
3. In this requirement, the decision on making the rotisserie attachments is irrelevant to the
analysis because the rotisserie attachments increase operating income and they will be made
whether the burners are purchased or made.
Relevant cost of manufacturing burners:
Variable costs, ($8 + $4 + $2 = $14) 32,000 $448,000
Batch costs, $200/batcha 32 batches 6,400
Machine rent 12,000
$466,400
Relevant cost of buying burners, $14.80 32,000 473,600
a$8,000 40 batches = $200 per batch
In this case, Weaver should make the burners.
11-37 (25 min.) Product mix, constrained resource.
Wechsler Company produces three products: A110, B382, and C657. All three products use the
same direct material, Voxx. Unit data for the three products are:
The demand for the products far exceeds the direct materials available to produce the products.
Voxx costs $6 per pound, and a maximum of 5,000 pounds is available each month. Wechsler
must produce a minimum of 200 units of each product.
Required:
1. How many units of product A110, B382, and C657 should Wechsler produce?
2. What is the maximum amount Wechsler would be willing to pay for another 1,200 pounds of
Voxx?