PART B NOTES

CVP ANALYSIS

CVP analysis is the study of the relationship that exists between cost,
volume and the profit of the company.
It is based on the concept of contribution.
As you will remember,

Contribution = Sales – Variable

costs

The contribution obtained is used to cover the fixed costs and thereby
generate profits. Since fixed costs are constant and do not vary with
production, we are primarily concerned with contribution, which after
covering all fixed costs, begins to contribute to higher profits.
CVP analysis is better understood by gaining an understanding of the few
terms and ratios that are provided below

C/S RATIO

In studying the relationship between cost volume and the profit, an

important measure that is used as a part of the analysis is the C/S ratio
(Contribution to sales ratio)

C/S RATIO =
Contribution per unit / Selling price per
unit
OR
Total Contribution / Total Sales revenue

BREAN-EVEN POINT

A company might need to quantify the number of units that it must certainly
produce to cover its fixed costs. Breakeven point is such a measure that tells
the management what level of production is needed to make zero profit or
zero loss.
Breakeven point may be expressed in units or revenue terms.
Breakeven point in units depicts the number of units to be produced to make
no gain/no loss and is given by the following formula:

B.E.P or Break-even point (in units) =

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 1

Fixed costs/contribution per unit

Break-even point in revenue terms depicts the amount of revenue the

company needs to generate to achieve zero losses. It may be computed as
follows:

B.E.P or Break-even point(in Revenue)=

Fixed costs / (C/S ratio) OR BEP (in units) x Sales price
/unit

MARGIN OF SAFTY

Margin of safety is yet another measure used by management in cost-

volume-profit analysis. It is a measure of how far away a company is from
its break-even point.
Margin of safety may be computed in terms of units or as a %.

In terms of units, MOS= Budgeted Sales-B.E.P (in units)

In terms of %, MOS=Budgeted sales - B.E.P (in units)/Budgeted
Sales

CALCULATING VOLUME NEEDED FOR TARGET PROFITS

At times, you could be asked to calculate the quantity required to be

produced to generate a certain target profit.
In such situations, the quantity produced will need to be higher than the BEP
as profit will be zero at BEP.
Beyond BEP, the contribution begins to contribute to the profits of the
organization .Hence to compute the units needed to achieve target profits,
the following may be used:

Units to achieve Target Profits = (Fixed costs + Targeted profits)

/Cost per unit.

Total revenue to generate targeted profit = (Fixed costs+ Target

profits) / (C/S ratio)

CVP CHARTS

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 2

Besides studying CVP analysis using the ratios and measures indicated
above, the same may be analyzed diagrammatically or graphically.
CVP graphs may be classified into 2 categories:
1. Break-even charts
2. P/V Charts

BREAK-EVEN CHARTS:

Break-even charts depict the total costs and revenues of an entity and
identify the level of production at which the entity breaks even i.e. the
breakeven point is identified.

PROFIT VOLUME CHARTS

PV or profit volume charts show the manner in which profits of an entity

varies in accordance with the volume.

PV charts can be drawn even in multi-product situations. For e.g. we were to

draw a PV chart it would look like this (as will you notice, one way of
depicting it is separately for each product in the descending order of C/s
ratio):

Limitations of Cost Volume profit analysis and BEP chart.

 It is based on a convenient but illogical assumption that a company sells

only one product or when it sells more than one product; the same is in a
constant proportion.
 Costs and revenues are assumed to be linear.
 Ignores changes in cost structure.
 Assumes that all costs are either variable or fixed. Ignores semi-variable
elements.
 Assumes fixed cost remain constant (where’s the concept of stepped
fixed!)

LINEAR PROGRAMMING

A limiting factor is the resource or factor that is limiting an organization’s

current level of activity. Often this is the forecast level of sales. In periods of
higher demand, limited supply of labour or machine time could govern the
level of output.
Questions of ACCA at this level, assume that a company wishes to maximize
its returns of the resources it has available.

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 3

Limiting factor analysis is the technique used to calculate the mix of
products that should be made to maximize return on a single limiting factor.
Illustration:
Take the two products below. Which one should the company make to
maximize its return on scarce machine hours?

Moan Groan
$ $
Unit sales price 40 80
Unit Variable Cost 10 20
Contribution 30
60
Unit Fixed cost 20 20
Unit Profit 10 40
It is tempting to state the Groan due to its higher unit profit.
However, this could be the wrong suggestion for two reasons:

Why shouldn’t we use profit per unit?

Profit should not be used as its calculations include fixed costs that do not
change as the result of the decision. Furthermore, the apportioning of fixed
cost between products could be quite arbitrary. Contribution should be used.

Why shouldn’t we use contribution per unit?

Even if contribution is used, the wrong decision can still be made.

Contribution per unit of product does not take into account the amount of
scarce resource used to generate that contribution. Decisions on production
priorities should be made use the contribution generated per unit of scarce
resource used – in this case contribution per machine hour.

What should we use?

Contribution per unit of scarce resources.

Imagine if 1000 machine hours are available and each Moan takes 1 hour
and each Groan 3 hours.

Moan Groan
$ $
Unit Sales Price 40 80
Unit Variable Cost 10 20
Contribution 30 60
Machine hrs. 1 3
Contribution per hours 30 20

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 4

Total hours available 1000 1000
Total contribution earned $30,000 $20,000
The rule that comes from this simple e.g. is maximizing output of the
product offering the highest contribution per unit of scarce resource used-in
this case the Moan.

LINEAR PROGRAMING

Limiting factor analysis can be used for multi-product situations but only in
situations where there is one limiting factor.
Linear programing can be looked at
 Graphically
 Using simultaneous equations

Linear programing can be used in situations where there are multiple

limiting factors (constraints) but only two products.
Steps

1) Define the decision variables involved in the problem

2) Establish the constraints
3) Establish the objective function
4) Graph the constraints
5) Identify the point at which the objective function is maximized
/minimized, either by reading values off the graph or by solving
equations simultaneously.

Decision Variables

These are factors that a company has control over-most commonly the
amount of an item/items it can produce.
These are factors that are constant at the time a problem is being
considered. They lie outside the immediate control of a company e.g the
time taken to produce an item ,the amount of raw materials available. In
the longer term these constraints can be overcome.

USE OF SHADOW PRICES

How does the optimum mix change?

What is the premium a company should be prepared to pay for this extra
unit of resource?
The answer to this question can be obtained by calculating shadow prices.

Shadow prices represent the maximum premium, above the standard unit
cost, a company should be prepared to pay for one extra unit of constraint.

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 5

Slack is the amount by which a resource is under-utilized. It occurs when
the optimum point does not fall on a given resource line. It is important as
unused resources can be put to other use to earn the company
contribution/profit.
Is-contribution Lines
Most feasible regions have several intersections, each possibly representing
the solution. This means several pairs of simultaneous equations have to be
solved, which is time consuming. Using an iso-contribution line it is possible
to identify which intersection correspondence to the optimal solution. In this
way only a single pair of simultaneous equations then needs to be solved.
The objective function defined earlier was C=50x+40y.Taking a convenient
value of C (one that gives whole number values for x and y),for example
$200,it is possible to write $200=50x+40y.Calculate the value of x when
y=0 and of y when x=0,and plot a line on the graph. All possible
combinations of x and y on this line will give a contribution of $200.Using a
ruler move outwards in parallel with the iso-contribution line. The last
intersection on the feasible region that the ruler passes through is the
maximum contribution point. Values of x and y corresponding to this point
can then be determined by solving the equations for the two lines that
comprise the intersection.

RELEVANT COSTING

In the short –term managers need to take key decision such as whether to
buy a product or make it, whether to continue or discard production of a
particular commodity, what price to offer a particular customer and so on.
In short-term decision need to be ideally based on Relevant costs.

 Relevant costs are future costs. Costs already incurred are not
relevant costs e.g. if A plc. Is to continue making a product, previous
research and development costs are not included in the calculation.
These are referred to as sunk costs.
 Costs that will arise irrespective of a decision are committed costs.eg
market research
 Relevant costs are cash flows and not notional costs. In other words
depreciation is not a relevant cost.
 Relevant costs can be incremental costs, the change in cost as a result
of a decision. Relevant costs are only those that change as a direct
result of the decision being made.
Relevant costs can be opportunity costs-benefits forgone by using
resources in a particular way compared to the next best alternative.eg

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 6

 If you use a factory premises ,you lose the chance to gain rental
income from the factory for a third party.

SO WHAT COSTS ARE RELEVANT?

In general all variable costs are relevant and all fixed costs are
irrelevant. But, incremental Fixed or directly attributable fixed costs
are relevant.
For e.g. directly attributable fixed costs are those that will change as a
result of a decision. A decision to expand production, for insurance
,might require rent of further buildings. In this case the increase in
rent would be treated as relevant costs.
Note: General fixed overheads apportioned amongst various division is
irrelevant as this will not change with the increase or decrease in
production of any single division and is incurred for the factory as a
whole irrespective of the level of production.
At times material cost (which is supposedly a variable cost)may be
treated as irrelevant especially if the material used is scrap with nil
value.

USING RELEVANT COSTS TO TAKE DECISION

Relevant costing can be used in short decision-making situations:

Situation 1: Make or Buy

Situation 2: Further processing decisions
Situation 3: Product Close Down Decisions
Situation 4: Costing cut price contracts

SITUATION 1: MAKE OR BUY

Manufacturing companies commonly face the problem of deciding

whether to produce components themselves or to buy them in from
other manufacturers. Equally, service companies face the problem of
deciding whether to meet a contract using their own staff and technical
resources or whether to buy in expert staff and teams from outside.
Whilst cost is a major consideration in any make or buy decision, other
issues are also important:

1) Can the quality of the bought in product or service be guaranteed?

2) Are the sub-contractors reliable enough to deliver on time and to

agreed specifications?
3) Are suppliers flexible enough to meet the demands of the company?

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 7

 4) Can the company retain sufficient control over the work once it has
been subcontracted?
Leaving asides these considerations, a decision to make or buy on cost
grounds involves comparing the relevant costs of the make and buy
options, the difference between the two being the differential cost.

SITUATION 2: FURTHER PROCESSING

At times, joint products are manufactured by an entity and it may

have the choice of selling these in the present form or alternatively
processing it further to convert it into anther product to generate
much higher revenues. The decision on whether further processing
needs to be undertaken is to be done by comparing incremental costs
with incremental revenues.

SITUATION 3: SHUT DOWN DECISIONS

Companies are often faced with the decision over whether to

discontinue/introduce new product lines. Relevant costing techniques
can be used as part of the decision making process.
Note: In practice, decision to continue/discontinue a product may not
simply by made on the grounds of cost. Cutting a loss-making product
line may reduce a company’s market share, for insurance, which may
have adverse knock-on effects on sales of its other product. Customer
dissatisfaction arising from discontinuing a product may also have the
same effect.

SITUATION 4: COSTING CUT PRICE CONTRACTS

In the short-term companies often have spare capacity that remains

idle. In order to maintain full utilization of capacity, companies may
consider accepting orders at below their usual price. Relevant costing
can be used to determine whether a company should accept such
work. In general ,an order is worth accepting if it will increase total
contribution.
In order to calculate the cost (which consequently becomes the
minimum price, we need to understand the rules of relevant cost of
material & relevant cost of labor)

Relevant cost of material

(i) If the materials are in stock and are to be replaced (in regular
use)they are valued at their replacement cost.

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 8

 (ii) If materials are in stock and are not to be replaced(no other
use),their relevant cost is determined by using the higher of the
following:
a) Their current resale value
b) The value they would obtain if put to an alternative use.
c) Scrap value
(iii) If the materials are NOT in stock and needs to be purchased,
relevant cost is actual price paid.

Relevant costs of labour

(i) When labour has idle time, with guaranteed wage or a

fixed wage, this cost is relevant.
(ii) When fresh labour needs to be hired, the relevant cost is
actual wages.
(iii) When labour is in short supply and labour is switched from
one product to another it results in relevant cost equal to
the labour cost per hr + the lost contribution per hr

RISK & UNCERTAINTY

In the process of making decisions, dealing with future events that cannot
be predicted with any certainty, is a common scenario.
Therefore, in making decisions, organizations need to be aware of the
possibility of various outcomes resulting from their action.
When an organization is unable to predict the future with any certainty,
there is apparently uncertainty inherent in the situation.
On the contrary, based on prior data, if a range of possible outcomes and
the changes of their occurrence can be enumerated with some amount of
certainty, there is certainly no uncertainty but there does exist an element of
risk inherent in the situation as any of the possible outcomes may occur and
the company can merely reasonably predict the future and there is no
assurance that the outcome would be as expected.
In order to incorporate risk into the process of taking decisions, organization
and management accountants may use various tools such as:
1.Expected value
2.Sensitivity

EXPECTED VALUES

Expected values(EVs) are weighted average values based on probabilities.

