Chapter 24(9)

Differential Analysis and Product Pricing

OBJECTIVES

Obj 1 Prepare a differential analysis report for decisions involving leasing or selling
equipment, discontinuing an unprofitable segment, manufacturing or purchasing a
needed part, replacing usable fixed assets, processing further or selling an
intermediate product, or accepting additional business at a special price.
Obj 2 Determine the selling price of a product, using the total cost, product cost, variable
cost, and target cost concepts.
Obj 3 Calculate the relative profitability of products in bottleneck production
environments.

QUESTION GRID

True / False
No. Objective Difficulty No. Objective Difficulty No. Objective Difficulty
1 24(9)-01 Easy 15 24(9)-01 Difficult 29 24(9)-02 Easy
2 24(9)-01 Easy 16 24(9)-01 Difficult 30 24(9)-02 Easy
3 24(9)-01 Difficult 17 24(9)-01 Difficult 31 24(9)-02 Easy
4 24(9)-01 Difficult 18 24(9)-01 Easy 32 24(9)-02 Easy
5 24(9)-01 Difficult 19 24(9)-01 Easy 33 24(9)-02 Easy
6 24(9)-01 Difficult 20 24(9)-01 Easy 34 24(9)-02 Difficult
7 24(9)-01 Difficult 21 24(9)-01 Easy 35 24(9)-02 Difficult
8 24(9)-01 Difficult 22 24(9)-01 Easy 36 24(9)-03 Easy
9 24(9)-01 Easy 23 24(9)-01 Easy 37 24(9)-03 Easy
10 24(9)-01 Difficult 24 24(9)-01 Easy 38 24(9)-03 Moderate
11 24(9)-01 Easy 25 24(9)-01 Moderate 39 24(9)-03 Moderate
12 24(9)-01 Easy 26 24(9)-02 Easy 40 24(9)-03 Moderate
13 24(9)-01 Easy 27 24(9)-02 Easy
14 24(9)-01 Difficult 28 24(9)-02 Easy

328
329  Chapter 24(9)/Differential Analysis and Product Pricing

Multiple Choice
No. Objective Difficulty No. Objective Difficulty No. Objective Difficulty
1 24(9)-01 Easy 27 24(9)-02 Moderate 53 24(9)-02 Moderate
2 24(9)-01 Easy 28 24(9)-02 Moderate 54 24(9)-02 Moderate
3 24(9)-01 Easy 29 24(9)-02 Moderate 55 24(9)-02 Moderate
4 24(9)-01 Moderate 30 24(9)-02 Moderate 56 24(9)-02 Moderate
5 24(9)-01 Moderate 31 24(9)-02 Moderate 57 24(9)-02 Moderate
6 24(9)-01 Moderate 32 24(9)-02 Easy 58 24(9)-02 Moderate
7 24(9)-01 Moderate 33 24(9)-02 Moderate 59 24(9)-02 Moderate
8 24(9)-01 Easy 34 24(9)-02 Easy 60 24(9)-02 Moderate
9 24(9)-01 Difficult 35 24(9)-02 Easy 61 24(9)-02 Moderate
10 24(9)-01 Difficult 36 24(9)-02 Easy 62 24(9)-02 Moderate
11 24(9)-01 Difficult 37 24(9)-02 Moderate 63 24(9)-02 Moderate
12 24(9)-01 Difficult 38 24(9)-02 Difficult 64 24(9)-02 Easy
13 24(9)-01 Difficult 39 24(9)-02 Moderate 65 24(9)-02 Easy
14 24(9)-01 Difficult 40 24(9)-02 Difficult 66 24(9)-02 Easy
15 24(9)-01 Moderate 41 24(9)-02 Easy 67 24(9)-02 Easy
16 24(9)-01 Moderate 42 24(9)-02 Easy 68 24(9)-02 Moderate
17 24(9)-01 Moderate 43 24(9)-02 Easy 69 24(9)-02 Moderate
18 24(9)-01 Moderate 44 24(9)-02 Easy 70 24(9)-02 Moderate
19 24(9)-01 Moderate 45 24(9)-02 Easy 71 24(9)-03 Moderate
20 24(9)-01 Moderate 46 24(9)-02 Difficult 72 24(9)-03 Moderate
21 24(9)-02 Moderate 47 24(9)-02 Difficult 73 24(9)-03 Moderate
22 24(9)-02 Moderate 48 24(9)-02 Difficult 74 24(9)-03 Moderate
23 24(9)-02 Moderate 49 24(9)-02 Easy 75 24(9)-03 Moderate
24 24(9)-02 Easy 50 24(9)-02 Easy 76 24(9)-03 Moderate
25 24(9)-02 Moderate 51 24(9)-02 Easy 77 24(9)-03 Moderate
26 24(9)-02 Moderate 52 24(9)-02 Moderate

Exercise/Other
No. Objective Difficulty No. Objective Difficulty No. Objective Difficulty
1 24(9)-01 Moderate 5 24(9)-01 Easy 9 24(9)-02 Moderate
2 24(9)-01 Easy 6 24(9)-01 Easy 10 24(9)-03 Moderate
3 24(9)-01 Easy 7 24(9)-02 Easy
4 24(9)-01 Moderate 8 24(9)-02 Moderate

Problem
No. Objective Difficulty No. Objective Difficulty No. Objective Difficulty
1 24(9)-01 Moderate 6 24(9)-01 Moderate 11 24(9)-02 Difficult
2 24(9)-01 Moderate 7 24(9)-02 Moderate 12 24(9)-02 Difficult
3 24(9)-01 Moderate 8 24(9)-02 Difficult 13 24(9)-02 Difficult
4 24(9)-01 Moderate 9 24(9)-02 Difficult 14 24(9)-03 Difficult
5 24(9)-01 Easy 10 24(9)-02 Difficult 15 24(9)-03 Difficult
 Chapter 24(9)/Differential Analysis and Product Pricing  330

Chapter 24(9)—Differential Analysis and Product Pricing

TRUE/FALSE

1. Differential revenue is the amount of income that would result from the best available alternative
proposed use of cash.
ANS: F DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

2. Differential revenue is the amount of increase or decrease in revenue expected from a particular
course of action as compared with an alternative.
ANS: T DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

3. If the total unit cost of manufacturing Product Y is currently $36 and the total unit cost after
modifying the style is estimated to be $48, the differential cost for this situation is $48.
ANS: F DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

4. If the total unit cost of manufacturing Product Y is currently $36 and the total unit cost after
modifying the style is estimated to be $48, the differential cost for this situation is $12.
ANS: T DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

Hill Co. can further process Product O to produce Product P. Product O is currently selling for $60 per
pound and costs $42 per pound to produce. Product P would sell for $82 per pound and would require an
additional cost of $13 per pound to produce.

