Exam 9: Differential Analysis: the Key to Decision Making

In a decision to drop a product, the product should not be charged for factory rent if the space in which the product is produced has no alternative use and the rental payment is unavoidable.

Hadley, Inc. makes a line of bathroom accessories. Because of a decline in sales, the company has 10,000 machine hours of idle capacity available each year. This idle capacity could be used by the company to make, rather than buy, one of the components used in its production process. Hadley needs 5,000 units of this component each year. At present, the component is being purchased from an outside supplier at $7.50 per unit. Variable production cost for the component would be $4.10 per unit, and additional supervisory costs would be $18,000 per year. Already existing fixed costs that would be allocated to this part amount to $300,000 per year. -What would the annual cost of additional supervision have to be in order for Hadley to be indifferent between making or buying the component? (Assume everything else remains the same.)

Only future costs that differ between alternatives are relevant in decision making.

Management is considering a one-time-only special order. There is sufficient idle capacity to fill the order without affecting any normal sales. Which one of the following is NOT relevant in making the decision?

Rama Corporation is presently making part J56 that is used in one of its products. A total of 4,000 units of this part are produced and used every year. The company's Accounting Department reports the following costs of producing the part at this level of activity: An outside supplier has offered to produce and sell the part to the company for $30.80 each. If this offer is accepted, the supervisor's salary and all of the variable costs, including direct labor, can be avoided. The special equipment used to make the part was purchased many years ago and has no salvage value or other use. The allocated general overhead represents fixed costs of the entire company, none of which would be avoided if the part were purchased instead of produced internally. -In addition to the facts given above, assume that the space used to produce part J56 could be used to make more of one of the company's other products, generating an additional segment margin of $13,000 per year for that product. What would be the impact on the company's overall net operating income of buying part J56 from the outside supplier and using the freed space to make more of the other product?

Fixed costs may or may not be relevant in decisions about whether a product should be dropped.

Tawstir Corporation has 800 obsolete personal computers that are carried in inventory at a total cost of $1,100,000. If these computers are upgraded at a total cost of $40,000, they can be sold for a total of $750,000. As an alternative, the computers can be sold in their present condition for $690,000. -Suppose the selling price of the upgraded computers has not been set. At what selling price per unit would the company be as well off upgrading the computers as if it just sold the computers in their present condition?

The constraint at Bonavita Corporation is time on a particular machine. The company makes three products that use this machine. Data concerning those products appear below: -Assume that sufficient time is available on the constrained machine to satisfy demand for all but the least profitable product. Up to how much should the company be willing to pay to acquire more of this constrained resource?

Jebb's Lettuce Stand currently sells 60,000 heads of lettuce each year for $1.00 per head. Jebb is thinking of expanding operations and serving the customer better by purchasing a "slice and dice" machine that will cut up each head of lettuce into bite-size pieces that can be used for salads. Jebb expects he will then be able to sell his lettuce for $1.70 per head. Jebb has prepared the following analysis for each option based on sales of 60,000 heads of lettuce: -Assume that Jebb is currently selling only 50,000 heads of lettuce per year instead of 60,000. Under this scenario, what will be Jebb's increase or decrease in profit for the year if he chooses to start slicing up the lettuce instead of selling it whole?

Dockwiller Inc. manufactures industrial components. One of its products, which is used in the construction of industrial air conditioners, is known as D53. Data concerning this product are given below: The above per unit data are based on annual production of 8,000 units of the component. Direct labor is a variable cost -The company has received a special, one-time-only order for 300 units of component D53. There would be no variable selling expense on this special order and the total fixed manufacturing overhead and fixed selling and administrative expenses of the company would not be affected by the order. However, assume that Dockwiller has no excess capacity and this special order would require 30 minutes of the constraining resource, which could be used instead to produce products with a total contribution margin of $1,800. What is the minimum price per unit on the special order below which the company should not go?

In a decision to drop a segment, the opportunity cost of the space occupied by the segment is the cost of renting or building similar space nearby.

Northern Stores is a retailer in the upper Midwest. The most recent monthly income statement for Northern Stores is given below: Northern is considering closing Store I. If Store I is closed, one-fourth of its traceable fixed expenses would continue. Also, the closing of Store I would result in a 20% decrease in sales in Store II. Northern allocates common fixed expenses on the basis of sales dollars and none of these costs would be saved if a store were shut down. Required: Compute the overall increase or decrease in the net operating income of Northern Stores if Store I is closed.

The following are the Jensen Corporation's unit costs of making and selling an item at a volume of 1,000 units per month (which represents the company's capacity): Present sales amount to 700 units per month. An order has been received from a customer in a foreign market for 100 units. The order would not affect current sales. Fixed costs, both manufacturing and selling and administrative, are constant within the relevant range between 700 units and 1,000 units. The variable selling and administrative expenses would have to be incurred on this special order as well as for all other sales. Direct labor is a variable cost. -Assume the company has 50 units left over from last year which have small defects and which will have to be sold at a reduced price for scrap. The sale of these defective units will have no effect on the company's other sales. Which of the following costs is relevant in this decision?

A study has been conducted to determine if Product A should be dropped. Sales of the product total $400,000 per year; variable expenses total $270,000 per year. Fixed expenses charged to the product total $160,000 per year. The company estimates that $70,000 of these fixed expenses are not avoidable even if the product is dropped. If Product A is dropped, the company's overall net operating income would:

Gierlach Beet Processors, Inc., processes sugar beets in batches. A batch of sugar beets costs $27 to buy from farmers and $17 to crush in the company's plant. Two intermediate products, beet fiber and beet juice, emerge from the crushing process. The beet fiber can be sold as is for $27 or processed further for $14 to make the end product industrial fiber that is sold for $34. The beet juice can be sold as is for $32 or processed further for $29 to make the end product refined sugar that is sold for $58. How much more profit (loss) does the company make by processing the intermediate product beet juice into refined sugar rather than selling it as is?

Which of the following is not an effective way of dealing with a production constraint (i.e., bottleneck)?

A vertically integrated company is more dependent on its suppliers than a company that is not vertically integrated.

Wenig Inc. has some material that originally cost $73,500. The material has a scrap value of $45,600 as is, but if reworked at a cost of $6,600, it could be sold for $58,100. What would be the incremental effect on the company's overall profit of reworking and selling the material rather than selling it as is as scrap?

Globe Manufacturing Company has just obtained a request for a special order of 12,000 units to be shipped at the end of the current year at a discount price of $7.00 each. The company has a production capacity of 90,000 units per year. At present, Globe is only selling 80,000 units per year through regular channels at a selling price of $11.00 each. Globe's per unit costs at an 80,000 unit level of production and sales are as follows: Variable selling and administrative expense will drop to $0.30 per unit on the special order units. The special order has to be taken in its entirety. This means that by accepting the special order, Globe will be forced to not sell 2,000 units to its regular customers. Required: If Globe accepts this special order, by what amount will its net operating income increase or decrease? SHOW YOUR COMPUTATIONS.

The Madison Corporation produces three products with the following costs and selling prices: -If Madison has a limit of 15,000 machine hours but no limit on direct labor hours, then the ranking of the products from the most profitable to the least profitable use of the constrained resource is: