SHORT-TERM DECISION MAKING – SOLUTIONS

Part 1

1. Firstorder makes three products – BeebeeAy, ArrtoDeeto, and SeaPeow – in the same
facility. For last year, Firstorder reports the following results.

BeebeeAy ArrtoDeeto SeaPeow Total

Sales $10,000 9,000 12,000 31,000
Variable costs 4,500 7,000 6,000 17,500
Contribution Margin 5,500 2,000 6,000 13,500
Allocated fixed costs 3,500 6,000 3,000 12,500
Net income 2,000 (4,000) 3,000 1,000

Allocated fixed costs represent general plant administration costs. ArrtoDeeto appears unprofitable
and management currently considers discontinuing the line. How would the discontinuation of
ArrtoDeeto affect Firstorder’s net income?

a) Increase by $2,000.
b) Increase by $4,000.
c) Increase by $6,000.
d) Decrease by $2,000.
e) Decrease by $4,000.

2. Day Star can either produce Product X internally or purchase it externally. Day Star collected the
following information:
Cost to buy one unit of X externally: $48

Day Star normally needs 25,000 units of product X per year. At this level of production, the
costs per unit (if made internally) are:
Direct materials $22
Direct labor $16
Variable overhead $2
Fixed overhead $15

What product level is required for Day Star to be indifferent between making or buying Product X
if $260,000 of fixed costs can be eliminated when the units are purchased externally:
a) 32,500 units Answering this question requires us to set the cost of purchasing
equal to the cost of making internally. Let Q = the
b) 37,143 units production level.

c) -4,727 units If Buy: $48*Q - $260,000 (the savings in fixed overhead)

If Make: $22*Q + $16*Q + $2*Q
d) 12,500 units
e) always prefer to purchase externally Setting these equations equal to each other and solving for Q gives us a
product level of 32,500 units
f) always prefer to produce internally

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 3. Moorehead Manufacturing Company produces two products for which the following data have been
tabulated. Fixed manufacturing cost is allocated at a rate of $1.00 per machine hour.

Per unit: Product A Product B

Selling price $4.00 $3.00

Variable manufacturing cost $2.00 $1.50

Fixed manufacturing cost $0.75 $0.20

Variable selling cost $1.00 $1.00

The sales manager has had a $160,000 increase in the budget allotment for advertising and wants
to apply the money to the most profitable product. The products are not substitutes for one another
in the eyes of the company’s customers.

Morehead has only 100,000 machine hours that can be made available to produce additional units
of products A and B. If the potential increase in sales units for either product that results from the
advertising is far in excess of this production capacity, which product should be advertised and what
is the estimated increase in total contribution margin?

a) Product A should be produced, yielding a contribution margin of $75,000

b) Product A should be produced, yielding a contribution margin of $133,333
c) Product B should be produced, yielding a contribution margin of $187,500
d) Product B should be produced, yielding a contribution margin of $250,000
e) None of the above
Morehead has a capacity constraint, so the amount of time each product spends on the machine is needed. Since fixed manufacturing costs are allocated at a rate
of $1 per machine hour, the amount of time A spends on the machine is ¾ hour ($0.75/$1.00) and B spends 1/5 hour ($0.20/$1.00). The contribution margin per
hour for A is ($4 - $2 - $1)/0.75 = $1.33 per hour, and for B is ($3 - $1.50 - $1)/0.20 = $2.50 per hour, so the company should advertise and produce B. With
100,00 machine hours available, the contribution margin is $2.50 x 100,000 = $250,000.

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 4. Clay Co. has considerable excess manufacturing capacity. The accounting system indicates that the
following manufacturing costs would be applied to a special order the company is considering
accepting:

Fixed costs $21,000

Variable costs $33,000

The fixed costs include a normal $3,700 allocation for in-house design costs, although no in-house
design will be done. Instead, the order will require the use of external designers costing $7,750. What
is the total amount to be included in the calculation to determine the minimum acceptable price for the
job?

a) $36,700
b) $40,750
c) $54,000
d) $58,050
e) None of the above
Because there is excess capacity, the fixed costs are irrelevant and there are no opportunity costs. The relevant incremental costs are $33,000 variable
manufacturing costs + $7,750 for external designers = $40,750

5. Which of the following costs would be relevant in short-term decision making?

a) Incremental fixed costs

b) All costs of inventory.
c) Total variable costs that are the same in the considered alternatives
d) Costs of fixed assets to be used in the alternatives
e) None of the above

6. Acct Inc. is considering discontinuing one of its products due to continuing losses. Data on the product
for the past year are given below.