5. The differential revenue of producing Product P is $82 per pound.

ANS: F DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

6. The differential revenue of producing Product P is $22 per pound.

ANS: T DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

7. The differential cost of producing Product P is $13 per pound.

ANS: T DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

8. The differential cost of producing Product P is $55 per pound.

ANS: F DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

9. Opportunity cost is the amount of increase or decrease in cost that would result from the best
available alternative to the proposed use of cash or its equivalent.
ANS: F DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis
331  Chapter 24(9)/Differential Analysis and Product Pricing

10. Differential analysis can aid management in making decisions on a variety of alternatives, including
whether to discontinue an unprofitable segment and whether to replace usable plant assets.
ANS: T DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

11. A cost that will not be affected by later decisions is termed a sunk cost.
ANS: T DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

12. A cost that will not be affected by later decisions is termed an opportunity cost.
ANS: F DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

13. The amount of income that would result from an alternative use of cash is called opportunity cost.
ANS: T DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

14. Since the costs of producing an intermediate product do not change regardless of whether the
intermediate product is sold or processed further, these costs are not considered in deciding whether
to further process a product.
ANS: T DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

15. The costs of initially producing an intermediate product should be considered in deciding whether to
further process a product, even though the costs will not change, regardless of the decision.
ANS: F DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

16. In deciding whether to accept business at a special price, the short-run price should be set high
enough to cover all costs and expenses, plus provide a reasonable amount for profit.
ANS: F DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

17. In deciding whether to accept business at a special price, the short-run price should be set high
enough to cover all variable costs and expenses.
ANS: T DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

18. Eliminating a product or segment may have the long-term effect of reducing fixed costs.
ANS: T DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

19. Make or buy options often arise when a manufacturer has excess productive capacity in the form of
unused equipment, space, and labor.
ANS: T DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  332

20. In addition to the differential costs in an equipment replacement decision, the remaining useful life
of the old equipment and the estimated life of the new equipment are important considerations.
ANS: T DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

21. Manufacturers must conform to the Robinson-Patman Act which prohibits price discrimination
within the United States unless differences in prices can be justified by different costs of serving
different customers.
ANS: T DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

22. When a company is showing a net loss, it is always best to discontinue the segment in order not to
continue with losses.
ANS: F DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

23. Discontinuing a segment or product may not be the best choice when the segment is contributing to
fixed expenses.
ANS: T DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

24. Make or buy decisions should be made only with related parties.
ANS: F DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

25. Depending on the capacity of the plant, a company may best be served by further processing some of
the product and leaving the rest as is, with no further processing.
ANS: T DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

26. A practical approach which is frequently used by managers when setting normal long-run prices is
the cost-plus approach.
ANS: T DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

27. The total cost concept includes all manufacturing costs plus selling and administrative expenses in
the cost amount to which the markup is added to determine product price.
ANS: T DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

28. The product cost concept includes all manufacturing costs plus selling and administrative expenses
in the cost amount to which the markup is added to determine product price.
ANS: F DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

29. The product cost concept includes all manufacturing costs in the cost amount to which the markup is
added to determine product price.
ANS: T DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis
333  Chapter 24(9)/Differential Analysis and Product Pricing

30. In using the total cost concept of applying the cost-plus approach to product pricing, selling
expenses, administrative expenses, and profit are covered in the markup.
ANS: F DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

31. In using the product cost concept of applying the cost-plus approach to product pricing, selling
expenses, administrative expenses, and profit are covered in the markup.
ANS: T DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

32. In using the variable cost concept of applying the cost-plus approach to product pricing, fixed
manufacturing costs and fixed selling and administrative expenses must be covered by the markup.
ANS: T DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

33. In using the variable cost concept of applying the cost-plus approach to product pricing, fixed
manufacturing costs and both fixed and variable selling and administrative expenses must be covered
by the markup.
ANS: F DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

34. When standard costs are used in applying the cost-plus approach to product pricing, the standards
should be based upon normal levels of performance.
ANS: T DIF: Difficult OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

35. When standard costs are used in applying the cost-plus approach to product pricing, the standards
should be based upon ideal levels of performance.
ANS: F DIF: Difficult OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

36. A bottleneck begins when demand for the company’s product exceeds the ability to produce the
product.
ANS: T DIF: Easy OBJ: 24(9)-03
NAT: AACSB Analytic | IMA-Decision Analysis

37. A bottleneck happens when an employee is too slow to keep with current production.
ANS: F DIF: Easy OBJ: 24(9)-03
NAT: AACSB Analytic | IMA-Decision Analysis

38. When a bottleneck occurs between two products, the company must determine the contribution
margin for each product and manufacture the product that has the highest contribution margin per
bottleneck hour.
ANS: T DIF: Moderate OBJ: 24(9)-03
NAT: AACSB Analytic | IMA-Decision Analysis

39. The theory of constraints is a manufacturing strategy that focuses on reducing the influence of
bottlenecks on a process.
ANS: T DIF: Moderate OBJ: 24(9)-03
NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  334

40. The lowest contribution margin per scarce resource is the most profitable.
ANS: F DIF: Moderate OBJ: 24(9)-03
NAT: AACSB Analytic | IMA-Decision Analysis

MULTIPLE CHOICE

1. The amount of increase or decrease in revenue that is expected from a particular course of action as
compared with an alternative is termed:
a. manufacturing margin
b. contribution margin
c. differential cost
d. differential revenue
ANS: D DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

2. The amount of increase or decrease in cost that is expected from a particular course of action as
compared with an alternative is termed:
a. period cost
b. product cost
c. differential cost
d. discretionary cost
ANS: C DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

3. A cost that will not be affected by later decisions is termed a(n):

a. historical cost
b. differential cost
c. sunk cost
d. replacement cost
ANS: C DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis
335  Chapter 24(9)/Differential Analysis and Product Pricing

4. The condensed income statement for a business for the past year is presented as follows:

Product
F G H Total
Sales $300,000 $220,000  $340,000 $860,000
Less variable costs   180,000   190,000    220,000 590,000
Contribution margin $120,000 $  30,000  $120,000 $270,000
Less fixed costs     50,000     50,000     40,000 140,000
Income (loss) from oper. $  70,000 $ (20,000) $ 80,000 $130,000

Management is considering the discontinuance of the manufacture and sale of Product G at the
beginning of the current year. The discontinuance would have no effect on the total fixed costs and
expenses or on the sales of Products F and H. What is the amount of change in net income for the
current year that will result from the discontinuance of Product G?
a. $20,000 increase
b. $30,000 increase
c. $20,000 decrease
d. $30,000 decrease
ANS: D DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

5. The condensed income statement for a business for the past year is as follows:

Product
T U
Sales $600,000  $320,000
Less variable costs   540,000    220,000
Contribution margin $ 60,000  $100,000
Less fixed costs   145,000     40,000
Income (loss) from operations $ (85,000) $ 60,000

Management is considering the discontinuance of the manufacture and sale of Product T at the
beginning of the current year. The discontinuance would have no effect on the total fixed costs and
expenses or on the sales of Product U. What is the amount of change in net income for the current
year that will result from the discontinuance of Product T?
a. $60,000 increase
b. $85,000 increase
c. $85,000 decrease
d. $60,000 decrease
ANS: D DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  336

6. A business is operating at 90% of capacity and is currently purchasing a part used in its
manufacturing operations for $15 per unit. The unit cost for the business to make the part is $20,
including fixed costs, and $12, not including fixed costs. If 30,000 units of the part are normally
purchased during the year but could be manufactured using unused capacity, what would be the
amount of differential cost increase or decrease from making the part rather than purchasing it?
a. $150,000 cost increase
b. $ 90,000 cost decrease
c. $150,000 cost increase
d. $ 90,000 cost increase
ANS: B DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

7. A business is operating at 70% of capacity and is currently purchasing a part used in its
manufacturing operations for $24 per unit. The unit cost for the business to make the part is $36,
including fixed costs, and $28, not including fixed costs. If 15,000 units of the part are normally
purchased during the year but could be manufactured using unused capacity, what would be the
amount of differential cost increase or decrease from making the part rather than purchasing it?
a. $60,000 cost decrease
b. $180,000 cost increase
c. $60,000 cost increase
d. $180,000 cost decrease
ANS: C DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

8. The amount of income that would result from an alternative use of cash is called:
a. differential income
b. sunk cost
c. differential revenue
d. opportunity cost
ANS: D DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

9. Jones Co. can further process Product B to produce Product C. Product B is currently selling for $30
per pound and costs $28 per pound to produce. Product C would sell for $60 per pound and would
require an additional cost of $24 per pound to produce. What is the differential cost of producing
Product C?
a. $30 per pound
b. $24 per pound
c. $28 per pound
d. $60 per pound
ANS: B DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis
337  Chapter 24(9)/Differential Analysis and Product Pricing

Neter Co. can further process Product J to produce Product D. Product J is currently selling for $21 per
pound and costs $15.75 per pound to produce. Product D would sell for $35 per pound and would require
an additional cost of $8.75 per pound to produce.

