SOLUTION
(30 min.) Make versus buy, activity-based costing, opportunity costs.
1. Relevant costs under buy alternative:
Relevant costs under make alternative:
The allocated fixed plant administration, taxes, and insurance will not change if
Lexington 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 Lexington to make rather than buy the
burners from the outside supplier.
2. Relevant costs under the make alternative:
Relevant costs under the buy alternative:
Additional contribution margin from using the space
where the burners were made to upgrade the grills by
Lexington 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:
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11-42 Product mix, constrained resource. Wechsler Company produces three products: A130,
B324, and C587. All three products use the same direct material, Brac. Unit data for the three
products are:
The demand for the products far exceeds the direct materials available to produce the products.
Brac costs $9 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 A130, B324, and C587 should Wechsler produce?
2. What is the maximum amount Wechsler would be willing to pay for another 1,200 pounds of
Brac?
SOLUTION
(25 min.) Product mix, constrained resource.
1.
A130 B324 C587
Selling price $252 $ 168 $210
Variable costs:
First, satisfy minimum requirements.
A130 B324 C587 Total
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The remaining 1,800 pounds (5,000 – 3,200) should be devoted to C587 because it has the
highest contribution margin per pound of direct material. Because each unit of C587 requires 3
pounds of Brac, the remaining 1,800 pounds can be used to produce another 600 units of C587.
The following combination yields the highest contribution margin given the 5,000 pounds
constraint on availability of Brac.
2. The demand for Wechsler’s products exceeds the materials available. Assuming that fixed
costs are covered by the original product mix, Wechsler would be willing to pay up to an
additional $21 per pound (the contribution margin per pound of C587) for another 1,200 pounds
of Brac. That is, Wechsler would be willing to pay $9 + $21 = $30 per pound of Brac for the
pounds of Brac that will be used to produce C587.1 If sufficient demand does not exist for 400
units (1,200 pounds ÷ 3 pounds per unit) of C587, then the maximum price Wechsler would be
willing to pay is an additional $12 per pound (the contribution margin per pound of A130) for the
pounds of Wechsler that will be used to produce A130. In this case Wechsler would be willing to
pay $9 + $12 = $21 pound. If all the 1,200 pounds of Brac are not used to satisfy the demand for
C587 and A130, then the maximum price Wechsler would be willing to pay is an additional
$8.40 per pound (the contribution margin per pound of B324) for the pounds of Brac that will be
used to produce B324. Wechsler would be willing to pay $8.40 + $9 = $17.40 per pound of
Brac.
1An alternative calculation focuses on column 3 for C587 of the table in requirement 1.
11-43 Product mix, special order. (N. Melumad, adapted) Gormley Precision Tools makes
cutting tools for metalworking operations. It makes two types of tools: A6, a regular cutting tool,
and EX4, a high-precision cutting tool. A6 is manufactured on a regular machine, but EX4 must
be manufactured on both the regular machine and a high-precision machine. The following
information is available:
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Additional information includes the following:
a. Gormley faces a capacity constraint on the regular machine of 50,000 hours per year.
b. The capacity of the high-precision machine is not a constraint.
c. Of the $1,100,000 budgeted fixed overhead costs of EX4, $600,000 are lease payments for
the high-precision machine. This cost is charged entirely to EX4 because Gormley uses the
machine exclusively to produce EX4. The company can cancel the lease agreement for the
high-precision machine at any time without penalties.
d. All other overhead costs are fixed and cannot be changed.
Required:
1. What product mix—that is, how many units of A6 and EX4—will maximize Gormley’s
operating income? Show your calculations.
2. Suppose Gormley can increase the annual capacity of its regular machines by 15,000
machine-hours at a cost of $300,000. Should Gormley increase the capacity of the regular
machines by 15,000 machine-hours? By how much will Gormley’s operating income
increase or decrease? Show your calculations.
3. Suppose that the capacity of the regular machines has been increased to 65,000 hours.
Gormley has been approached by Clark Corporation to supply 20,000 units of another cutting
tool, V2, for $240 per unit. Gormley must either accept the order for all 20,000 units or reject
it totally. V2 is exactly like A6 except that its variable manufacturing cost is $130 per unit. (It
takes 1 hour to produce one unit of V2 on the regular machine, and variable marketing cost
equals $20 per unit.) What product mix should Gormley choose to maximize operating
income? Show your calculations.
SOLUTION
(30–40 min.) Product mix, relevant costs.
1.
A6 EX4
Selling price $ 180 $ 280
Even though EX4 has the higher contribution margin per unit of the constrained resource, the
fact that Gormley must incur additional costs of $600,000 to achieve this higher contribution
margin means that Gormley is better off using its entire 50,000-hour capacity on the regular
2. If capacity of the regular machines is increased by 15,000 machine-hours to 65,000
machine-hours (50,000 originally + 15,000 new), the net relevant benefit from producing A6 and
EX4 is as follows:
A6 EX4
Total contribution margin from selling only
A6 or only EX4
Adding 15,000 machine-hours of capacity for regular machines and using all the capacity to
produce EX4 increases operating income by $3,000,000.
Investing in the additional capacity increases Gormley’s operating income by $500,000
3.
