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CHAPTER 10
RELEVANT INFORMATION FOR DECISION MAKING
QUESTIONS
1. Relevance means that a factor should be considered in making a decision. A rele-
resources.
2. Time is correlated with relevance. For costs to be relevant, they must reside in the
future; historical costs are never relevant.
3. Opportunity costs are benefits that are sacrificed to pursue one decision alternative
of this decision is the lost contribution margin on Product B. The lost contribution
4. Sunk costs are costs that have already been incurred (i.e., they are historical
curred, it cannot be “unincurred.”
5. Outsourcing occurs when a firm chooses to acquire necessary service functions or
is even more tense because vendors selected in outsourcing decisions often are
6. A scarce resource is any input that constrains production capacity. In the short
may be the most binding constraint on capacity, and if a supplier becomes bank-
7. The object of managing the sales mix is to increase the contribution margin (or
total profit) realized on the sale of a portfolio of products. The major factors that
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8. A special order decision involves the analysis of a nonrecurring sale of products.
of the proposed sale on existing business. A business may refuse a special order
9. Segment margin is sales less variable costs and avoidable fixed costs. Segment
margin is used in decisions about whether to keep or eliminate a product line. The
costs deducted in arriving at segment margin include only relevant costs (total di-
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EXERCISES
10. a. One option is to rework the shirts as described in the problem; a second option
c. Rework alternative: $5.50 per T-shirt.
d. Incremental profit of rework alternative: $10.25 – $5.50 = $4.75 per T-shirt
11. a. The only sunk cost is the purchase cost of the lettuce, $0.65 per head; or $0.65
× 3,000 = $1,950
b. The unspoken alternative is to do nothing. Doing nothing might simply mean
shelter.
c.
Do
Sell to
Sell to
Nothing
Restaurant
Incremental revenue
$ 0
$ 750
$ 3,150
Incremental costs
0
0
2,500
Incremental profit
$ 0
$ 750
$ 650
12. The minimum price is equal to the incremental cost of selling the obsolete units.
13. a. The relevant factors include the difference between the starting salaries for
$98,800).
c. The out-of-pocket cost would include the cost of tuition, books, lab fees, and
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d. The other factors to be considered would be the qualitative factors, e.g., the
relative satisfaction, prestige, and happiness obtained from jobs that can be se-
time, and travel opportunities.
14. a. You would explain to Catanac that the purchase cost of $95 is not relevant to
any decision she can now make regarding the DVD player. No matter what ac-
tors, Catanac should select the alternative that minimizes total relevant costs.
features between the existing DVD player and replacement players as well.
She may be willing to pay more than $75 for a new player if it has additional
features. This would be a qualitative consideration.
15. a. The sunk cost is the original cost of the old equipment, $350,000.
ferential) salvage values in five years.
c. The relevant costs include the cost of the new equipment, $396,000, the cur-
operating savings.
d. The opportunity costs associated with keeping the old equipment include the
vage value of the old equipment.
e. The incremental cost to purchase the new equipment is the difference between
machine, $396,000 – $88,000 = $308,000.
f. Some qualitative factors to be considered would include how the new machine
16. Incremental savings ($32,000 × 10)
$ 320,000
Incremental cost of software ($840,000 – $356,000)
(484,000)
Incremental loss
$(164,000)
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17. a. Relevant cost to manufacture = $4.60
b. Relevant cost to buy
$ 4.00
Avoidable variable costs
(3.48)
Minimum avoidable fixed costs
$ 0.52 per unit
18. The relevant costs to make the bumpers include only the variable costs:
Direct material
$53 (incl. purchased mounting hardware at $15)
Direct labor
17
Overhead ($45 × 1/3)
15
Total
$85
Incremental profit per bumper = $170 – $85 = $85
Increased profit from released facilities: ($85 × 4,800)
$ 408,000
Increased cost of production on first 300,000 units:
($20 – $15) × 300,000
(1,500,000)
Net loss from purchasing mounting hardware
$(1,092,000)
19. a. Cost to make: $27,000 + ($2.70 × 25,000)
$ 94,500
Cost to buy: 25,000 × $3.60
(90,000)
Advantage of purchasing
$ 4,500
b. Cost to make: $27,000 + ($2.70 × 60,000)
$ 189,000
Cost to buy: 60,000 × $3.60
(216,000)
Disadvantage of purchasing
$ (27,000)
with the cost to buy:
$27,000 + $2.70 X = $3.60X
X = 30,000 units
20. a.
MP3 Players
PDAs
Contribution margin
$14
$20
Divide by labor time per unit
÷ 1
÷ 2
CM per unit of labor time
$14
$10
b. The company should consider the need to provide a market assortment of
21. a.
Individual
Estate
Corporate
Revenue
$350
$1,200
$ 750
Variable cost
(50)
(200)
(150)
Contribution margin
$300
$1,000
$ 600
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Contribution margin per hour of professional time:
Individual: $300 ÷ 2
$150
Estate: $1,000 ÷ 8
$125
Corporate: $600 ÷ 5
$120
b.
Contribution margin: 2,000 $150
$300,000
Fixed costs
(80,000)
Pre-tax income
$220,000
vices.
d. White could overcome the time constraint in one of two generic ways. First, she
could employ accountants in her firm to do work in all service lines. Second,
full array of services to clients.
22. a.
Grooming
Training
Total
Revenue
$1,500,000
$1,400,000
$ 2,900,000
Labor cost
(600,000)
(820,000)
(1,420,000)
Material cost
(180,000)
(140,000)
(320,000)
CM
$ 720,000
$ 440,000
$ 1,160,000
Fixed cost
(250,000)
(260,000)
(510,000)
Income before taxes
$ 470,000
$ 180,000
$ 650,000
b. Contribution margin
$ 720,000
$ 440,000
Divide by sales
÷1,500,000
÷1,400,000
Contribution margin %
48%
31% (rounded)
cent.
c.
