True-False

F 1. If the results of a decision are not as good as expected, there has been an error in the decision-making process.

T 2. The costs of operating a joint process can be fixed or variable.

T 3. Incremental costs can be either fixed or variable.

T 4. In general, the smaller the segment being considered in a decision, the fewer the avoidable costs.

T 5. A given fixed cost might be separable and relevant for the purpose of one decision and common and irrelevant for the
purpose of another decision in the same company.

F 6. Opportunity cost is usually the amount paid for a resource.

T 7. Fixed costs that are allocated to several segments are normally irrelevant to decisions for one of those segments.

T 8. The only revenues or costs that are relevant in decision making are the differential revenues or costs.

T 9. Constraints may be internal to the firm or external to the firm.

T 10. Management's objective should be to exploit a constraint rather than to eliminate it.

Problems

1. Wilson Company expects the following results, without considering any of the changes described below.
Product A Product B Total
--------- --------- -----
Sales $100 $300 $400
Variable costs 40 100 140
---- ---- ----
Contribution margin $ 60 $200 $260
Fixed costs - avoidable (20) (30) (50)
- unavoidable (50) (100) (150)
---- ---- ----
Profit (loss) $(10) $ 70 $ 60
===== ==== ====

The unavoidable costs are allocated based on unit sales of 1,000 A and 2,000 B. CONSIDER EACH QUESTION
INDEPENDENTLY UNLESS TOLD OTHERWISE.

a. Compute Wilson's income if product A is dropped.

b. If product A were dropped and the unit sales of product B increased by 30%, what would the company's income be?

c. Product A can be dropped and replaced with a new product, C, which would have avoidable fixed costs of $50. Product C
would sell for $0.60, have variable costs of $0.20, and expected volume of 400 units. Compute Wilson's income if A
were replaced by C.

d. Suppose now that products A and B are joint products that are being sold at split-off. All of the costs shown on the income
statement are the materials, labor, and overhead of the joint process. Find income if product B were processed further
at additional costs of $90 and sold for $350.

SOLUTION:

a. Wilson's income: $20 ($200 CM from B - $30 - $150)

b. Wilson's income: $80 ($260 CM from B - $30 - $150)

c. Wilson's income: $130 [$20 + 400($0.60 - $0.20) - $50]

d. Wilson's income: $20 ($60 CM from A + $50 incremental revenue –
$90 incremental cost)

2. Arapahoe Corp. can make three products from a joint process. The monthly cost of the joint process is $10,000. Following are
data about the three products.

Sales Value Sales Value Costs of

at if Further Additional
Product Split-off Point Processed Processing
------- --------------- ----------- ----------
A $ 8,000 $12,000 $2,500
B $ 9,000 $10,000 $2,000
C $ 0 $ 2,500 $1,000

a. Which product(s) should be sold at the split-off point?

b. Arapahoe is currently processing all three products rather than selling any of them at the split-off point. Find its current
income.

SOLUTION:

a. Product B should be sold at split-off.

b. Income: $9,000 ($12,000 + $10,000 + $2,500 - $2,500 - $2,000 - $1,000 - $10,000)

3. Madison Co. operates a joint process. Three products, B, C, and D emerge from that process, each of which can be sold
immediately or processed further. Monthly output is 50,000 gallons; 50% is B, 30% is C, and 20% is D. You have the
following information.
B C D
------- ------- -------
Per-gallon split-off price $8 $9 $6
Per-gallon price after further
processing $13 $15 $12
Per-gallon variable cost of
further processing $4 $2 $4
Avoidable direct fixed costs of
further processing, per month $35,000 $45,000 $18,000
Unavoidable direct fixed costs
of further processing, per month $18,000 $40,000 $ 7,000

Which product(s), if any, should be sold at split-off?

SOLUTION:
B should be sold at split-off.
B: [50,000 x 50%] x [$13 - $8 - $4] - $35,000 = -$10,000
C: [50,000 x 30%] x [$15 - $9 - $2] - $45,000 = $15,000
D: [50,000 x 20%] x [$12 - $6 - $4] - $18,000 = $2,000

4. Milton Company has three products: A, B, and C. Three machines are used to produce the products. The contribution margins,
sales demands, and time on each machine (in minutes) is as follows:

time time time

Demand CM on M1 on M2 on M3
A 100 $45 10 15 12
B 80 $30 10 5 8
 C 60 $40 5 10 5

There are 2,400 minutes available on each machine during the week. All materials needed are readily available on a just-in-
time basis.

a. What are the load factors for each of the three machines?

b. Which machine is the bottleneck?

c. How many units of A, B, and C should be produced during the week?

