Week six (Chapter 8)

Exercises and problems E8-37, E8-27, E8-28, E8-20, E8-59, E8-56, 8-61

Exercise 8-37 Model for Making Tactical Decisions (Objective 1)

The model for making tactical decisions described in the text has six steps. These steps are listed, out
of order, below.

Required:

Put the steps in the correct order, starting with the step that should be taken first.

1. Select the alternative with the greatest overall benefit.

2. Identify the costs and benefits associated with each feasible alternative.
3. Assess qualitative factors.
4. Recognize and define the problem.
5. Identify alternatives as possible solutions to the problem.
6. Total the relevant costs and benefits for each alternative.

Brief Exercise 8-27 Structuring a Make-or-Buy Problem (Objective 2 Example 8.1)

Coed Scents, a national producer of young adult perfumes and colognes, needs to determine if it
would be cheaper to produce 100,000 bottles of its most popular perfume, Two AM, for sale in its
college town shops or to purchase them from an outside supplier for $25 each. Cost information on
internal production includes the following:

Fixed overhead will continue whether Two AM is produced internally or externally. No additional
costs of purchasing will be incurred beyond the purchase price.

Required:

1. What are the alternatives for Coed Scents?

1) Make or produce perfume (2AM)
2) Purchase from external supplier
2. List the relevant cost(s) of internal production and of external purchase.
Relevant costs of purchasing: Purchase price ($25)
3. Which alternative is more cost effective and by how much?

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4. Now assume that Coed Scents’ internal audit team learned through a special data analytics
project that intellectual property theft is a significant threat for outsourced production. The team
estimates that if Coed Scents outsources its production, it will need to spend $350,000 to
manage intellectual property theft of its Two AM brand by competitors operating in the country
where the outsourced production occurs. Which alternative is more cost effective and by how
much?

Brief Exercise 8-28 Structuring a Special-Order Problem (Objective 2 Example 8.2)

Rabbit Foot Motors has been approached by a new customer with an offer to purchase
5,000 units of its hands-free, Wi-Fi-enabled automotive model—the SMAK—at a price of
$18,000 per automobile. Rabbit Foot’s other sales would not be affected by this new
customer offer. Rabbit Foot normally produces 100,000 units of its SMAK model per year
but only plans to produce and sell 90,000 in the coming year. The normal sales price is
$35,000 per SMAK. Unit cost information for the normal level of activity is as follows:

An account shows the following information (for special order): Direct materials $10,000,
Direct labor, 2,000, Variable overhead, 4,000, Fixed overhead 8,000, Total, $24,000

Fixed overhead will not be affected by whether or not the special order is accepted.

Required:

1. What are the relevant costs and benefits of the two alternatives (accept or reject the
special order)?

 Accept - Relevant benefit is the extra revenue of $18,000 Relevant cost is the extra
raw material, extra labour cost and extra varaible overhead

 Reject- No relevant benefit or cost

2. By how much will operating income increase or decrease if the order is accepted?

8-20 Structuring a Keep-or-Drop Product-Line Problem (Objective 2 Example 8.4)

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Hickory’s management is deciding whether to keep or drop the parquet product line.
Hickory’s parquet flooring product line has a contribution margin of $50,000 (sales of
$300,000 less total variable costs of $250,000). All variable costs are relevant. Relevant fixed
costs associated with this line include 80% of parquet’s machine rent and all of parquet’s
supervision salaries.

Required:

1. List the alternatives being considered with respect to the parquet flooring line.

 Alternative 1 – keep the parquet flooring line

 Alternative 2 – to drop the parquet flooring line

2. List the relevant benefits and costs for each alternative.

Keep the product line – benefit is receiving contribution 50,000

Costs are machine rent 40,000 ($50,000 x 80%) and supervision salary is $20,000

Drop the product line – none of the relevant benefit and costs would occur

3. Which alternative is more cost effective and by how much?

Problem 8-59 Make or Buy, Qualitative Considerations (Objective 1, 2)

Hetrick Dentistry Services operates in a large metropolitan area. Currently, Hetrick has its
own dental laboratory to produce porcelain and gold crowns. The unit costs to produce the
crowns are as follows:

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Fixed overhead is detailed as follows:

Salary (supervisor) $26,000

Depreciation 5,000
Rent (lab facility) 32,000

Overhead is applied on the basis of direct labour hours. These rates were computed by
using 5,500 direct labour hours.