10. What is the differential cost of producing Product D?

a. $7 per pound
b. $8.75 per pound
c. $15 per pound
d. $5.25 per pound
ANS: B DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

11. What is the differential revenue of producing Product D?

a. $7 per pound
b. $8.75 per pound
c. $14 per pound
d. $5.25 per pound
ANS: C DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

12. Jones Co. can further process Product B to produce Product C. Product B is currently selling for $60
per pound and costs $42 per pound to produce. Product C would sell for $82 per pound and would
require an additional cost of $13 per pound to produce. What is the differential revenue of producing
and selling Product C?
a. $22 per pound
b. $42 per pound
c. $45 per pound
d. $18 per pound
ANS: A DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

13. Wilson Company is considering replacing equipment which originally cost $500,000 and which has
$460,000 accumulated depreciation to date. A new machine will cost $790,000. What is the sunk
cost in this situation?
a. $330,000
b. $500,000
c. $40,000
d. $290,000
ANS: C DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

14. Mathews Company is considering replacing equipment which originally cost $500,000 and which
has $460,000 accumulated depreciation to date. A new machine will cost $790,000 and the old
equipment can be sold for $8,000. What is the sunk cost in this situation?
a. $53,000
b. $40,000
c. $37,000
d. $290,000
ANS: B DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  338

15. A business is considering a cash outlay of $200,000 for the purchase of land, which it could lease for
$35,000 per year. If alternative investments are available which yield an 18% return, the opportunity
cost of the purchase of the land is:
a. $35,000
b. $36,000
c. $  1,000
d. $37,000
ANS: B DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

16. A business is considering a cash outlay of $250,000 for the purchase of land, which it could lease for
$36,000 per year. If alternative investments are available which yield an 18% return, the opportunity
cost of the purchase of the land is:
a. $45,000
b. $36,000
c. $  9,000
d. $54,000
ANS: A DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

17. A business is considering a cash outlay of $500,000 for the purchase of land, which it could lease for
$40,000 per year. If alternative investments are available which yield a 21% return, the opportunity
cost of the purchase of the land is:
a. $105,000
b. $  40,000
c. $  65,000
d. $    8,400
ANS: A DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

18. A business received an offer from an exporter for 20,000 units of product at $15 per unit. The
acceptance of the offer will not affect normal production or domestic sales prices. The following data
are available:

Domestic unit sales price $21

Unit manufacturing costs:
  Variable 12
  Fixed 5

What is the differential revenue from the acceptance of the offer?

a. $300,000
b. $420,000
c. $120,000
d. $240,000
ANS: A DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis
339  Chapter 24(9)/Differential Analysis and Product Pricing

A business received an offer from an exporter for 10,000 units of product at $16 per unit. The acceptance
of the offer will not affect normal production or domestic sales prices. The following data are available:

Domestic unit sales price $20

Unit manufacturing costs:
Variable 13
Fixed 1

19. What is the differential revenue from the acceptance of the offer?
a. $200,000
b. $160,000
c. $130,000
d. $140,000
ANS: B DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

20. What is the differential cost from the acceptance of the offer?
a. $200,000
b. $160,000
c. $140,000
d. $130,000
ANS: D DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

21. What is the amount of gain or loss from acceptance of the offer?
a. $30,000 gain
b. $40,000 loss
c. $30,000 loss
d. $20,000 loss
ANS: A DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

A business received an offer from an exporter for 20,000 units of product at $15 per unit. The acceptance
of the offer will not affect normal production or domestic sales prices. The following data are available:

Domestic unit sales price $21

Unit manufacturing costs:
  Variable 12
  Fixed 5

22. What is the differential cost from the acceptance of the offer?
a. $120,000
b. $240,000
c. $300,000
d. $420,000
ANS: B DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  340

23. What is the amount of the gain or loss from acceptance of the offer?
a. $35,000 loss
b. $40,000 gain
c. $60,000 gain
d. $50,000 gain
ANS: C DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

24. Relevant revenues and costs focus on:

a. activities that occurred in the past
b. monies already earned and/or spent
c. last year's net income
d. differences between the alternatives being considered
ANS: D DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

25. Assume that Darrow Co. is considering disposing of equipment that cost $50,000 and has $40,000 of
accumulated depreciation to date. Darrow Co. can sell the equipment through a broker for $25,000
less 5% commission. Alternatively, Minton Co. has offered to lease the equipment for five years for
a total of $48,750. Darrow will incur repair, insurance, and property tax expenses estimated at
$10,000. At lease-end, the equipment is expected to have no residual value. The net differential
income from the lease alternative is:
a. $15,000
b. $ 5,000
c. $25,000
d. $12,500
ANS: A DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

26. Frank Co. is currently operating at 80% of capacity and is currently purchasing a part used in its
manufacturing operations for $5 a unit. The unit cost for Frank Co. to make the part is $6, which
includes $.40 of fixed costs. If 4,000 units of the part are normally purchased each year but could be
manufactured using unused capacity, what would be the amount of differential cost increase or
decrease for making the part rather than purchasing it?
a. $12,000 cost decrease
b. $20,000 cost increase
c. $20,000 cost decrease
d. $2,400 cost increase
ANS: D DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

27. Franklin and Johnson, CPAs, currently work a five-day week. They estimate that net income for the
firm would increase by $45,000 annually if they worked an additional day each month. The cost
associated with the decision to continue the practice of a five-day work week is an example of:
a. differential revenue
b. sunk cost
c. differential income
d. opportunity cost
ANS: D DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis
341  Chapter 24(9)/Differential Analysis and Product Pricing

28. Benson Co. is considering disposing of a machine with a book value of $12,500 and estimated
remaining life of five years. The old machine can be sold for $1,500. A new high-speed machine can
be purchased at a cost of $25,000. It will have a useful life of five years and no residual value. It is
estimated that variable manufacturing costs will be reduced from $26,000 to $23,500 if the new
machine is purchased. The total net differential increase or decrease in cost for the new equipment
for the entire five years is:
a. decrease of $11,000
b. decrease of $15,000
c. increase of $11,000
d. increase of $15,000
ANS: C DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

29. Sorrentino Inc. is considering disposing of a machine with a book value of $22,500 and an estimated
remaining life of three years. The old machine can be sold for $6,250. A new machine with a
purchase price of $68,750 is being considered as a replacement. It will have a useful life of three
years and no residual value. It is estimated that variable manufacturing costs will be reduced from
$43,750 to $20,000 if the new machine is purchased. The net differential increase or decrease in cost
for the entire three years for the new equipment is:
a. $8,750 increase
b. $31,250 decrease
c. $8,750 decrease
d. $2,925 decrease
ANS: C DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

Dary Co. Produces a single product. Its normal selling price is $28 per unit. The variable costs are $18 per
unit. Fixed costs are $20,000 for a normal production run of 5,000 units per month. Dary received a
request for a special order that would not interfere with normal sales. The order was for 1,500 units and a
special price of $17.50 per unit. Dary Co. has the capacity to handle the special order and, for this order, a
variable selling cost of $2 per unit would be eliminated.