A6 EX4 V2
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Selling price $180 $280 $240
Contribution margin per unit of the constrained resource
$50
1
= $50;
$30
0.5
$30
0.5
= $60;
$70
1
$90
1
= $90
The first step is to compare the operating profits that Gormley could earn if it accepted the
Clark Corporation offer for 20,000 units with the operating profits Gormley is currently
earning. V2 has the highest contribution margin per hour on the regular machine and
A6 EX4
Total contribution margin from selling only
Gormley should use all the 45,000 hours of available capacity to produce 45,000 units of A6.
Thus, the product mix that maximizes operating income is 20,000 units of V2, 45,000 units of
11-44 Theory of constraints, throughput margin, and relevant costs. Washington Industries
manufactures electronic testing equipment. Washington also installs the equipment at
customers’ sites and ensures that it functions smoothly. Additional information on the
manufacturing and installation departments is as follows (capacities are expressed in terms of
the number of units of electronic testing equipment):
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Washington manufactures only 250 units per year because the installation department has only
enough capacity to install 250 units. The equipment sells for $55,000 per unit (installed) and has
direct material costs of $30,000. All costs other than direct material costs are fixed. The
following requirements refer only to the preceding data. There is no connection between the
requirements.
Required:
1. Washington’s engineers have found a way to reduce equipment manufacturing time. The new
method would cost an additional $500 per unit and would allow Washington to manufacture
30 additional units a year. Should Washington implement the new method? Show your
calculations.
2. Washington’s designers have proposed a change in direct materials that would increase direct
material costs by $2,000 per unit. This change would enable Washington to install 285 units
of equipment each year. If Washington makes the change, it will implement the new design
on all equipment sold. Should Washington use the new design? Show your calculations.
3. A new installation technique has been developed that will enable Washington’s engineers to
install 7 additional units of equipment a year. The new method will increase installation costs
by $145,000 each year. Should Washington implement the new technique? Show your
calculations.
4. Washington is considering how to motivate workers to improve their productivity (output
per hour). One proposal is to evaluate and compensate workers in the manufacturing and
installation departments on the basis of their productivities. Do you think the new proposal
is a good idea? Explain briefly.
SOLUTION
(20 min.) Theory of constraints, throughput contribution, relevant costs.
1. It will cost Washington $500 per unit to reduce manufacturing time. But manufacturing is
2. Increase in throughput margin, $25,000 5 units, $ 875,000
Alternatively, compare throughput margin under each alternative.
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3. Increase in throughput margin, $25,000 units $ 175,000
4. Motivating installation workers to increase productivity is worthwhile because
installation is a bottleneck operation, and any increase in productivity at the bottleneck will
increase throughput margin. On the other hand, motivating workers in the manufacturing
11-45 Theory of constraints, contribution margin, sensitivity analysis. Damon Furniture
(DF) produces fiberglass doors in two processes: molding and finishing. DF is currently
producing two models: Masoline and Aldernite. Production in the molding department is limited
by the amount of materials available. Production in the finishing department is limited by the
amount of trained labor available. The only variable costs are materials in the molding
department and labor in the finishing department. Following are the requirements and limitations
by model and department:
The following requirements refer only to the preceding data. There is no connection between the
requirements.
Required:
1. If there were enough demand for either door, which door would DF produce? How many of
these doors would it make and sell?
2. If DF sells three Masoline for each Aldernite, how many doors of each type would it produce
and sell? What would be the total contribution margin?
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3. If DF sells three Masoline for each Aldernite, how much would production and contribution
margin increase if the molding department could buy 9,000 more pounds of materials for $3
per pound?
4. If DF sells three Masoline for each Aldernite, how much would production and contribution
margin increase if the assembly department could get 780 more labor hours at $15 per hour?
SOLUTION
11-45 (30-35 min.) Theory of constraints, contribution margin, sensitivity analysis.
1. Assuming only one type of door is produced, the maximum production in each
department given their resource constraints is:
Molding
Department
Finishing Department Contribution Margin
Masoline
540,000 lbs = 18,000
30 lbs
102,000 hours = 34,000
3 hours
$235 − 30 × $3 – 3 × $15
= $100
Aldernite
540,000 lbs = 12,000
45 lbs
102,000 hours = 25,500
4 hours
$305 − 45 × $3 – 4 × $15
= $110
For both types of doors, the constraining resource is the availability of material because this
constraint causes the lowest maximum production.
2. As shown in Requirement 1, available material in the Molding department is the limiting
constraint.
If DF sells three Masolines for each Aldernite, then the maximum number of Aldernite doors the
Molding Department can produce (where the number of Aldernite doors is denoted as A) is:
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Contribution margin
3. With 9,000 more pounds of materials, DF would produce more doors. Using the same
technique as in Requirement 2, the increase in production is:
4. With 780 more labor hours, production would not change. The limiting constraint is
pounds of material, not labor hours. DF already has more labor hours available than it needs.
11-46 Closing down divisions. Ainsley Corporation has four operating divisions. The budgeted
revenues and expenses for each division for 2017 follows:
Further analysis of costs reveals the following percentages of variable costs in each division:
Closing down any division would result in savings of 40% of the fixed costs of that division.
Top management is very concerned about the unprofitable divisions (A and B) and is
considering closing them for the year.
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Required:
1. Calculate the increase or decrease in operating income if Ainsley closes division A.
2. Calculate the increase or decrease in operating income if Ainsley closes division B.
3. What other factors should the top management of Ainsley consider before making a
decision?
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