For eg. Expected value can be utilized to calculate the likely profits of a

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 9

project (based on the various outcomes & their related probabilities)
together with the most profitable course of action. Expected values are of
most use in longer term planning and have limited use in the case ofone-off
decisions.
If P is the probability of a particular outcome and x is the value of the
outcome, the expected value is calculated as follows:

EXPECTED VALUE=∑Px

Where:
EV(x) is the expected value of x
∑ = the sum of
X = value of x
P = probability of x occurring

ADVANTAGES OF EV

 Incorporates all possible outcomes

 Enables probabilities to be quantified and incorporated into
computation
 Simple to compute and understand, hence making decisions easy

DISADVANTAGES OF EV

 Expected values are long-term average values. They may not apply to
one off decisions.
 EV`s calculated can be values that will never arise
 Probabilities can be hard to determine.(subjective)

WHEN TO USE EV ?

 When the outcomes and related probabilities can be predicted with

reasonable certainty
 The decision taking using EV is one that is often made. In other words,
EV is more suitable for long-term frequent decisions rather than one-
off decision taken by any organization.
 The risk and the decision are of relatively smaller consequence of the
company

SENSITIVITY

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 10

 Sensitivity analysis is used to establish which the effect of possible
variations in the variables or estimates on the final decisions. It is
normally expressed as a percentage of the value used in the original
decision
Those factors with a low percentage are the most sensitive to change and
are have to be seriously thought of by management.

ADVANTAGES OF SENSITIVITY

- Sensitivity analysis helps analyze impact on change in each variable

influencing the decision
- Sensitivity analysis helps draw attention to critical areas which need to
be continually monitored for project success.

DISADVANTAGES OF SENSITIVITY

- Sensitivity analysis assumes that changes to variables are independent

of one another. If one variable changes, all other variables are
assumed to remain constant.
- It only identifies the extent to which a variable can change and not the
chances of such a variation
- Sensitivity analysis does not help in objective decision making ,as it is
merely a measure of the risk. Decision-makers need to consider the
sensitivity values and take decisions accordingly

HANDLING UNCERTAINTY

Uncertainty is a term commonly used for scenarios where it is impossible to

identify different possible outcome and assign probabilities to them.
when probabilities of the occurrence of a particular outcome(s) are not
available ,there are still several tools available that aid decision-making:
1. Research techniques
2. using pay-off tables (Maxima, maxim in, Minima Regret)
3. scenario planning & simulation

RESEARCH TECHNIQUES

Market research is an important means of assessing and reducing

uncertainty about future occurrences.
Research can take the form of:
Desk Research

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 11

  The information is collected from secondary sources
 It obtains existing data by studying published and other available
sources of information. For e.g ,press articles, published accounts,
census information.

Field Research

 Information is collected from primary sources by direct contact with a

targeted group.
 Although it is more expensive and time consuming than desk research
the results should be more accurate, relevant and up to date.

Focus Group Study

 Focus groups are a common market research tool involving small

groups (typically eight to ten people) selected from the broader
population. The group is interviewed through facilitator-led discussions
in an informal environment in order to gather their opinions and
reactions to a particular subject.

USING PAY-OFF TABLES

Pay-off tables are extensively used in plotting the outcome against the
action taken by an organization. Through this process,a company can
identify what course of action to take.
In plotting a pay-off table, the various possible actions that the organization
takes is plotted on the horizontal axis and the various outcomes are
plotted on the vertical axis
A typical pay-off table would look like this:

PAY-OFF TABLE ACTION 1 ACTION 2 ACTION 3

OUTCOME X X X X
OUTCOME Y X X X
OUTCOME Z X X X
The pay-off table so arrived at can be used to take decisions using the three
criterions listed below:

MAXIMIN (PESSIMIST`S CRITERIA)

In this strategy the decision-maker takes the project that has the least worst
outcome – in effect playing it safe. This is a very conservative strategy that
can lead to low returns for a company. We start of by analyzing the

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 12

worst outcome for each action and then choosing the best out the
worst outcomes so identified.

MAXIMAX (OPTIMIST`S CRITERIA)

+

In this approach the company seeks to maximize the best possible outcome.
We start of by analyzing the best outcome for each action and then
choosing the best out the best outcomes so identified. This can be a
high risk strategy as no account is take of possible losses or how likely each
outcome is:

MINIMAX REGRET(THE BAD LOSER CRITERIA)

In this decision making rule the decision market tries to minimizes the
regret from making the wrong decision. Regret refers to any opportunity
lost as a result of making the wrong decision. This involves making up a
table of regrets, identifying the maximum regret of each action and then
choosing that action with minimum ‘maximum regret`.

VALUE OF PERFECT INFORMATION

Perfect information is guaranteed to predict the future with 100%

accuracy. Imperfect information is better than no information at all but
could be wrong in its prediction for the future.
The value of perfect information is the difference between the EV of profit
with perfect information and the EV of profit without perfect information.
In other words, the value of perfect information represents the benefit or
increase in profits as a result of you knowing what will actually happen.

SCENARIO PLANNING & SIMULATION

Scenario planning is a technique of handling uncertainty wherein the

various possible scenario or plausible outcomes are developed and
studied. Scenario planning involves 7 stages:
A. Identify the high-impact ,high-uncertainty factors in the
environment.
B. For each of the factors, identify the possible values.
C. Group the various possible values for the different factors & identify
scenarios.
D. Write up the scenario
F. For each scenario, identify possible courses of action the company can
take.

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 13

 G. Apply the strategic options identified under the relevant scenario
occurring
Simulation is a modeling tool that is often used in decision-taking, which
involves construction of a statistical model by analyzing the various
possible outcomes through random generation of values for each variable
affecting the decision under consideration. All the random values so
generated are combined and analyzed.

ADVANTAGES OF SIMULATION

 Incorporate the uncertainty inherent in many systems and can be used

to produce a range of possible results arising from a particular
decision.
 Simulation models allow system evolution to be studied, which may be
as important as the system`s final state. Simulation is used, for
instance, to model corporate finance. Even if the final status of the
company is healthy, it is useful if potential financial problems say a
liquidity crisis, can be identified in advance.
 Simulation models are capable of dealing with complex systems.
 Simulation unlike sensitivity analysis assumes that all variables change
simultaneously and continuously.

DISADVANTAGES OF SIMULATION

 Full scale simulation models are complex, expensive to develop, and

require computer solution.
 Simulation models produce a set of results likely to arise from making
a particular decision. In isolation it is difficult to assess whether they
represent an optimal solution. By comparing sets of results it becomes
possible to identify an optimum solution, though this can be a very
time consuming procedure.