30. If the order is accepted, what would be the impact on net income?
a. decrease of $750
b. decrease of $6,750
c. increase of $2,250
d. increase of $1,500
ANS: C DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

31. Should the special order be accepted?

a. Cannot determine from the data given
b. Yes
c. No
d. There would be no difference in accepting or rejecting the special order
ANS: B DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  342

32. Java, Inc has bought a new server and is having to decide what to do with the old one. The cost of
the old server was originally $60,000 and has been depreciated $45,000. The company has received
two offers that it must consider. One offer was made to purchase the equipment outright for $18,500
less a 5% sales commission. The other offer was to lease the equipment for $7,000 for the next five
years but the company will be required to provide maintenance and insurance totaling $3,000 per
year. What offer should Java, Inc. accept?
a. $2,425 in favor of leasing
b. Reject both offers
c. $11,500 in favor of selling
d. $16,500 in favor of leasing
ANS: A
Differential Revenue:
Revenue from lease ($7,000 * 5 years) $ 35,000
Revenue from sale 18,500
Differential revenue from lease $ 16,500

Differential Costs
Maintenance and Insurance ($3000 * 5) $15,000
Commission Expense on Sale ($18,500* 5%) 925 $ 14,075
Net differential income from the lease alternative $ 2,425

DIF: Easy OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis

33. Security Fire Alarm is currently buying 50,000 motherboard from MotherBoard’s Inc at a price of
$65 per board. It was suggested at the last manager’s meeting that the company should consider
making its own boards. The costs to make the part are as follows: Direct Materials $32 per unit,
Direct labor $10 per unit, Variable Factory Overhead $16.00, Fixed Costs for the plant would
increase by $75,000. As the financial advisor, what would you recommend?
a. Buy - $75,000 more in profits
b. Make - $275,000 increase in profits
c. Buy - $275,000 more in profits
d. Make - $350,000 increase in profits
ANS: B DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis
343  Chapter 24(9)/Differential Analysis and Product Pricing

34. Carnival Corp. is considering selling its old popcorn machine and replacing it with a newer one. The
old machine originally cost $5,000 and has been fully depreciated. Annual costs are $4,000. A high
school is willing to buy it for $2,000. New equipment would cost $18,000 and annual operating costs
would be $1,500. Both machines have an estimated useful life of 5 years.
a. Stay with the old equipment $3,500 less in net costs
b. Purchase the new equipment $3,500 cost savings
c. Purchase the new equipment - deduction in costs $14,500
d. Stay with the old equipment - cost savings of $2,000
ANS: A
Proposal to Replace Equipment
October 30, 2008

Annual variable costs - present equipment $4,000

Annual variable costs - new equipment 1,500
Annual differential decrease in cost $2,500
Number of years applicable 5
Total differential decrease in cost $12,500
Proceeds from sales of present equipment 2,000 $14,500
Cost of New Equipment 18,000
Annual net differential increase in cost - new equipment ( $ 3,500)

DIF: Easy OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  344

35. Sandy Art Company sells unfinished wooden decorations at a price of $15.00. The current profit
margin is $5.00 per decoration. The company is considering taking individual orders and
customizing them for sale. To finish the decoration the company would have to pay additional labor
of $3.00, additional materials costing an average of $4.00 per unit and fixed costs would increase by
$1,500. If the company estimates that it can sell 600 units for $25 each month, would they make
additional profits or losses?
a. $300 profit
b. $300 loss
c. $800 profit
d. $800 loss
ANS: A

Proposal to Process Decorations Further

September 3, 2009

Differential revenue:
Revenue for finished decorations (600 units * $25.) $15,000
Revenue for unfinished decorations ( 600 units * $15) 9,000
Differential Revenue $ 6,000
Differential cost:
Direct Materials (600 units * $3.00) $1,800
Direct Labor (600 * $4.00) 2,400
Additional Fixed Costs 1,500 $ 5,700
Differential income from further processing $ 300

DIF: Easy OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis

36. Safe Security Company manufacturers home alarms. Currently it is manufacturing one of its
components at a variable cost of $45 and fixed costs of $15 per unit. An outside provider of this
component has offered to sell Safe Security the component for $50. Determine the best plan and
calculate the savings.
a. $5 savings per unit - Manufacture
b. $5 savings per unit - Purchase
c. $10 savings per unit - Manufacture
d. $15 savings per unit - Purchase
ANS: A DIF: Easy OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

37. Discontinuing a product or segment is a huge decision that must be carefully analyzed. Which of the
following would be a valid reason not to discontinue an operation?
a. when the losses are minimal
b. when the variable costs are less than revenues
c. when the variable costs are more than revenues
d. when fixed costs are more than revenues
ANS: B DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis
345  Chapter 24(9)/Differential Analysis and Product Pricing

38. Which of the following would be considered a sunk cost?

a. Purchase of new equipment
b. Equipment rental for the production area
c. Net book value of obsolete equipment that has no market value
d. Depreciation expense
ANS: C DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

39. All of the following should be considered in a make or buy decision except
a. cost savings
b. quality issues with the supplier
c. future growth in the plant and other production opportunities
d. the supplier will make a profit that would no longer belong to the business
ANS: D DIF: Moderate OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

40. A business may decide to accept additional business at a special price for all of the following reasons
except
a. if additional sales will not conflict with regular sales.
b. if additional sales will increase differential income.
c. if there is an increase to sales only if fixed expenses are not increased.
d. if there is an increase to sales even if fixed expenses are also increased.
ANS: D DIF: Difficult OBJ: 24(9)-01
NAT: AACSB Analytic | IMA-Decision Analysis

41. A practical approach which is frequently used by managers when setting normal long-run prices is
the:
a. cost-plus approach
b. economic theory approach
c. price graph approach
d. market price approach
ANS: A DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

42. Which of the following is NOT a cost concept commonly used in applying the cost-plus approach to
product pricing?
a. Total cost concept
b. Product cost concept
c. Variable cost concept
d. Fixed cost concept
ANS: D DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  346

43. In using the total cost concept of applying the cost-plus approach to product pricing, what is included
in the markup?
a. Total selling and administrative expenses plus desired profit
b. Total fixed manufacturing costs, total fixed selling and administrative expenses, and desired
profit
c. Total costs plus desired profit
d. Desired profit
ANS: D DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

44. In using the product cost concept of applying the cost-plus approach to product pricing, what is
included in the markup?
a. Desired profit
b. Total fixed manufacturing costs, total fixed selling and administrative expenses, and desired
profit
c. Total costs plus desired profit
d. Total selling and administrative expenses plus desired profit
ANS: D DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

45. In using the variable cost concept of applying the cost-plus approach to product pricing, what is
included in the markup?
a. Total costs plus desired profit
b. Desired profit
c. Total selling and administrative expenses plus desired profit
d. Total fixed manufacturing costs, total fixed selling and administrative expenses, and desired
profit
ANS: D DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

46. What cost concept used in applying the cost-plus approach to product pricing covers selling
expenses, administrative expenses, and desired profit in the "markup"?
a. Total cost concept
b. Product cost concept
c. Variable cost concept
d. Sunk cost concept
ANS: B DIF: Difficult OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

47. What cost concept used in applying the cost-plus approach to product pricing includes only desired
profit in the "markup"?
a. Product cost concept
b. Variable cost concept
c. Sunk cost concept
d. Total cost concept
ANS: D DIF: Difficult OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis
347  Chapter 24(9)/Differential Analysis and Product Pricing

48. What cost concept used in applying the cost-plus approach to product pricing includes only total
manufacturing costs in the "cost" amount to which the markup is added?
a. Variable cost concept
b. Total cost concept
c. Product cost concept
d. Opportunity cost concept
ANS: C DIF: Difficult OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

49. Managers who often make special pricing decisions are more likely to use which of the following
cost concepts in their work?
a. Total cost
b. Product cost
c. Variable cost
d. Fixed cost
ANS: C DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

50. Defense contractors would be more likely to use which of the following cost concepts in pricing their
product?
a. Variable cost
b. Product cost
c. Total cost
d. Fixed cost
ANS: C DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

51. In contrast to the total product and variable cost concepts used in setting seller's prices, the target
cost approach assumes that:
a. a markup is added to total cost
b. selling price is set by the marketplace
c. a markup is added to variable cost
d. a markup is added to product cost
ANS: B DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  348

McClelland Corporation uses the total cost concept of product pricing. Below is cost information for the
production and sale of 60,000 units of its sole product. McClelland desires a profit equal to a 21% rate of
return on invested assets of $600,000.