Sales of 30,000 units $ 300,000

Variable expenses (240,000)
Contribution margin 60,000
Fixed expenses (80,000)
Net operating profit/(loss) $ (20,000)

If the product were discontinued, fixed costs can be reduced by $16,000 per year. The annual
financial advantage (disadvantage) for Acct Inc. from discontinuing the product would be:

a) ($60,000)
b) ($44,000)
c) $20,000
d) $36,000
e) None of the above

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7. One of the dangers of allocating common fixed costs to a product line is that such allocations can make
the product line appear less profitable than it really is.

a) True
b) False
c) Cannot be generally determined
d) None of the above

8. ABC company manufactures two products in one process. Joint processing costs up to the split-off
point total $33,600 a year. The company allocates these costs to the joint products on the basis of their
total sales values at the split-off point. Each product may be sold at the split-off point or processed
further. Data concerning these products appear below.

Product X Product Y Total

Allocated joint processing costs $ 16,800 $ 16,800 $ 33,600
Sales value at split-off point $ 24,000 $ 24,000 $ 48,000
Costs of further processing $ 15,000 $ 18,700 $ 33,700
Sales value after further processing $ 35,500 $ 45,100 $ 80,600

What is the financial advantage (disadvantage) for the company of processing Product X beyond
the split-off point?

a) ($3,500)
b) $3,700
c) $20,500
d) $27,700
e) None of the above

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Part 2
The Jaccu Company manufactures spark plugs for air- and space-crafts. Its manufacturing plant has the
capacity to produce 10,000 plugs each month. Current production and sales are 7,500 plugs per month. The
company normally charges $150 per plug. Cost information for the current activity level is as follows:

Variable costs that vary with the number of units produced:

Direct materials $262,500
Direct manufacturing labor 300,000
Variable costs that vary with the number of batches: 75,000
Fixed manufacturing cost 275,000
Fixed marketing cost 175,000
Total costs $1,087,500

A batch represents a production run consisting of a group of products. Jaccu makes plugs for its existing
customers in batch sizes of 50 plugs (e.g., it currently plans to produce 150 batches of 50 plugs each).

Jaccu has just received a special one-time-only order for 2,500 plugs at $100 per plug. Accepting the
order would not affect the company’s regular business. The special order requires Jaccu to make the plugs
in 25 batches of 100 plugs.

Required:

1. Compute the change in Jaccu profits if the company accepts the order

Jaccu’s profits INCREASE DECREASE by $ 50,000

Solution:
Current number of batches = 7,500/50 = 150

Cost/batch = 75,000/150 = $500/batch

CM = 2,500 x ($100 – $75) – (25 x $500) = $50,000 increase.

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2. Suppose plant capacity was only 9,000 plugs instead of 10,000 plugs each month.
The special order must either be taken in full or rejected completely. (Assume that orders to existing
customers can be reduced if the special order is filled.) Should Jaccu accept the special order?
Circle your answer and show your calculations.

Jaccu should Accept Reject

Solution:
Lose margin on 1,000 of existing sales. Those sales will be produced in 20 batches
(1,000/50=20)
 lost margin = 1,000 x ($150 – $75) – (20 x $500) = $65,000

Should reject: Lost margin of $65,000 greater than $50,000 income from order.

3. Again assume that monthly capacity is 10,000 spark plugs. Jaccu is concerned that if it accepts the
special order, its existing customers will immediately demand a price discount of $10 in the month
in which the special order is being filled. Compute the change in Jaccu’s profitability is it accepts
the special order under these conditions.

Jaccu’s profits INCREASE DECREASE by $ 25,000

Solution:
Lost profits from regular sales: $10 x 7,500 = $75,000

Profits will decrease by $50,000 – 75,000 = $25,000

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Part 3
Gaming Corp. produces and sells the “Game-Box 720”, a digital gaming device. The market selling
price is $190 per unit.

The firm’s regular costs are as follows:

Fixed production costs $1,000

Variable production costs per unit $ 50
Variable marketing costs per unit
sold in the normal market $ 10

The firm’s production facilities provide it with the capacity to produce a total of 15 units of product
per period. Given current market conditions, the firm expects to produce and sell 10 units.

As a result of a special order received and accepted last year, Gaming Corp. leased additional
production facilities which are available for use this year. For this year, the rent for these leased
facilities is $300 and they will provide the company with the capacity to produce an additional 5
units.

Required:

1. At the expected level of output, what is the firm’s average production cost per unit?

Average production cost $ 180 per unit

Cost per unit = 1,000 + 300 + (50 x 10) = 180

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2. At the expected level of output, what will the firm’s total profit be?