DECISION TREES

A decision tree is a diagrammatic representation of a decision problem and

forces the decision maker to consider a logical sequence of events.
It works by breaking a complex problem down into a series of choices and
outcomes.

A square is used to represent a decision point. At a decision point

the decision maker has a choice of which course of action he wishes to
undertake

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 14

 A circle is used at a chance outcome point. The branches from here
are always subject to probabilities.
The decision tree is draw as follows:
Process:
 Draw out the relationship `branches` working from the left to right of
the page
 Add costs/revenues given in the question to the branches
 Add probabilities given in the question
 Calculate Expected Value working from right to left of the page. This
can be called roll back analysis and it evaluates the EV of each decision
option to help the decision maker choose what the best course of
action is.

PART B QUESTIONS

1. Cut and Stitch (CS) make two types of suits using skilled tailors (labour) and a delicate
and unique fabric (material). Both the tailors and the fabric are in short supply and so
the accountant at CS has correctly produced a linear programming model to help decide
the optimal production mix.
The model is as follows: Variables:
Let W = the number of work suits
produced Let L = the number of
lounge suits produced

Constraints

Tailors’ time: 7W + 5L ≤ 3,500 (hours) – this is line T

on the diagram
Fabric: 2W + 2L ≤ 1,200 (metres) – this is line F on the
diagram
Production of work suits: W ≤ 400 – this is line P on the
diagram
Objective is to maximise contribution
subject to: C = 48W + 40L
On the diagram provided the accountant has correctly identified OABCD as the feasible region and
point B as the optimal point.

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 15

 Required

(a) Find by appropriate calculation the optimal production mix and related maximum
contribution that could be earned by CS.

(b) Calculate the shadow prices of the fabric per metre and the tailor time per hour.

2. Ennerdale has been asked to quote a price for a one-off contract. The company's
management accountant has asked for your advice on the relevant costs for the contract.
The following information is available:
Materials
The contract requires 3,000 kg of material K, which is a material used regularly by the company in
other production. The company has 2,000 kg of material K currently in inventory which had been
purchased last month for a total cost of $19,600. Since then the price per kilogram for material K has
increased by 5%.
The contract also requires 200 kg of material L. There are 250 kg of material L in inventory which
are not required for normal production. This material originally cost a total of $3,125. If not used on
this contract, the inventory of material L would be sold for $11 per kg.
Labour

The contract requires 800 hours of skilled labour. Skilled labour is paid $9.50 per hour. There is a
shortage of skilled labour and all the available skilled labour is fully employed in the company in the
manufacture of product P. The following information relates to product P:

$ per unit $ per unit

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 16

Selling price 100

Less:

Skilled labour 38

Other variable costs 22

(60)
40

Required
Prepare calculations showing the total relevant costs for making a decision about the contract in
respect of the following cost elements:
Materials K and L
Skilled labour

The company also manufactures three joint products (M, N and P) from the same common process. In
a typical month, output from the common process consists of 25,000 litres of M, 15,000 litres of N
and 45,000 litres of P, in fixed proportions. The monthly costs of the common process are $480,000
Each one of the products can be sold immediately after the common process, but each one of them
can be further processed individually before being sold. The following further processing costs and
selling prices per litre are expected:

Product Selling price after Selling price after Further variable

common process further processing processing cost
$/litre $/litre $/litre
M 6.25 8.40 1.75
N 5.20 6.45 0.95
P 6.80 7.45 0.85
Evaluate the viability of the common process, and determine the optimal processing plan for each of
the three products, showing appropriate calculations.

3. Hair Co manufactures three types of electrical goods for hair: curlers (C), straightening
irons (S) and dryers (D.) The budgeted sales prices and volumes for the next year are as
follows:

C S D
Selling price $110 $160 $120
Units 20,000 22,000 26,000

Each product is made using a different mix of the same materials and labour. The
budgeted sales volumes for all the products have been calculated by adding 10% to
last year’s sales.

The standard cost card for each product is shown below.

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 17

 C S D
$ $ $
Materials 20 50 42
Labour 30 54 50
Labour costs are variable. The general fixed overheads are expected to be $640,000 for the next year.

Required

Calculate the weighted average contribution to sales ratio for Hair Co.

Note. Round all workings to two decimal places.

Calculate the total break-even sales revenue for the next year for Hair Co.

Note. Round all workings to two decimal places.

Using the graph paper provided, draw a multi-product profit-volume (PV) chart showing clearly the
profit/loss lines assuming:
You are able to sell the products in order of the ones with the highest
ranking contribution to sales ratios first; and
You sell the products in a constant mix.

Note. Only one graph is required.

4. Higgins Co (HC) manufactures and sells pool cues and snooker cues. The cues
both use the same type of good quality wood (ash) which can be difficult to
source in sufficient quantity. The supply of ash is restricted to 5,400 kg per
period. Ash costs $40 per kg.
The cues are made by skilled craftsmen (highly skilled labour) who are well known
for their workmanship. The skilled craftsmen take years to train and are difficult to
recruit. HC's craftsmen are generally only able to work for 12,000 hours in a period.
The craftsmen are paid $18 per hour.
HC sells the cues to a large market. Demand for the cues is strong, and in any
period, up to 15,000 pool cues and 12,000 snooker cues could be sold. The selling
price for pool cues is $41 and the selling price for snooker cues is $69.
Manufacturing details for the two products are as
follows:
Pool cues Snooker cues
Craftsmen time per cue 0.5 hours 0.75 hours
Ash per cue 270 g 270 g
Other variable costs per cue $1.20 $4.70
The contribution per unit is $20 for pool cues and $40 per unit for snooker cues.
HC does not keep inventory.
Required
Determine the optimal production plan for a typical period assuming that HC is seeking
to maximise the contribution earned. You should use a linear programming graph,
identify the feasible region and the optimal point and accurately calculate the maximum
contribution that could be earned using whichever equations you need.

Explain the meaning of a shadow price (dual price) and calculate the shadow price of both the labour
(craftsmen) and the materials (ash).