Fixed factory overhead cost $37,500

Fixed selling and administrative costs 7,500
Variable direct materials cost per unit 4.50
Variable direct labor cost per unit 1.88
Variable factory overhead cost per unit 1.13
Variable selling and administrative cost per unit 4.50

52. The dollar amount of desired profit from the production and sale of the company's product is:
a. $126,000
b. $67,200
c. $73,500
d. $96,000
ANS: A DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

53. The cost per unit for the production and sale of the company's product is:
a. $12
b. $12.76
c. $15
d. $13.50
ANS: B DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

54. The markup percentage for the company's product is:

a. 21.0%
b. 16.5%
c. 15.7%
d. 24.0%
ANS: B DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic |IMA-Decision Analysis

55. The unit selling price for the company's product is:
a. $15.00
b. $13.82
c. $14.86
d. $14.76
ANS: C DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis
349  Chapter 24(9)/Differential Analysis and Product Pricing

Mendoza Corporation uses the product cost concept of product pricing. Below is cost information for the
production and sale of 45,000 units of its sole product. Mendoza desires a profit equal to a 10.8% rate of
return on invested assets of $900,000.

Fixed factory overhead cost $72,000

Fixed selling and administrative costs 45,000
Variable direct materials cost per unit 4.50
Variable direct labor cost per unit 7.65
Variable factory overhead cost per unit 2.25
Variable selling and administrative cost per unit .90

56. The dollar amount of desired profit from the production and sale of the company's product is:
a. $105,840
b. $225,000
c. $  97,200
d. $220,500
ANS: C DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

57. The cost per unit for the production of the company's product is:
a. $14.40
b. $16.00
c. $15.30
d. $15.75
ANS: B DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

58. The markup percentage for the company's product is:

a. 25.38%
b. 10.98%
c. 26.1%
d. 18%
ANS: A DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

59. The unit selling price for the company's product is:
a. $17.73
b. $15.75
c. $22.05
d. $20.06
ANS: D DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  350

Elfrink Corporation uses the variable cost concept of product pricing. Below is cost information for the
production and sale of 35,000 units of its sole product. Elfrink desires a profit equal to a 11.2% rate of
return on invested assets of $350,000.

Fixed factory overhead cost $105,000

Fixed selling and administrative costs 35,000
Variable direct materials cost per unit 4.34
Variable direct labor cost per unit 5.18
Variable factory overhead cost per unit .98
Variable selling and administrative cost per unit .70

60. The dollar amount of desired profit from the production and sale of the company's product is:
a. $89,600
b. $39,200
c. $70,000
d. $84,000
ANS: B DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

61. The variable cost per unit for the production and sale of the company's product is:
a. $14.00
b. $12.60
c. $  9.80
d. $11.20
ANS: D DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

62. The markup percentage for the sale of the company's product is:
a. 14%
b. 5.6%
c. 45.71%
d. 11.2%
ANS: C DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

63. The unit selling price for the company's product is:
a. $16.32
b. $13.44
c. $12.10
d. $13.72
ANS: A DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis
351  Chapter 24(9)/Differential Analysis and Product Pricing

64. What pricing method may be used if there are several providers in the same market and there is
sufficient demand for your product?
a. Demand-based method
b. Total cost method
c. Cost-plus method
d. Competition-based method
ANS: D DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

65. What pricing method is used if all costs are considered and a fair mark-up is added to determine the
selling price?
a. Total cost method
b. Demand-based method
c. Variable cost method
d. Mark-up method
ANS: A DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

66. Using the variable cost concept determine the selling price for 30,000 units using the following data:
Variable cost per unit $13.00, $120,000 desired profit, and total fixed costs $80,000.
a. $20.00
b. $21.67
c. $17.00
d. $19.67
ANS: D
Markup percentage =

MP = = 51.3%

Selling price = $13.00 * 51.3%= 6.66

SP = $13 + $6.67 =$19.67

DIF: Easy OBJ: 24(9)-02

NAT: AACSB Analytic | IMA-Decision Analysis

67. Which equation better describes Target Costing?

a. Selling Price - Desired Profit = Target Costs
b. Selling Price - Target Costs = Profit
c. Target Variable Costs + Contribution Margin = Selling Price
d. Selling Price = Target Variable Costs + Target Fixed Costs + Profit
ANS: A DIF: Easy OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  352

The Koko Company produces their product at a total cost of $43 per unit. Of this amount $8 per unit is
selling and administrative costs. The total variable cost is $30 per unit The desired profit is $20 per unit.

68. Determine the mark up percentage on product cost.

a. 80%
b. 46%
c. 70%
d. 65%
ANS: A DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

69. Determine the mark up percentage on variable cost.

a. 100%
b. 110%
c. 80%
d. 57%
ANS: C DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

70. Target costing is arrived at by

a. taking the selling price and subtracting desired profit.
b. taking the selling price and adding desired profit.
c. taking the selling price and subtracting the budget standard cost.
d. taking the budget standard cost and reducing it by 10%.
ANS: A DIF: Moderate OBJ: 24(9)-02
NAT: AACSB Analytic | IMA-Decision Analysis

71. Soap Company manufactures Soap X and Soap Y and can sell all it can make of either. Based on the
following data, which statement is true?

X Y
Sales Price $32 $40
Variable Cost 22 24

Hours needed to process 5 8

a. X is more profitable than Y

b. Y is more profitable than X
c. Neither X nor Y have a positive contribution margin.
d. X and Y are equally profitable.
ANS: B DIF: Moderate OBJ: 24(9)-03
NAT: AACSB Analytic | IMA-Decision Analysis
353  Chapter 24(9)/Differential Analysis and Product Pricing

Niva Co. manufactures three products: Bales; Tales; and Wales. The selling prices are: 55; 78; and 32,
respectively. The variable costs for each product are: 20; 50; and 15, respectively. Each product must go
through the same processing in a machine that is limited to 2,000 hours per month. Bales take 7 hours to
process, Tales take 4 hours, and Wales take 1 hour.