A local dental laboratory has offered to supply Hetrick all the crowns it needs. Its price is
$125 for porcelain crowns and $150 for gold crowns; however, the offer is conditional on
supplying both types of crowns—it will not supply just one type for the price indicated. If
the offer is accepted, the equipment used by Hetrick’s laboratory would be scrapped (it is
old and has no market value), and the lab facility would be closed. Hetrick uses 2,000
porcelain crowns and 600 gold crowns per year.

Required:

1. CONCEPTUAL CONNECTION Should Hetrick continue to make its own crowns, or should
they be purchased from the external supplier? What is the dollar effect of purchasing?

2. CONCEPTUAL CONNECTION What qualitative factors should Hetrick consider in making

this decision?

3. CONCEPTUAL CONNECTION Suppose that the lab facility is owned rather than rented
and that the $32,000 is depreciation rather than rent (assume that the original $5,000 of
depreciation remains). What effect does this have on the analysis in Requirement 1?

4. CONCEPTUAL CONNECTION Refer to the original data. Assume that the volume of
crowns used is 4,200 porcelain and 600 gold. Should Hetrick make or buy the crowns?
Explain the outcome.

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Problem 8-56 Special-Order Decision 9 (Objective 1, 2)

Rianne Company produces a light fixture with the following unit cost:

The production capacity is 300,000 units per year. Because of a depressed housing market,
the company expects to produce only 180,000 fixtures for the coming year. The company
also has fixed selling costs totalling $500,000 per year and variable selling costs of $1 per
unit sold. The fixtures normally sell for $12 each.

At the beginning of the year, a customer from a geographic region outside the area normally
served by the company offered to buy 100,000 fixtures for $7 each. The customer also
offered to pay all transportation costs. Since there would be no sales commissions involved,
this order would not have any variable selling costs.

Required:

1. CONCEPTUAL CONNECTION: Based on a quantitative (numerical) analysis, should the

company accept the order?
2. CONCEPTUAL CONNECTION What qualitative factors might impact the decision?
Assume that no other orders are expected beyond the regular business and the special
order.

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Problem 8-61 Keep or Drop (Objectives 1, 2)

AudioMart is a retailer of vintage vinyl records and equipment. The store carries two
popular sound systems--system A and system B. System A, of slightly higher quality than
System B, costs $20 more. With rare exceptions, the store also sells a specialized headset
when a system is sold. The headset can be used with either system. Variable-costing income
statements for the three products follow:

The owner of the store is concerned about the profit performance of System B and is
considering dropping it. If the product is dropped, sales of System A will increase by 30%,
and sales of headsets will drop by 25%. (Note: Round all answers to the nearest whole
number.)

Required:

(adapted)

1. Prepare income statements for the three products, using a better format.
2. CONCEPTUAL CONNECTION Prepare income statements for System A and the headsets
assuming that System B is dropped. Should B be dropped?
3. CONCEPTUAL CONNECTION Suppose that a third system, System C, with a similar quality
to System B, could be acquired. Assume that with C the sales of A would remain
unchanged; however, C would produce only 80% of the revenues of B, and sales of the
headsets would drop by 10%. The contribution margin ratio of C is 50%, and its direct
fixed costs would be identical to those of B. Should System B be dropped and replaced
with System C?

General Rule for Make or Buy Decisions:

1. Choose the option with the lowest relevant cost

2. Existing fixed costs are relevant only if they can be avoided through outsourcing

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