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 18

 5. The Cosmetic Co is a company producing a variety of cosmetic creams and lotions. The
creams and lotions are sold to a variety of retailers at a price of $23.20 for each jar of face
cream and $16.80 for each bottle of body lotion. Each of the products has a variety of
ingredients, with the key ones being silk powder, silk amino acids and aloe vera. Six months
ago, silk worms were attacked by disease causing a huge reduction in the availability of silk
powder and silk amino acids. The Cosmetic Co had to dramatically reduce production and
make part of its workforce, which it had trained over a number of years, redundant.
The company now wants to increase production again by ensuring that it uses the limited ingredients
available to maximise profits by selling the optimum mix of creams and lotions. Due to the
redundancies made earlier in the year, supply of skilled labour is now limited in the short-term to 160
hours (9,600 minutes) per week, although unskilled labour is unlimited. The purchasing manager is
confident that they can obtain 5,000 grams of silk powder and 1,600 grams of silk amino acids per
week. All other ingredients are unlimited. The following information is available for the two products:

Cream Lotion
Materials required: silk powder (at $2.20 per
gram) 3 grams 2 grams
– Silk amino acids (at $0.80 per gram) 1 gram 0.5 grams
– Aloe vera (at $1.40 per gram) 4 grams 2 grams
Labour required: skilled ($12 per hour) 4 minutes 5 minutes
1.5
– Unskilled (at $8 per hour) 3 minutes minutes
Each jar of cream sold generates a contribution of $9 per unit, whilst each bottle of lotion generates a
contribution of $8 per unit. The maximum demand for lotions is 2,000 bottles per week, although
demand for creams is unlimited. Fixed costs total $1,800 per week. The company does not keep
inventory although if a product is partially complete at the end of one week, its production will be
completed in the following week.
Required

On the graph paper provided, use linear programming to calculate the optimum number of each
product that the Cosmetic Co should make per week, assuming that it wishes to maximise
contribution. Calculate the total contribution per week for the new production plan. All workings must
be rounded to two decimal places.

Calculate the shadow price for silk powder and the slack for silk amino acids. All workings must be
rounded to two decimal places.

6. The Telephone Co (T Co) is a company specialising in the provision of telephone systems

for commercial clients. There are two parts to the business:
–Installing telephone systems in businesses, either first time installations or replacement
installations;
–Supporting the telephone systems with annually renewable maintenance contracts.

T Co has been approached by a potential customer, Push Co, who wants to install a telephone system
in new offices it is opening. Whilst the job is not a particularly large one, T Co is hopeful of future
business in the form of replacement systems and support contracts for Push Co. T Co is therefore
keen to quote a competitive price for the job. The following information should be considered:

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 19

 A) One of the company’s salesmen has already been to visit Push Co, to give them a
demonstration of the new system, together with a complimentary lunch, the costs of which
totalled $400.
B) The installation is expected to take one week to complete and would require three engineers,
each of whom is paid a monthly salary of $4,000. The engineers have just had their annually
renewable contract renewed with T Co. One of the three engineers has spare capacity to
complete the work, but the other two would have to be moved from contract X in order to
complete this one. Contract X generates a contribution of $5 per engineer hour. There are no
other engineers available to continue with Contract X if these two engineers are taken off the
job. It would mean that T Co would miss its contractual completion deadline on Contract X by
one week. As a result, T Co would have to pay a one-off penalty of $500. Since there is no
other work scheduled for their engineers in one week’s time, it will not be a problem for them
to complete Contract X at this point.
C) T Co’s technical advisor would also need to dedicate eight hours of his time to the job. He is
working at full capacity, so he would have to work overtime in order to do this. He is paid an
hourly rate of $40 and is paid for all overtime at a premium of 50% above his usual hourly
rate.
D) Two visits would need to be made by the site inspector to approve the completed work. He is
an independent contractor who is not employed by T Co, and charges Push Co directly for the
work. His cost is $200 for each visit made.
E) T Co’s system trainer would need to spend one day at Push Co delivering training. He is paid
a monthly salary of $1,500 but also receives commission of $125 for each day spent
delivering training at a client’s site.
F) 120 telephone handsets would need to be supplied to Push Co. The current cost of these is
$18.20 each, although T Co already has 80 handsets in inventory. These were bought at a
price of $16.80 each. The handsets are the most popular model on the market and frequently
requested by T Co’s customers.
G) Push Co would also need a computerised control system called ‘Swipe 2’. The current market
price of Swipe 2 is $10,800, although T Co has an older version of the system, ‘Swipe 1’, in
inventory, which could be modified at a cost of $4,600. T Co paid $5,400 for Swipe 1 when it
ordered it in error two months ago and has no other use for it. The current market price of
Swipe 1 is $5,450, although if Push Co tried to sell the one they have, it would be deemed to
be ‘used’ and therefore only worth $3,000.
H) 1,000 metres of cable would be required to wire up the system. The cable is used frequently
by T Co and it has 200 metres in inventory, which cost $1.20 per metre. The current market
price for the cable is $1.30 per metre.

You should assume that there are four weeks in each month and that the standard working
week is 40 hours long.
Required
Prepare a cost statement, using relevant costing principles, showing the minimum cost that T
Co should charge for the contract. Make detailed notes showing how each cost has been
arrived at and explain why each of the costs above has been included or excluded from your
cost statement.

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 20

 7. Robber Co manufactures control panels for burglar alarms, a very profitable product.
Every product comes with a one year warranty offering free repairs if any faults arise
in this period.
It currently produces and sells 80,000 units per annum, with production of them being restricted by
the short supply of labour. Each control panel includes two main components – one key pad and one
display screen. At present, Robber Co manufactures both of these components in-house. However, the
company is currently considering outsourcing the production of keypads and/or display screens. A
newly established company based in Burgistan is keen to secure a place in the market, and has
offered to supply the keypads for the equivalent of $4·10 per unit and the display screens for the
equivalent of $4·30 per unit. This price has been guaranteed for two years

The current total annual costs of producing the keypads and the display screens are:
Keypads Display screens
Production 80,000 units 80,000 units
$’000 $’000
Direct materials 160 116
Direct labour 40 60
Heat and power costs 64 88
Machine costs 26 30
Depreciation and insurance costs 84 96
Total annual production costs 374 390
Notes.

Materials costs for keypads are expected to increase by 5% in six months’ time; materials costs for
display screens are only expected to increase by 2%, but with immediate effect.
Direct labour costs are purely variable and not expected to change over the next year.

Heat and power costs include an apportionment of the general factory overhead for heat and power
as well as the costs of heat and power directly used for the production of keypads and display
screens. The general apportionment included is calculated using 50% of the direct labour cost for
each component and would be incurred irrespective of whether the components are manufactured in-
house or not.
Machine costs are semi-variable; the variable element relates to set up costs, which are based
upon the number of batches made. The keypads’ machine has fixed costs of $4,000 per annum
and the display screens’ machine has fixed costs of $6,000 per annum. Whilst both components
are currently made in batches of 500, this would need to change, with immediate effect, to
batches of 400.
60% of depreciation and insurance costs relate to an apportionment of the general factory
depreciation and insurance costs; the remaining 40% is specific to the manufacture of keypads and
display screens.
Required

Advise Robber Co whether it should continue to manufacture the keypads and display screens in-
house or whether it should outsource their manufacture to the supplier in Burgistan, assuming it
continues to adopt a policy to limit manufacture and sales to 80,000 control panels in the coming
year.