SOLUTION:

a. M1: 87.5% [(10 x 100) + (10 x 80) + (5 x 60)]/2,400

M2: 104.2% [(15 x 100) + (5 x 80) + (10 x 60)]/2,400
M3: 89.2% [(12 x 100) + (8 x 80) + (5 x 60)]/2,400

b. The bottleneck is M2 as identified by the load factor exceeding 100%

c. A: 93, B: 80, C: 60
A: $45/15 = $3
B: $30/5 = $6
C: $40/10 = $4

Time available 2,400

Produce B first 80 x 5 = 400
Time remaining 2,000
Produce C: 60 x 10 = 600
Time remaining 1,400
Produce A 93 x 15 1,395
Time remaining 5

5. LaCrosse Company expects the following results, without considering any of the changes described below.
Product A Product B Total
--------- --------- ------
Sales $1,000 $3,000 $4,000
Variable costs 400 1,000 1,400
----- ----- -----
Contribution margin $ 600 $2,000 $2,600
Fixed costs - avoidable (200) (300) (500)
- unavoidable (500) (1,000) (1,500)
----- ------ -----
Profit (loss) $ (100) $ 700 $ 600
===== ====== ======

The unavoidable costs are allocated based on unit sales of 1,000 A and 2,000 B. An exporter has offered $0.80 per unit for 200
units of A.

a. Find the change in income if LaCrosse accepts the o rder, assuming no loss of regular sales.

b. The managers believe that if they accept the special order, they will lose some sales at the regular price. Determine the
number of units they could lose before the order became unprofitable.

c. The managers believe that they will lose 80 units at the regular price if they accept the order. Calculate the price they must
charge for the special order to increase income by $50.

SOLUTION:

a. Change in income: $80 increase [200 x ($0.80 - $0.40 variable cost per unit)]

b. Sales to lose: 133 units [$80/($1.00 - $0.40)] = 133

c. Price: $0.89
Lost contribution margin (80 x $0.60) $48.0
Desired profit 50.0
-----
Contribution margin required from special order $98.0
Divided by 20. units 200
-----
Equals contribution margin per unit $0.49
Plus variable cost 0.40
-----
Equals required price $0.89
=====

6. Mays Company manufactures 200,000 units of part XYZ annually. The following information has been collected:

Materials $200,000
Direct labor 110,000
Variable overhead 50,000
Fixed overhead 100,000
--------
Total costs $460,000
========

Clemens Company has offered to provide part XYZ for $2 per unit. Assume no other productive use of the space exists.

a. What would be the dollar impact if Mays accepted the offer?

b. What is the maximum price Mays is willing to pay for the part?

SOLUTION:

a. $40,000 less profits ($360,000 make - $400,000 buy)

Cost to buy the part: 200,000 x $2 = $240,000

Cost to make the part: $200,000 + 110,000 + 50,000 = $360,000

b. $1.80 ($360,000/200,000)

7. Gonzalez can produce any of three products with its current production line. The heat treating equipment has 400 hours
available during any given month. Per unit production, sales, and cost statistics are as follows:
A B C
--- --- ---
Selling price $15 $20 $10
Variable cost $ 9 $12 $ 7
Required time in heat treat 1.5 hrs 2.5 hrs. 1.0 hrs
Maximum demand per month 100 100 100

a. How many of each product should Gonzalez produce and sell?

b. Suppose the selling price of C increases to $12. How many of each product should Gonzalez produce and sell?

SOLUTION:

a. 100 A, 100 B, 0 C
A: ($15 - 9)/1.5 = $4.00/hr 100 x 1.5 hrs = 150.0 hrs
B: ($20 - 12)/2.5 = $3.20/hr 100 x 2.5 hrs = 250.0
 C: ($10 - 7)/1.0 = $3.00/hr 0 (no hours remaining)

b. 100 A, 60 B, 100 C
C: ($12 - 7)/1.0 = $5.00/hr 100 x 1.0 hrs = 100.0 hrs
A: ($15 - 9)/1.5 = $4.00/hr 100 x 1.5 hrs = 150.0
B: ($20 - 12)/2.5 = $3.20/hr (400 - 100 - 150)/2.5 hrs = 60 units
8. Scottso Enterprises has the following products and costs:

A B C
Unit demand pe