Expected total profit $0

Expected total profit = 190 - [(180 + 10) x 10] = 0

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3. During the year, the firm received a special order from Cassar Inc. for 5 units at a price of $130 per
unit. Cassar wants to give the devices away next period as a part of an advertising promotion. Should
the firm accept or reject the offer?
(Provide the calculations that support/justify your answer.)

Should the firm accept or reject the offer? ACCEPT / REJECT

Total Contribution Margin for the offer = (130 - 50) x 5 = 400 > 0

4. Before reaching a decision regarding the Cassar order described above, Gaming Corp. received a
second special order from Baiman Corp. Baiman offered to purchase 8 units at a price of $129 per
unit. In addition, Gaming Corp. was approached by the company that leased it the additional factory
space last year. It offered to cancel Gaming Corp.’s lease for a cancellation fee of $80. What is the
maximum profit that Gaming Corp. can achieve?

Maximum profit achievable $ 642

Contribution Margin for Baiman offer = (129 – 50) x 8 = 632 Total

Profit with:
Baiman offer, only = 0 + (129 - 50) x 8 = 632
Cassar offer, only, and cancel of lease = 0 + 400 + (300 – 80) = 620

Baiman + Cassar offers with reduction of market sales

= 0 + 632 + 400 – [(190 - 60) x 3] = 642

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Part 4
Buffalo Bob, an old prospector, runs a side business. He buys rattlesnakes from “snake hunters” in west Texas,
paying an average of $10 per snake. Each snake comes complete (i.e., no missing body parts), with each snake
having one rattle. Bob produces canned snake meat, cured skins, and souvenir rattles. Bob’s primary product is
snake meat. At the end of the recent season, Buffalo Bob evaluated his financial results:

Meat Skin Rattles Tota

Sales $30,000 $8,000 $2,000 $40,000
Share of snake 18,000 4,800 1,200 24,000
cost
Processing 6,000 900 600 7,500
expenses
Allocated 4,000 600 400 5,000
overhead
Income (loss) $2,000 $1,700 ($200) $3,500

The cost of snakes is assigned to each product line using the relative sale of meat, skins, and rattles (i.e., the
percentage of total sales generated by each product). Processing expenses are directly traced to each product
line. Overhead costs represent Bob’s basic living expenses. These overhead costs are allocated to each
product line on the basis of processing expenses.

Bob has a philosophy of every product line paying for itself and is determined to cut his losses on rattles.

Required:
a) Determine whether Buffalo Bob should drop rattles from his product offerings. Support your
answer with computations.

The cost of the snake is not relevant for this decision because Buffalo Bob will have the rattles even if he
drops the rattles product line. Thus, the cost of the snake is sunk with respect to this decision. The
allocated overhead costs are also irrelevant for this decision because Bob will still incur basic living
expenses no matter what he does with the rattles (i.e., the costs are the same under both alternatives, so
they are not relevant to the decision). The key question is whether the incremental profits from the rattles
product line is positive:

Revenue $2,000
- Cost 600 (incremental processing costs only) Incremental profit
$1,400

The rattles product line should not be dropped.

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 b) An old miner has offered to buy every rattle “as is” without processing for $0.50 per rattle (note: “as
is” refers to the situation where Bob only removes the rattle from the snake and no processing costs
are incurred). Assume that Bob processes the same number of snakes each season. Should Bob sell
rattles to the miner? Support your answer with computations.

We first need to determine how many snakes Buffalo Bob processes each season, and then compare the
revenue if the old miner buys the rattles to the incremental profit computed in (1a).

The total costs of snakes this season was $24,000, and Bob paid an average of $10 per snake. Thus, Bob
processed 2,400 snakes. For these snakes he earned an incremental profit of $1,400 for the rattles. If he sells
this many rattles to the old miner, he receives 2,400 rattles x $0.50 = $1,200. The rattles should not be sold
to the old miner.

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Part 5

Grand Alf hand makes white robes and grey scrubs for medical professionals.
The following data are available.
 The selling price of each product is $40.
 Grand Alf is able to sell 60 units of each product per week.
 The variable cost per white robe is $10 per unit; the variable cost cost per grey scrub is
$12.
Both products have to go through 4 different manufacturing processes. The following table lists the labor
hours that a unit of each product needs in each of the 4 manufacturing processes.

Sewing Coloring Packaging Total Hours

Direct labor hours per unit

White Robes 0.4 0.2 0.3 0.9

Grey Scrubs 0.5 0.2 0.25 0.95

Available hours per week 50 20 40

Required:

1. (4 points) What is the contribution margin per unit?

Contribution margin per white robe $ 30

Contribution margin per gray scrub $ 28

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2. (6 points) Which step in the manufacturing process is the bottleneck?
To receive credit you have to show your calculations.