72. Which product has the highest contribution margin per machine hour?
a. Bales
b. Tales
c. Wales
d. Bales and Tales have the same
ANS: C DIF: Moderate OBJ: 24(9)-03
NAT: AACSB Analytic | IMA-Decision Analysis

73. What is the contribution margin per machine hour for Bales?
a. $7
b. $5
c. $35
d. $28
ANS: B DIF: Moderate OBJ: 24(9)-03
NAT: AACSB Analytic | IMA-Decision Analysis

74. What is the contribution margin per machine hour for Tales?
a. $7
b. $5
c. $28
d. $35
ANS: A DIF: Moderate OBJ: 24(9)-03
NAT: AACSB Analytic | IMA-Decision Analysis

75. What is the contribution per machine hour for Wales?

a. $35
b. $28
c. $17
d. $8.50
ANS: C DIF: Moderate OBJ: 24(9)-03
NAT: AACSB Analytic | IMA-Decision Analysis

76. Assuming that Niva Co. can sell all of the products they can make, what is the maximum
contribution margin they can earn per month?
a. $64,000
b. $70,000
c. $56,000
d. $34,000
ANS: D DIF: Moderate OBJ: 24(9)-03
NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  354

77. Assuming that Niva produced enough product with the highest contribution margin per unit to use
1,000 hours of machine time. Product demand does not warrant any more production of that product.
What is the maximum additional contribution margin that can be realized by utilizing the remaining
1,000 hours on the product with the second highest contribution margin per hour?
a. $5,000
b. $7,000
c. $4,000
d. $28,000
ANS: B DIF: Moderate OBJ: 24(9)-03
NAT: AACSB Analytic | IMA-Decision Analysis

EXERCISE/OTHER

1. The Delicious Cake Factory owns a building for its operations. Delicious uses only half of the
building and is considering two options that have been presented to them. The Candy Store would
like to purchase the half of the building that is not being used for $550,000. A 7% commission would
have to be paid at the time of purchase. Ice Cream Delight would like to lease the half of the building
for the next 5 years at $100,000 each year. Delicious would have to continue paying $9,000 of
property taxes each year and $1,000 of yearly insurance on the property, according to the proposed
lease agreement.

Determine the differentia income or loss from the lease alternative.

ANS:
Differential revenue from alternatives:
Revenue from lease $500,000
Revenue from sale 550,000
Differential loss from lease (50,000)
Differential cost of alternatives:
Property tax and insurance $50,000
Commission expense 38,500
Differential cost of lease (11,500)
Net differential loss from the lease alternative ($61,500)

DIF: Moderate OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis TOP: Example Exercise 24(9)-1
355  Chapter 24(9)/Differential Analysis and Product Pricing

2. Koko Company Division B recorded sales of $350,000, variable cost of goods sold of $315,000,
variable selling expenses of $13,000, and fixed costs of $60,000, creating a loss from operations of
$38,000. Determine (a) the differential income or loss from the sales of Division B and (b) should
this division be discontinued?
ANS:
(a)
Differential revenue $350,000
Differential costs:
Variable cost of goods sold $315,000
Variable selling expenses 13,000 328,000
Annual differential income Division B 22,000

(b) Division B should not be discontinued.

DIF: Easy OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis TOP: Example Exercise 24(9)-2

3. Safe Security Company manufacturers home alarms. Currently it is manufacturing one of its
components at a variable cost of $45 and fixed costs of $15 per unit. An outside provider of this
component has offered to sell them the component for $30. Provide a differential analysis of the
outside purchase proposal.
ANS:
Differential cost to purchase:
Purchase price of the component $30
Differential cost to manufacture:
Variable manufacturing costs $45
Cost savings from purchasing component $15

DIF: Easy OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis TOP: Example Exercise 24(9)-3

4. An oven with a book value of $67,000 has an estimated 5 year life. A proposal is offered to sell the
oven for $8,500 and replace it with a new oven for $115,000. The new machine has a five year life
with no residual value. The new machine would reduce annual maintenance costs by $23,000.
Provide a differential analysis on the proposal to replace the machine.
ANS:
Annual maintenance cost reduction $23,000
Number of years applicable 5
Total differential decrease in cost $115,000
Proceeds from sale of equipment 8,500 $123,500
Cost of new equipment 115,000
Net differential decrease in cost from replacing equipment $8,500

DIF: Moderate OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis TOP: Example Exercise 24(9)-4
 Chapter 24(9)/Differential Analysis and Product Pricing  356

5. An unfinished desk is produced for $36.00 and sold for $65. An additional amount of $6.65 of
processing can be added to the desk which will allow the company to sell the desk for $75. Provide a
differential analysis for further processing.
ANS:
Differential revenue from further processing:
Revenue per unfinished desk $65.00
Revenue per finished desk 75.00
Differential revenue $10.00
Differential cost per desk:
Additional cost for producing 6.65
Differential income from further processing $3.35

DIF: Easy OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis TOP: Example Exercise 24(9)-5

6. Delicious Cake Factory normally sells their specialty cake for $22. An offer to buy 100 cakes for $18
per cake was made by an organization hosting a national event in the city. The variable cost per cake
is $12. A special decoration per cake will add another $1 to the cost. Determine the differential
income or loss per cake from selling the cakes.
ANS:
Differential revenue:
Revenue per cake $18
Differential cost:
Variable manufacturing costs $12
Additional decoration 1 13
Differential income from accepting special order $5

DIF: Easy OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis TOP: Example Exercise 24(9)-6

7. The Koko Company produces their product at a total cost of $50 per unit. Of this amount $14 per
unit is selling and administrative costs. The total variable cost is $38 per unit The desired profit is
$20 per unit. Determine the mark up percentage on total cost.
ANS:
Mark up percentage: $20 / $50 = 40%

DIF: Easy OBJ: 24(9)-02

NAT: AACSB Analytic | IMA-Decision Analysis TOP: Example Exercise 24(9)-7

8. The Koko Company produces their product at a total cost of $50 per unit. Of this amount $14 per
unit is selling and administrative costs. The total variable cost is $38 per unit The desired profit is
$20 per unit. Determine the mark up percentage on product cost.
ANS:
Mark Up Percentage on Product cost = ($20 + 14) / $36 = 94 %

DIF: Moderate OBJ: 24(9)-02

NAT: AACSB Analytic | IMA-Decision Analysis TOP: Example Exercise 24(9)-8
357  Chapter 24(9)/Differential Analysis and Product Pricing

9. The Koko Company produces their product at a total cost of $50 per unit. Of this amount $14 per
unit is selling and administrative costs. The total variable cost is $38 per unit The desired profit is
$20 per unit. Determine the mark up percentage on variable cost.
ANS:
Markup percentage on variable cost = ($20 + $12) / $38 = 84%

DIF: Moderate OBJ: 24(9)-02

NAT: AACSB Analytic | IMA-Decision Analysis TOP: Example Exercise 24(9)-9

10. Koko Company produces two products. Product A has a contribution margin of $20 and requires 4
machine hours. Product B has a contribution margin of $18 and requires 3 machine hours. Determine
the most profitable product assuming the machine hours are the constraint.
ANS:
Product A Product B
Contribution margin per unit $20 $18
Machine hours 4 3
Contribution margin per bottleneck hour $5 $6

Product B is the most profitable.

DIF: Moderate OBJ: 24(9)-03

NAT: AACSB Analytic | IMA-Decision Analysis TOP: Example Exercise 24(9)-10

PROBLEM

1. Bell Company is considering the disposal of equipment that is no longer needed for operations. The
equipment originally cost $600,000 and accumulated depreciation to date totals $460,000. An offer
has been received to lease the machine for its remaining useful life for a total of $290,000, after
which the equipment will have no salvage value. The repair, insurance, and property tax expenses
during the period of the lease are estimated at $75,800. Alternatively, the equipment can be sold
through a broker for $230,000 less a 10% commission.