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 21

 Robber Co takes 0.5 labour hours to produce a keypad and 0.75 labour hours to produce a
display screen. Labour hours are restricted to 100,000 hours and labour is paid at $1 per hour.
Robber Co wishes to increase its supply to 100,000 control panels (ie 100,000 each of keypads
and display screens).
Advise Robber Co as to how many units of keypads and display panels they should either manufacture
and/or outsource in order to minimise their costs.

8. Stay Clean manufactures and sells a small range of kitchen equipment. Specifically the
product range contains a dishwasher (DW), a washing machine (WM) and a tumble dryer
(TD). The TD is of a rather old design and has for some time generated negative
contribution. It is widely expected that in one year’s time the market for this design of TD
will cease, as people switch to a washing machine that can also dry clothes after the washing
cycle has Completed.
Stay Clean is trying to decide whether or not to cease the production of TD now or in 12
months’ time when the new combined washing machine/drier will be ready. To help with this
decision the following information has been provided:
The normal selling prices, annual sales volumes and total variable costs for the
three products are as follows:
DW WM TD
$ $ $
Selling price per unit 200 350 80
Material cost per unit 70 100 50
Labour cost per unit 50 80 40
Contribution per unit 80 170 -10

Annual sales 5,000 units 6,000 units 1,200 units

It is thought that some of the customers that buy a TD also buy a DW and a WM. It is
estimated that 5% of the sales of WM and DW will be lost if the TD ceases to be produced.
All the direct labour force currently working on the TD will be made redundant immediately if TD
is ceased now. This would cost $6,000 in redundancy payments. If Stay Clean waited for 12
months the existing labour force would be retained and retrained at a cost of $3,500 to enable
them to produce the new washing/drying product. Recruitment and training costs of labour in
12 months’ time would be $1,200 in the event that redundancy takes place now.
Stay Clean operates a just in time (JIT) policy and so all material cost would be saved on the TD
for 12 months if TD production ceased now. Equally, the material costs relating to the lost sales
on the WM and the DW would also be saved. However, the material supplier has a volume
based discount scheme in place as follows:
Total annual expenditure Discount
$ %
0 – 600,000 0
600,001 – 800,000 1
800,001 – 900,000 2
900,001 – 960,000 3
960,001 and above 5

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 22

Stay Clean uses this supplier for all its materials for all the products it manufactures. The
figures given above in the cost per unit table for material cost per unit are net of any discount
Stay Clean already qualifies for.
The space in the factory currently used for the TD will be sublet for 12 months on a
short-term lease contract if production of TD stops now. The income from that contract
will be $12,000.
The supervisor (currently classed as an overhead) supervises the production of all three
products spending approximately 20% of his time on the TD production. He would continue to
be fully employed if the TD ceases to be produced now.
Required

Calculate whether or not it is worthwhile ceasing to produce the TD now rather than waiting 12
months
(ignore any adjustment to allow for the time value of money).

Explain two pricing strategies that could be used to improve the financial position of the business in
the next 12 months assuming that the TD continues to be made in that period.

9. Bits and Pieces (B&P) operates a retail store selling spares and accessories for the car market.
The store has previously only opened for six days per week for the 50 working weeks in the
year, but B&P is now considering also opening on Sundays.
The sales of the business on Monday through to Saturday averages at $10,000 per day with average
gross profit of 70% earned.
B&P expects that the gross profit % earned on a Sunday will be 20 percentage points lower than the
average earned on the other days in the week. This is because they plan to offer substantial discounts
and promotions on a Sunday to attract customers. Given the price reduction, Sunday sales revenues
are expected to be 60% more than the average daily sales revenues for the other days. These
Sunday sales estimates are for new customers only, with no allowance being made for those
customers that may transfer from other days.
B&P buys all its goods from one supplier. This supplier gives a 5% discount on all purchases if
annual spend exceeds $1,000,000.
It has been agreed to pay time and a half to sales assistants that work on Sundays. The normal
hourly rate is $20 per hour. In total five sales assistants will be needed for the six hours that the
store will be open on a Sunday. They will also be able to take a half-day off (four hours) during the
week. Staffing levels will be allowed to reduce slightly during the week to avoid extra costs being
incurred.
The staff will have to be supervised by a manager, currently employed by the company and paid an
annual salary of $80,000. If he works on a Sunday he will take the equivalent time off during the
week when the assistant manager is available to cover for him at no extra cost to B&P. He will also be
paid a bonus of 1% of the extra sales generated on the Sunday project.

The store will have to be lit at a cost of $30 per hour and heated at a cost of $45 per hour. The
heating will come on two hours before the store opens in the 25 'winter' weeks to make sure it is
warm enough for customers to come in at opening time. The store is not heated in the other weeks.
The rent of the store amounts to $420,000 per annum.

Required

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 23

Calculate whether the Sunday opening incremental revenue exceeds the incremental costs over
a year (ignore inventory movements) and on this basis reach a conclusion as to whether
Sunday opening is financially justifiable.

Briefly discuss whether offering substantial price discounts and promotions on Sunday is a good
suggestion.

10. BDU Co is a manufacturer of baby equipment and is planning to launch a revolutionary new
style of sporty pushchair. The company has commissioned market research to establish
possible demand for the pushchair and the following information has been obtained.
If the price is set at $425, demand is expected to be 1,000 pushchairs, at $500 it will be 730
pushchairs and at $600 it will be 420 pushchairs. Variable costs are estimated at either $170,
$210 or $260.
A decision needs to be made on what price to charge.

A table showing the expected contribution for each of the nine possible outcomes has been prepared,
as follows.
Price
$425 $500 $600

$170 255,000 (W1) 240,900 (W3) 180,600

Variable cost $210 215,000 (W2) 211,700 163,800
$260 165,000 175,200 142,800

Workings

(425 – 170) 1,000 = $255,000

(425 – 210) 1,000 = $215,000
(500 – 170) 730 = $240,900
Required

Explain what is meant by maximax, maximin and minimax regret decision rules, using the information
in the scenario to illustrate your explanations.

Explain the use of expected values and sensitivity analysis and suggest how BDU could make use of
such techniques.

11. Gym Bunnies (GB) is a health club. It currently has 6,000 members, with each member paying
a subscription fee of $720 per annum. The club is comprised of a gym, a swimming pool and a
small exercise studio.