Grooming
Training
Revenue per hr.
$ 50
$ 70
Variable costs per hr.
(26)
(48)
CM per hr.
$ 24
$ 22
grooming services.
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23. a.
Sales (120,000 × $60)
$ 7,200,000
Variable costs [($25 + $12) × 120,000]
(4,440,000)
Contribution margin
$ 2,760,000
Fixed costs
(1,240,000)
Projected profit
$ 1,520,000
b.
New sales [(120,000 × 1.20) × ($60 × 0.90)]
$ 7,776,000
New variable costs [(120,000 × 1.20) × $37]
(5,328,000)
New contribution margin
$ 2,448,000
Old contribution margin
(2,760,000)
Change in profit
$ (312,000)
c.
Change in CM ($2,760,000 0.20)
$ 552,000
Change in fixed costs
(185,000)
Change in profit
$ 367,000
24. a. Profit effect of option 1:
Cell Phones
Ear Buds
Charger
Total
Increase in sales*
$10,500,000
$ 800,000
$ 400,000
$11,700,000
Increase in VC
(8,960,000)
(200,000)
(140,000)
(9,300,000)
Contribution margin
$ 1,540,000
$ 600,000
$ 260,000
$ 2,400,000
Increase in FC
(1,000,000)
Increase in profits
$ 1,400,000
* New sales volume would be as follows:
Cell phones: 2,200,000 × 0.70 = 1,540,000
Ear buds: 2,200,000 × 0.20 = 440,000
Charger: 2,200,000 × 0.10 = 220,000
Change in sales volume would be as follows:
Cell phones: 1,540,000 – 1,400,000 = 140,000
Ear buds: 440,000 – 400,000 = 40,000
Charger: 220,000 – 200,000 = 20,000
Profit effect of option 2:
Cell Phones
Ear Buds
Charger
Total
Increase in sales*
$ 115,500,000
$10,000,000
$ 5,000,000
$ 130,500,000
Increase in VC
(112,000,000)
(2,500,000)
(1,750,000)
(116,250,000)
Contribution
margin
$ 3,500,000
$ 7,500,000
$ 3,250,000
$ 14,250,000
Increase in FC
(0)
Increase in profits
$ 14,250,000
*(1,750,000 × $70) – [1,400,000 × ($75 – $70)]
b. One alternative is to decrease the price of the ear buds and charger. Although
this alternative would minimally impact cell phone sales volume, sales vol-
cell phones.
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25. a. Only the variable production costs are relevant to this decision: $560 + $40 +
$50 = $650.
b.
Incremental revenue: $670 × 200
$ 134,000
Incremental costs: $650 × 200
(130,000)
Incremental profit
$ 4,000
26. a. The relevant costs include the lost contribution margin associated with the 20
units of regular production that would be sacrificed to accept the special order,
and the variable production costs for the three special stands:
Normal sales price (20 $230)
$ 4,600
Variable costs (20 $100)
(2,000)
Lost contribution margin
$ 2,600
Production costs (3 $690)
2,070
Total costs
$ 4,670
b.
Additional sales
$ 3,800
Less total relevant costs
(4,670)
Incremental loss
$ (870)
27. a. If the U.S. division had been eliminated, Borderland’s income statement
would have appeared as follows:
Sales
$ 3,600,000
Variable costs
(2,088,000)
Contribution margin
$ 1,512,000
Fixed costs:
Direct
$ 490,000
Corporate
2,790,000
(3,280,000)
Operating income (loss)
$(1,768,000)
b.
United States
Mexico
Total
Sales
$ 7,200,000
$ 3,600,000
$10,800,000
Variable costs
(4,740,000)
(2,088,000)
(6,828,000)
Direct fixed costs
(800,000)
(490,000)
(1,290,000)
Segment margin
$ 1,660,000
$ 1,022,000
$ 2,682,000
Corporate costs
(2,790,000)
Operating income (loss)
$ (108,000)
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28. a.
Gross margin GL services
$ 1,200,000
Avoidable fixed and variable operating costs
(1,470,000)
Segment margin
$ (270,000)
b. The pre-tax profit of the company would rise by $270,000 (the amount of the
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PROBLEMS
29. a. The loss on the sale of the warehouse should not be relevant to the decision to
sell the warehouse. The loss arises only because a sunk cost (net book value of
b. In the long run, the remaining cost of the warehouse, $12,200,000, will be
charged against income no matter what course of action Cosgrove takes. If the
building is retained, its cost will be written off through periodic depreciation
30. a.
Cost of new machine
$(1,600,000)
Sales value of old machine
200,000
Incremental cost of new machine
$(1,400,000)
Operating cost savings ($295,000 × 5)
1,475,000
Net advantage of buying new machine
$ 75,000
levels of the two machines.
31. a. The relevant costs include the cost to purchase the new turbine, the current
market value of the old turbine, and the difference in annual operating costs
between the old and new turbines.
b. Incremental cost of new turbine: $6,000,000 – $400,000
$(5,600,000)
Incremental cost savings of new turbine:
[($210,000 – $45,000) × 4] × 8
5,280,000
Incremental profit from buying new turbine
$ (320,000)
c. The maximum amount that the company could pay:
Total annual operating savings
$5,280,000
Cash value of old machine
400,000
Total
$5,680,000
32. a. Ethical issues to consider: whether the competitor is exploiting the workers;
whether the competitor is displacing the domestic workforce; whether the