Prepare a differential analysis report, dated June 15 of the current year, on whether the equipment
should be leased or sold.
 Chapter 24(9)/Differential Analysis and Product Pricing  358

ANS:

Bell Company
Proposal to Lease or Sell Equipment
June 15, 20--
Net Revenue from leasing:
  Revenue from lease $290,000
  Costs associated with the lease    75,800
    Net revenue from lease $214,200
Net Revenue from selling:
  Sales price $230,000
  Commission expense on sale   23,000
    Net from selling   207,000
Net advantage of lease alternative $    7,200

DIF: Moderate OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis

2. Product J is one of the many products manufactured and sold by Goodstein Company. An income
statement by product line for the past year indicated a net loss for Product J of $12,250. This net loss
resulted from sales of $260,000, cost of goods sold of $186,500, and operating expenses of $85,750.
It is estimated that 30% of the cost of goods sold represents fixed factory overhead costs and that
40% of the operating expense is fixed. If Product J is retained, the revenue, costs, and expenses are
not expected to change significantly from those of the current year. However, because of the net loss,
management is considering the elimination of the unprofitable endeavor. Because of the large
number of products manufactured, the total fixed costs and expenses are not expected to decline
significantly if Product J is discontinued.

Prepare a differential analysis report, dated February 8 of the current year, on the proposal to
discontinue Product J.
ANS:

Goodstein Company
Proposal to Discontinue Product J
February 8, 20--
Differential revenue from annual sales of product:
  Revenue from sales $260,000
Differential cost of annual sales
  of product:
  Variable cost of goods sold $130,550
  Variable operating expenses   51,450   182,000
Annual differential income from
  sales of Product J $ 78,000

DIF: Moderate OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis
359  Chapter 24(9)/Differential Analysis and Product Pricing

3. Pnok Company has been purchasing a component, Part Q, for $18.90 a unit. Pnok is currently
operating at 70% of capacity and no significant increase in production is anticipated in the near
future. The cost of manufacturing a unit of Part Q, determined by absorption costing methods, is
estimated as follows:

Direct materials $11.25

Direct labor 4.50
Variable factory overhead 1.12
Fixed factory overhead    3.15
Total $20.02

Prepare a differential analysis report, dated March 12 of the current year, on the decision to make or
buy Part Q.
ANS:

Pnok Company
Proposal to Manufacture Part Q
March 12, 20--
Purchase price of part $18.90
Differential cost to manufacture part:
Direct materials $11.25
Direct labor 4.50
Variable factory overhead    1.12   16.87
Cost savings from manufacturing
Part Q $ 2.03

DIF: Moderate OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis

4. FDE Manufacturing Company has a normal plant capacity of 37,500 units per month. Because of an
extra large quantity of inventory on hand, it expects to produce only 30,000 units in May. Monthly
fixed costs and expenses are $112,500 ($3 per unit at normal plant capacity) and variable costs and
expenses are $8.25 per unit. The present selling price is $13.50 per unit. The company has an
opportunity to sell 7,500 additional units at $9.90 per unit to an exporter who plans to market the
product under its own brand name in a foreign market. The additional business is therefore not
expected to affect the regular selling price or quantity of sales of FDE Manufacturing Company.

Prepare a differential analysis report, dated April 21 of the current year, on the proposal to sell at the
special price.
 Chapter 24(9)/Differential Analysis and Product Pricing  360

ANS:

Proposal to Sell to Exporter

April 21, 20--
Differential revenue from accepting offer:
Revenue from sale of 7,500 additional units at $9.90 $74,250

Differential cost of accepting offer:

Variable costs and expenses of 7,500 additional units at $8.25   61,875
Differential income from accepting offer $12,375

DIF: Moderate OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis

5. Due to Medicare reimbursement cuts, Nurturing Home Care is considering shutting down it’s
Certified Nursing Assistant Division. Fixed costs will have to be transferred to the Nursing Division
if the CNA division is discontinued. Currently, the fixed costs are shared equally. Using the Income
Statement below, make a recommendation to the president regarding this decision.

Nurturing Home Care

Condensed Income Statement
For the Year Ended December 31, 2007

Nursing CNA’s Total

Revenues $3,500,000 $900,000 $4,400,000

Variable Costs 2,000,000 800,000 2,800,000
Fixed Costs 400,000 400,000 800,000
Net Income from operations $1,100,000 ($300,000) $ 800,000

ANS:

Proposal to Discontinue CNA’s

December 31, 2007

Differential revenue from annual revenue from CNA’s $900,000

Differential variable costs from CNA’s 800,000
Annual differential income from CNA’s revenue $100,000

Keep for now as operating income would decrease by $100,000 if the CNA division were discontinued.

DIF: Easy OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis
361  Chapter 24(9)/Differential Analysis and Product Pricing

6. Christmas Decorations Unique has been approached by the community college to make special
decorations for the faculty and staff. The college is willing to buy 5,000 Christmas ornaments with
their own design for $5 a piece. The company normally sells its decorations for $12.00 each. A break
down of their costs is as follows:

Direct Materials $2.00

Direct Labor .50
Variable Costs 1.00
Fixed Costs _1.75
Total Cost Per Unit $5.25

Should Christmas Decorations Unique accept the special order made by the college? The company
has enough excess capacity to make this order.
ANS:

Proposal to Sell Christmas Decorations to College

November 5, 2008

Differential Revenue from accepting offer (5,000 * $5) $25,000

Differential variable costs of additional units (5,000 * $3.50) 17,500
Differential income from accepting the offer $ 7,500

DIF: Easy OBJ: 24(9)-01

NAT: AACSB Analytic | IMA-Decision Analysis

7. The Koko Company produces their product at a total cost of $86 per unit. Of this amount $15 per
unit is selling and administrative costs. The total variable cost is $60 per unit The desired profit is
$25 per unit. Determine the mark up percentage on (a) total cost, (b) product cost and (c) variable
cost concepts.
ANS:
(a) $25 / $86 = 29%

(b) ($25 + $15) / $71 = 56%

(c) ($25 + $26) / $60 = 85%

DIF: Moderate OBJ: 24(9)-02

NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  362

8. Mavis Company uses the total cost concept of applying the cost-plus approach to product pricing.
The costs and expenses of producing and selling 38,400 units of Product E are as follows:

Variable costs:
Direct materials $ 4.70
Direct labor 2.50
Factory overhead 1.90
Selling and administrative expenses   2.60
Total $ 11.70
Fixed costs:
Factory overhead $80,000
Selling and administrative expenses 14,000

Mavis desires a profit equal to a 14% rate of return on invested assets of $640,000.

(a) Determine the amount of desired profit from the production and sale of Product E.
(b) Determine the total costs and the cost amount per unit for the production and sale of 38,400
units of Product E.
(c) Determine the markup percentage for Product E.
(d) Determine the selling price of Product E.

ANS:
(a) $89,600 ($640,000  14%)

(b) Total costs:

  Variable ($11.70  38,400 units) $449,280
  Fixed ($80,000 + $14,000)    94,000
    Total $543,280
Cost amount per unit: $543,280/38,400 units $ 14.15

(c) Markup Percentage = Desired Profit

 Total Costs

Markup Percentage =  $89,600 

$543,280

Markup Percentage = 16.5%

(d) Cost amount per unit $14.15

Markup ($14.15  16.5%)     2.33
Selling price $16.48

DIF: Difficult OBJ: 24(9)-02

NAT: AACSB Analytic | IMA-Decision Analysis
363  Chapter 24(9)/Differential Analysis and Product Pricing

9. Moreland Company uses the product cost concept of applying the cost-plus approach to product
pricing. The costs and expenses of producing 25,000 units of Product K are as follows:

Variable costs:
Direct materials $2.50
Direct labor 4.25
Factory overhead 1.25
Selling and administrative expenses    .50
Total $8.50

Fixed costs:
Factory overhead $25,000
Selling and administrative expenses 17,000

Moreland desires a profit equal to a 5% rate of return on invested assets of $642,500.