A competitor company is opening a new gym in GB’s local area, and this is expected to cause a
fall in GB’s membership numbers, unless GB can improve its own facilities. Consequently, GB is
considering whether or not to expand its exercise studio in a hope to improve its membership
numbers. Any improvements are expected to last for three years.
Option 1

No expansion. In this case, membership numbers would be expected to fall to 5,250 per
annum for the next three years. Operational costs would stay at their current level of $80 per
member per annum.

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 24

Option 2

Expand the exercise studio. The capital cost of this would be $360,000.The expected
effect on membership numbers for the next three years is as follows:
Probability Effect on membership numbers
0.4 Remain at their current level of 6,000 members per annum
0.6 Increase to 6,500 members per annum

The effect on operational costs for the next three years is expected to be:

Probability Effect on operational costs

0.5 Increase to $120 per member per annum
0.5 Increase to $180 per member per annum

Required
Using the criterion of expected value, prepare and fully label a decision tree that shows the
two options available to GB. Recommend the decision that GB should make.
Note. Ignore time value of money.

Calculate the maximum price that GB should pay for perfect information about the expansion’s exact
effect on membership numbers.

12. Shifters Haulage (SH) is considering changing some of the vans it uses to transport crates for
customers. The new vans come in three sizes; small, medium and large. SH is unsure about
which type to buy. The capacity is 100 crates for the small van, 150 for the medium van and
200 for the large van.
Demand for crates varies and can be either 120 or 190 crates per period, with the probability
of the higher demand figure being 0.6.
The sale price per crate is $10 and the variable cost $4 per crate for all van sizes subject to
the fact that if the capacity of the van is greater than the demand for crates in a period then
the variable cost will be lower by 10% to allow for the fact that the vans will be partly empty
when transporting crates.
SH is concerned that if the demand for crates exceeds the capacity of the vans then
customers will have to be turned away. SH estimates that in this case goodwill of $100 would
be charged against profits per period to allow for lost future sales regardless of the number of
customers that are turned away.
Depreciation charged would be $200 per period for the small, $300 for the medium and $400 for
the large van.

SH has in the past been very aggressive in its decision-making, pressing ahead with rapid
growth strategies. However, its managers have recently grown more cautious as the
business has become more competitive.

Required

(a) Prepare a profits table showing the six possible profit figures per period.

Using your profit table from (b) above discuss which type of van SH should buy taking into
consideration the possible risk attitudes of the managers

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 25

 13. WX Co manufactures two products, A and B. Both products pass through two
production departments, mixing and shaping. The organisation's objective is
to maximise contribution to fixed costs.

Product A is sold for $1.50 whereas product B is priced at $2.00. There is unlimited
demand for product A but demand for B is limited to 13,000 units per annum. The
machine hours available in each department are restricted to 2,400 per annum. Other
relevant data are as follows.

Machine hours required Mixing Shaping

Hrs Hrs

Product A 0.06 0.04

Product B 0.08 0.12

Variable cost per unit $

Product A 1.30
Product B 1.70

Find out the optimal solution using LPP ?

14. TW manufactures two products, the D and the E, using the same material for each. Annual
demand for the D is 9,000 units, while demand for the E is 12,000 units. The variable
production cost per unit of the D is $10, that of the E $15. The D requires 3.5 kgs of raw
material per unit, the E requires 8 kgs of raw material per unit. Supply of raw material will
be limited to 87,500 kgs during the year.
A sub-contractor has quoted prices of $17 per unit for the D and $25 per unit for the E to supply
the product. How many of each product should TW manufacture in order to maximise profits?
Required
Fill in the blanks in the sentence below.

TW should manufacture ........... units of D and .............. units of E to maximise profits

15. MM manufactures three components, S, A and T using the same machines for
each. The budget for the next year calls for the production and assembly of
4,000 of each component. The variable production cost per unit of the final
product is as follows.
Machine hours

1 unit of S 3 20
1 unit of A 2 36
1 unit of T 4 24
Assembly 20
100

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 26

Only 24,000 hours of machine time will be available during the year, and a sub-
contractor has quoted the following unit prices for supplying components: S $29; A
$40; T $34.
Required
Advise MM.

16. Lucky manufactures and sells three products, X, Y and Z, for which budgeted sales demand,
unit selling prices and unit variable costs are as follows.
X Y Z
Budgeted sales demand 550 units 500 units 400 units
$ $ $ $ $ $
Unit sales price 16 18 14
Variable costs: materials 8 6 2
Labour 4 6 9
12 12 11
Unit contribution 4 6 3

The organisation has existing inventory of 250 units of X and 200 units of Z, which it is quite willing to
use up to meet sales demand. All three products use the same direct materials and the same type of
direct labour. In the next year, the available supply of materials will be restricted to $4,800 (at cost)
and the available supply of labour to $6,600 (at cost).
Required

Determine what product mix and sales mix would maximise the organisation's profits in the next year.

17. Sausage makes two products, the Mash and the Sauce. Unit variable costs are as follows.

Mash Sauce
$ $
Direct materials 1 3
Direct labour ($3 per hour) 6 3
Variable overhead 1 1
8 7

The sales price per unit is $14 per Mash and $11 per Sauce. During July the
available direct labour is limited to 8,000 hours. Sales demand in July is expected
to be as follows.
Mash 3,000 units
Sauce 5,000 units

Required
Determine the production budget that will maximise profit, assuming that fixed
costs per month are $20,000 and that there is no opening inventory of finished
goods or work in progress.

18. Sutton produces four products. Relevant data is shown below for period 2.

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 27

 Product M Product A Product R Product P

C/S ratio 5% 10% 15% 20%

Maximum sales value $200,000 $120,000 $200,000 $180,000

Minimum sales value $50,000 $50,000 $20,000 $10,000

The fixed costs for period 2 are budgeted at $60,000.

Required

Fill in the blank in the sentence below.

The lowest breakeven sales value, subject to meeting the minimum sales value constraints, is
$........…..

19. A company sells three products, X, Y and Z. Cost and sales data for one period are as follows.

X Y Z
Sales volume 2,000 units 2,000 units 5,000 units
Sales price per unit $3 $4 $2
Variable cost per unit $2.25 $3.50 $1.25
Total fixed costs $3,250
Required

Construct a multi-product P/V chart

20. O'Reilly Co has been approached by a customer who would like a special job to
be done for him, and who is willing to pay $22,000 for it. The job would require
the following materials:

Total units Units already in Book value of Realisable Replacement

Material required inventory units in inventory value cost
$/unit $/unit $/unit
A 1,000 0 – – 6
B 1,000 600 2 2.5 5
C 1,000 700 3 2.5 4
D 200 200 4 6.0 9
Material B is used regularly by O'Reilly Ltd, and if units of B are required for this job,
they would need to be replaced to meet other production demand.
Materials C and D are in inventory as the result of previous over-buying, and they have a
restricted use. No other use could be found for material C, but the units of material D
could be used in another job as substitute for 300 units of material E, which currently
costs $5 per unit (of which the company has no units in inventory at the moment).

