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SOLUTION
(20–25 min.) Relevant costs, contribution margin, product emphasis.
1.
Cola Lemonade Punch
Natural
Orange
Juice
2. The argument fails to recognize that shelf space is the constraining factor. There are only
12 feet of front shelf space to be devoted to drinks. Sexton should aim to get the highest daily
contribution margin per foot of front shelf space:
Cola Lemonade Punch
Natural
Orange
Juice
3. The allocation that maximizes the daily contribution from so, drink sales is:
Daily Contribution
Feet of per Foot of Total Contribution
Shelf Space Front Shelf Space Margin per Day
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The maximum of six feet of front shelf space will be devoted to Natural Orange Juice because it
has the highest contribution margin per unit of the constraining factor. Four feet of front shelf
space will be devoted to Punch, which has the second highest contribution margin per unit of
11-28 Selection of most profitable product. Body Image, Inc., produces two basic types of
weight-lifting equipment, Model 9 and Model 14. Pertinent data are as follows:
The weight-lifting craze suggests that Body Image can sell enough of either Model 9 or Model
14 to keep the plant operating at full capacity. Both products are processed through the same
production departments.
Required:
Which product should the company produce? Briefly explain your answer.
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SOLUTION
(10 min.) Selection of most profitable product.
Only Model 9 should be produced. The key to this problem is the relationship of manufacturing
overhead to each product. Note that it takes twice as long to produce Model 9; machine-hours
for Model 9 are twice that for Model 14. Management should choose the product mix that
maximizes operating income for a given production capacity (the scarce resource in this
situation). In this case, despite the fact that model 9 requires twice the number of machine
hours to produce each unit, its contribution margin per unit is so great that it still has a higher
contribution margin per machine-hour. Model 14 will yield a $29 contribution to <xed costs per
machine hour, and Model 9 will yield $40:
Model 9 Model 14
Selling price
$150.00
$85.00
*Variable cost per unit = Direct material cost per unit + Direct manufacturing labor cost per
11-29 Theory of constraints, throughput margin, relevant costs. The Denver Corporation
manufactures filing cabinets in two operations: machining and finishing. It provides the
following information:
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Each cabinet sells for $75 and has direct material costs of $35 incurred at the start of the
machining operation. Denver has no other variable costs. Denver can sell whatever output it
produces. The following requirements refer only to the preceding data. There is no connection
between the requirements.
Required:
1. Denver is considering using some modern jigs and tools in the finishing operation that would
increase annual finishing output by 1,150 units. The annual cost of these jigs and tools is
$35,000. Should Denver acquire these tools? Show your calculations.
2. The production manager of the Machining Department has submitted a proposal to do faster
setups that would increase the annual capacity of the Machining Department by 9,000 units
and would cost $20,000 per year. Should Denver implement the change? Show your
calculations.
3. An outside contractor offers to do the finishing operation for 10,000 units at $9 per unit,
triple the $3 per unit that it costs Denver to do the finishing in-house. Should Denver accept
the subcontractor’s offer? Show your calculations.
4. The Hammond Corporation offers to machine 5,000 units at $3 per unit, half the $6 per unit
that it costs Denver to do the machining in-house. Should Denver accept Hammond’s offer?
Show your calculations.
5. Denver produces 2,000 defective units at the machining operation. What is the cost to Denver
of the defective items produced? Explain your answer briefly.
6. Denver produces 2,000 defective units at the finishing operation. What is the cost to Denver
of the defective items produced? Explain your answer briefly.
SOLUTION
(25 min.) Theory of constraints, throughput contribution, relevant costs.
1. Finishing is a boCleneck operation. Therefore, producing 1,150 more units will generate
additional contribution (throughput) margin and operating income.
Denver should invest in the modern jigs and tools because the benefit of higher contribution
(throughput) margin of $46,000 exceeds the cost of $35,000.
2. The Machining Department has excess capacity and is not a boCleneck operation.
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3. Finishing is a boCleneck operation. Therefore, geFng an outside contractor to produce
10,000 units will increase contribution (throughput) margin.
Denver should contract with an outside contractor to do 10,000 units of <nishing at $9 per unit
4. Operating costs in the Machining Department of $600,000, or $6 per unit, are <xed
costs. Denver will not save any of these costs by subcontracting machining of 5,000 units to
5. The cost of 2,000 defective units in the Machining Operation is $35 per unit 2,000
6. The cost of 2,000 defective units in the Finishing Operation is:
Alternatively, the cost of 2,000 defective units in the Finishing Operation equals the revenues
11-30 Closing and opening stores. Sanchez Corporation runs two convenience stores, one in
Connecticut and one in Rhode Island. Operating income for each store in 2017 is as follows:
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The equipment has a zero disposal value. In a senior management meeting, Maria Lopez, the
management accountant at Sanchez Corporation, makes the following comment, “Sanchez can
increase its profitability by closing down the Rhode Island store or by adding another store like
it.”
Required:
1. By closing down the Rhode Island store, Sanchez can reduce overall corporate overhead
costs by $44,000. Calculate Sanchez’s operating income if it closes the Rhode Island store. Is
Maria Lopez’s statement about the effect of closing the Rhode Island store correct? Explain.
2. Calculate Sanchez’s operating income if it keeps the Rhode Island store open and opens
another store with revenues and costs identical to the Rhode Island store (including a cost of
$22,000 to acquire equipment with a one-year useful life and zero disposal value). Opening
this store will increase corporate overhead costs by $4,000. Is Maria Lopez’s statement about
the effect of adding another store like the Rhode Island store correct? Explain.
SOLUTION
(2530 min.) Closing and opening stores.
1. Solution Exhibit 11-30, Column 1, presents the relevant loss in revenues and the relevant
savings in costs from closing the Rhode Island store. Lopez is correct that Sanchez Corporation’s
2. Solution Exhibit 11-30, Column 2, presents the relevant revenues and relevant costs of
opening another store like the Rhode Island store. Lopez is correct that opening such a store
would increase Sanchez Corporation’s operating income by $11,000. Incremental revenues of
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SOLUTION EXHIBIT 11-30
Relevant-Revenue and Relevant-Cost Analysis of Closing Rhode Island Store and Opening
Another Store Like It.
Incremental
(Loss in Revenues) Revenues and
and Savings in (Incremental Costs)
Costs from Closing of Opening New Store
Rhode Island Store Like Rhode Island Store
(1) (2)
Revenues $(860,000) $ 860,000
Cost of goods sold 660,000 (660,000)
Lease rent 75,000 (75,000)
Labor costs 42,000 (42,000)
Depreciation of equipment 0 (22,000)
Utilities (electricity, heating) 46,000 (46,000)
Corporate overhead costs 44 ,000 (4 ,000)
Total costs 867 ,000 (849 ,000)
Effect on operating income (loss) $ 7 ,000 $ 11 ,000
11-31 Choosing customers. Newbury Printers operates a printing press with a monthly capacity
of 3,200 machine-hours. Newbury has two main customers: Wallace Corporation and Kimberly
Corporation. Data on each customer for January are:
Kimberly Corporation indicates that it wants Newbury to do an additional $160,000 worth of
printing jobs during February. These jobs are identical to the existing business Newbury did for
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Kimberly in January in terms of variable costs and machine-hours required. Newbury anticipates
that the business from Wallace Corporation in February will be the same as that in January.
Newbury can choose to accept as much of the Wallace and Kimberly business for February as its
capacity allows. Assume that total machine-hours and fixed costs for February will be the same
as in January.
Required:
What action should Newbury take to maximize its operating income? Show your calculations.
What other factors should Newbury consider before making a decision?
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