(a) Determine the amount of desired profit from the production and sale of Product K.
(b) Determine the total manufacturing costs and the cost amount per unit for the production and
sale of 25,000 units of Product K.
(c) Determine the markup percentage for Product K.
(d) Determine the selling price of Product K.

ANS:
(a) $32,125 ($642,500  5%)

(b) Total manufacturing costs:

Variable ($8.00  25,000 units) $200,000
Fixed factory overhead    25,000
Total $225,000
Cost amount per unit: $225,000/25,000 units $ 9.00

(c)

Total Manufacturing Costs

$225,000

$225,000

Markup Percentage = $ 61,625 = 27.4%

$225,000

(d) Cost amount per unit $ 9.00

Markup ($9.00  27.4%)    2.47
Selling price $11.47

DIF: Difficult OBJ: 24(9)-02

NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  364

10. Star Company uses the variable cost concept of applying the cost-plus approach to product pricing.
The costs and expenses of producing and selling 75,000 units of Product T are as follows:

Variable costs:
Direct materials $ 7.00
Direct labor 3.50
Factory overhead 1.50
Selling and administrative expenses    3.00
Total $ 15.00
Fixed costs:
Factory overhead $45,000
Selling and administrative expenses 20,000

Star desires a profit equal to a 18% rate of return on invested assets of $1,440,000.

(a) Determine the amount of desired profit from the production and sale of Product T.
(b) Determine the total variable costs for the production and sale of 75,000 units of Product T.
(c) Determine the markup percentage for Product T.
(d) Determine the unit selling price of Product T.

ANS:
(a) $259,200($1,440,000  18%)

(b) Total variable costs: $15.00  75,000 units = $1,125,000

(c) Markup Percentage = Desired Profit + Total Fixed Costs

Total Variable Costs

Markup Percentage = $259,200 + $45,000 + $20,000

$1,125,000

Markup Percentage = $324,200

$1,125,000

Markup Percentage = 28.8%

(d) Cost amount per unit $15.00

Markup ($15  28.8%)    4.32
Selling price $19.32

DIF: Difficult OBJ: 24(9)-02

NAT: AACSB Analytic | IMA-Decision Analysis
365  Chapter 24(9)/Differential Analysis and Product Pricing

11. Carrigan Inc. manufactures Product B, incurring variable costs of $15.00 per unit and fixed costs of
$70,000. Carrigan desires a profit equal to a 12% rate of return on assets, $785,000 of assets are
devoted to producing Product B, and 100,000 units are expected to be produced and sold.

(a) Compute the markup percentage, using the total cost concept.
(b) Compute the selling price of Product B.

ANS:
(a) Markup Percentage = Desired Profit
Total Costs

Markup Percentage =             $785,000  .12            

($15  100,000) + $70,000

Markup Percentage =         $94,200        

$1,570,000

Markup Percentage = 6%

(b) Cost amount per unit $15.70

Markup ($15.70  6%)     .94
Selling price of Product B $16.64

DIF: Difficult OBJ: 24(9)-02

NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  366

12. Linderman Co. produces an automotive product and incurs total manufacturing costs of $2,500,000
in the production of 80,000 units. The company desires to earn a profit equal to a 12% rate of return
on assets. Linderman employs $960,000 of assets to manufacture the product. Total selling and
administrative expenses are $105,000.

(a) Calculate the markup percentage, using the product cost concept.
(b) Compute the price of the automotive product.

ANS:
(a) Markup Percentage = Desired Profit + Total Selling and Administrative Expenses
Total Manufacturing Costs

Markup Percentage = $115,200 + $105,000

$2,500,000

Markup Percentage =  $220,200 

$2,500,000

Markup Percentage = 8.8%

(b) Cost amount per unit $31.25

Markup ($31.25  8.8%)    2.75
Selling price $34.00

DIF: Difficult OBJ: 24(9)-02

NAT: AACSB Analytic | IMA-Decision Analysis
367  Chapter 24(9)/Differential Analysis and Product Pricing

13. Sacks Co. manufactures mobile cellular equipment and develops a price for the product by using a
variable cost concept. Sacks incurs variable costs of $1,900,000 in the production of 100,000 units.
Fixed costs total $50,000. The company employs $4,725,000 of assets and wishes to earn a profit
equal to a 10% rate of return on assets.

(a) Compute a markup percentage based on variable cost.

(b) Determine a selling price.

ANS:
(a)
Markup Percentage = Desired Profit + Total Fixed Costs
  Total Variable Costs

Markup Percentage = $472,500 + $50,000

  $1,900,000

Markup Percentage = $522,500 

  $1,900,000

Markup Percentage = 27.5%

(b) Cost amount per unit $19.00

Markup ($19  27.5%)    5.23
Selling price $24.23

DIF: Difficult OBJ: 24(9)-02

NAT: AACSB Analytic | IMA-Decision Analysis
 Chapter 24(9)/Differential Analysis and Product Pricing  368

14. Snazzle Soft Drinks makes three products: iced tea, soda, and lemonade. The following data are
available:

Iced Tea Soda Lemonade

Sales price per unit $.90 $.60 $.50
Variable cost per unit   .30   .15  .10
Contribution margin per unit $.60 $.45 $.40

Snazzle is experiencing a bottleneck in one of its processes that affects each product as follows:

Iced Tea Soda Lemonade

Bottleneck process hours per unit 3 3 4

(a) Using a theory of constraints (TOC) approach, rank the products in terms of profitability.
(b) What price for lemonade would equate its profitability to that of soda?

ANS:
(a)
Contribution Margin per Unit = CM per Bottleneck Hour
Bottleneck Hours per Unit

Rank

(1) Iced Tea: $.60  = $.20 = CM per Bottleneck Hour

   3

(2) Soda: $.45  = $.15 = CM per Bottleneck Hour

   3

(3) Lemonade: $.40  = $.10 = CM per Bottleneck Hour

   4

(b)
Contribution margin Revised Price of Variable Cost
= –
per bottleneck hour of soda Lemonade (L) of Lemonade
Bottleneck Hours per Unit of Lemonade

$.15 = L - $.10
     4

$.60 = L - $.10

$.60 + $.10 = L

$.70 = L

DIF: Difficult OBJ: 24(9)-03

NAT: AACSB Analytic | IMA-Decision Analysis
369  Chapter 24(9)/Differential Analysis and Product Pricing

15. The Delicious Cake Factory sells chocolate cakes, birthday decorated cakes, and specialty cakes. The
factory is experiencing a bottleneck and is trying to determine which cake is more profitable. Even
though the company may have to limit the orders that it takes, they are concerned about customer
service and satisfaction.
(A) Calculate the contribution margin per hour per cake.
(B) Determine which cakes the company should try to sell more of first, second, then last.

Chocolate Cake Birthday Cake Specialty Cake

Sales price $25.00 $45.00 $30.00
Variable cost per cake $5.00 $12.00 $10.00
Hours needed to bake, 1 hour 2.5 hours 2 hours
frost, and decorate

ANS:
(A) Chocolate $20, Birthday $33, Speciality $20
(B) Chocolate, Birthday, Specialty

Chocolate Cake Birthday Cake Specialty Cake

Sales price $25.00 $45.00 $30.00
Variable cost per cake $5.00 $12.00 $10.00
Contribution Margin per cake $20.00 $33.00 $20.00
Hours needed to bake, frost, 1 hour 2.5 hours 2 hours
and decorate
Contribution margin per hour $20.00 $16.50 $10.00

DIF: Difficult OBJ: 24(9)-03

NAT: AACSB Analytic | IMA-Decision Analysis