What are the relevant costs of material, in deciding whether or not to accept the contract?

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 28

 21. Shellfish Co makes four components, W, X, Y and Z, for which costs in the
forthcoming year are expected to be as follows.

W X Y Z
Production (units) 1,000 2,000 4,000 3,000
Unit marginal costs $ $ $ $
Direct materials 4 5 2 4
Direct labour 8 9 4 6
Variable production overheads 2 3 1 2
14 17 7 12
Directly attributable fixed costs per annum and committed fixed costs:
$
Incurred as a direct consequence of making W 1,000
Incurred as a direct consequence of making X 5,000
Incurred as a direct consequence of making Y 6,000
Incurred as a direct consequence of making Z 8,000
Other fixed costs (committed) 30,000
50,000

Directly attributable fixed costs are all items of cash expenditure that are incurred as a direct
consequence of making the product in-house.
A sub-contractor has offered to supply units of W, X, Y and Z for $12, $21, $10 and $14
respectively. Should Shellfish make or buy the components?

22. The Poison Chemical Company produces two joint products, Alash and Pottum from the
same process. Joint processing costs of $150,000 are incurred up to split-off point, when
100,000 units of Alash and 50,000 units of Pottum are produced. The selling prices at split-
off point are $1.25 per unit for Alash and $2.00 per unit for Pottum.
The units of Alash could be processed further to produce 60,000 units of a new chemical, Alashplus,
but at an extra fixed cost of $20,000 and variable cost of 30c per unit of input. The selling price of
Alashplus would be $3.25 per unit. Should the company sell Alash or Alashplus?

A company manufactures four products from an input of a raw material to Process 1. Following this
process, product A is processed in Process 2, product B in Process 3, product C in Process 4 and
product D in Process 5.

23. LD Co. provides two cleaning services for staff uniform to hotels and similar business. One of
the services us a laundry service and the other is a dry cleaning service. Both of the services use
the same resources, but in different quantities. Details of the expected resource requirements,
revenues and costs of each service are shown below.
Laundry Dry cleaning
$ per service $ per service
Selling price 5.60 13.20
Cleaning materials ($10.00 per litre) 2.00 3.00
Direct labour ($6.00 per hour) 1.20 2.00
Variable machine cost ($3.00 per hour) 0.50 1.50
Fixed costs * 1.15 2.25
Profit 0.75 4.45

* Total annual fixed costs are $32,825.

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 29

 The maximum resources expected to be available in December 20x3 are

Cleaning materials 5,000 litres

Direct labour hours 6,000 hours
Machine hours 5,000 hours

LD Co has one particular contract which it entered into six months ago with a local hotel to
guarantee 1,200 laundry services and 2,000 dry cleaning services every month. If LD Co. does not
honour this contract it has to pay substantial financial penalties to the local hotel.

The maximum demand for laundry is expected to be 14,000 services and for dry cleaning 9,975
services.

Required

(a) Assuming that a graphical linear programming solution is to be used to maximize profit:
(i) State the constraints and objective function. (4 marks)
(ii) Determine the maximum profit that can be made. (7 marks)
(b) Calculate the shadow price of a machine hour and explain what this means for LD Co.
(4 marks)
(15 marks)

24. Metallica Ltd, an engineering company manufactures a range of products and components. One
of the company’s suppliers has announced that the amount of M1, one of the materials it
currently supplies, will be limited to 1,000 square metres in total for the next three-month period
because there will be insufficient M1 to satisfy demand.

The only items manufactured using M1 and their production costs and selling prices (where
applicable) are shown below.

Product P4 Product P6 Component C3 Component C5

$/unit $ /unit $/unit $/unit

Selling price 125 175 n/a n/a

Direct materials:
M1* 15 10 5 10
M2 10 20 15 20
Direct labour 20 30 16 10
Variable Overhead** 10 15 8 5
Fixed overhead** 20 30 16 10
Total cost 75 105 60 55

* Material M1 is expected to be limited in supply during the next three months. These costs are based on M1
continuing to be available at a price of $ 20 per square metre.
** Fixed overhead is absorbed as a percentage of direct labour cost.

Products P4 and P6 are sold externally. Components C3 and C5 are used in other products made by the
company.
These other products do not require any further amounts of material M1.

The estimated total demand for these products and components during the next three months is as follows.

P4 2,000 units
P6 1,500 units

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 30

 C3 500 units
C5 1,000 units

Components C3 and C5 are essential components. They would have to be bought in if they could not be
made internally. They can be purchased from external suppliers for $75 and $95 per unit respectively. The
bought in components are of the same quality as those manufactured by the company. The product they are
used in have sufficient margins to remain financially worthwhile if C3 and C5 are bought in at these prices.

Required
(a) Prepare calculations to show the most profitable course of action for the company for the next three
months, assuming that there are no other suppliers of material M1. (7 marks)
(b) Outline three factors that Metallica should consider before making its decision. (3 marks)
(10 marks)
25. Omelettee Co is trying to set the sales price for one of its products. Three prices are under
consideration, and expected sales volumes and costs are as follows.

Pricing choice Sales demand (units)

$4 Best possible 16,000
Most likely 14,000
Worst possible 10,000
$4.30 Best possible 14,000
Most likely 12,500
Worst possible 8,000
$4.40 Best possible 12,500
Most likely 12,000
Worst possible 6,000
Fixed costs are $20,000 and variable costs of sales are $2 per unit.
Prepare a pay-off table for the different possible outcomes for each decision option.

26. A company is considering which one of three alternative courses of action, A,B and C to take.
The profit or loss from each choice depends on which one of four economic circumstances, I, II,
III or IV will apply. The possible profits and losses, in thousands of pounds, are given in the
following payoff table. Losses are shown as negative figures.

Decision option
A B C
I 70 60 70
Circumstance/outcome II -10 20 -5
III 80 0 50
IV 60 100 115

Required

State which option would be selected using

(a) The maximax decision rule
(b) The Maximin decision rule

CMA MUHAMMED MP ACMA, CMA(US), CPA,IIA Page 31