Bottleneck process: Coloring

Solution:
Max production per step:
Sewing
1. Robes: 50 / 0.4 = 125
2. Scrubs: 50 / 0.5 = 100
Coloring
1. Robes: 20 / 0.2 = 100
2. Scrubs: 20 / 0.2 = 100
Packaging
1. Robes: 40 / 0.3 = 133
2. Scrubs: 40 / 0.25 = 160
Coloring is the bottleneck as it limits Grand Alf’s production to 100 units in total.

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 3. (8 points) Disregard your answer to the last question and assume that Sewing is the bottleneck.
What is Grand Alf’s optimal short term production for White Robes and Grey Scrubs?
To receive credit you have to show your calculations.

Optimal production volume White Robes 60 units

Optimal production volume Grey Scrubs 52 units

Solution:
Since Sewing is the bottleneck, we have to consider the contribution margin per hour on the
bottleneck.
White Robes: 30/0.4 = 75 Rank 1
Grey Scrubs: 28/0.5 = 56 Rank 2

We produce Robes until maximum market demand of 60 units (which take 60 * 0.4 = 24 hours to
complete). We then use the remaining 26 hours to produce 26/0.5=52 Grey Scrubs.

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Part 6
Flopro makes and sells two products, A and B, each of which passes through the same automated
production operations. The following estimated information is available for period 1:

Product unit data A B____

Selling price per unit ($) 60 70
Direct material cost ($) 2 40
Variable production overhead cost ($) 28 4
Total machine hours per unit (hours) 0.25 0.15

Furthermore,
- Budgeted sales of products A and B are 144,000 units and 54,000 units, respectively.
- The selling prices per unit for A and B are $60 and $70, respectively.
- Total fixed production overhead cost is $1,470,000. This is allocated to the products based on
total machine hours.
- One of the production operations has a maximum capacity of 3,075 hours that has been
identified as a bottleneck that limits the overall production/sales of products A and B.
- The bottleneck hours required per product unit for products A and B are 0.02 and 0.015
respectively.

Required:

1. What is the contribution margin per unit for the two products?

Contribution margin per unit of A $ 30

Contribution margin per unit of B $ 26

A = $60 – (2 + 28) = $30

B = $70 – (40 + 4) = $26

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2. Calculate the mix of products that maximizes Flopro’s profits and the value of the maximum
profits.

Optimal production of A 113,250 units

Optimal production of B 54,000 units

Maximum profits $ 3,331,500

Contribution margin per bottleneck hour

A: ($30/unit)/(0.02 hrs/unit) = $1,500/hr
B: ($26/unit)/(0.015hrs/unit) = $1,733.33/hr

Therefore, produce and sell product B up to its maximum demand and then
produce A with the remaining capacity:
Bottleneck hours required for B: (54,000 × 0.015) = 810 hours
Bottleneck hours available for A: (3,075 – 810) = 2,265 hours
Output of product A which is possible (2,265 ÷ 0.02) = 113,250 units

Total contribution margin

113,250 × $30 + 54,000 × $26 = 3,397,500 + 1,404,000 = 4,801,500
Less: Fixed overhead cost:
(1,470,000)
Net profit
3,331,500

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Part 7

Webster Corp. produces and sells two products: A and B. Production of the two products
requires three operating processes using machines X, Y and Z.

Per unit, A requires 10 minutes on machine X, 15 minutes on machine Y and 15 minutes on

machine Z. B requires 5 minutes on machine X, 20 minutes on machine Y and 12 minutes on
machine Z. Each machine can be operated for a maximum of 100 hours per week.

Both products sell for $30. Product A requires $10 of variable costs. Product B requires $8 of
variable costs. Demand for both goods is 300 units per week.

Webster Corp. makes production decisions in order to maximize throughput.

1. Given Webster Corp.’s existing production capacity, what will the total contribution margin be?

Total contribution margin: $______________

Contribution margin:
A: $30 - $10 = $20
B: $30 - $8 = $22

Time required to fulfill demand:

Machine X: [(10/60) * 300 ] + [(5/60) * 300] = 75 hours
Machine Y: [(15/60) * 300] + [20/60) * 300] = 175 hours
Machine Z: [(15/60) * 300] + [(12/60) * 300] = 135 hours

Machine Y is the bottleneck.

CM per hour
A: 20*4=80 equivalent way of calculating: 20 / (15/60) = 80
B: 22*3=66 equivalent way of calculating: 22 / (20/60) = 66

80>66, so A is ranked first. Produce A, then B.

Produce A to satisfy demand (300 units), using 300/4=75 hours. 75<100 so this is feasible.
Produce B with the remaining 25 hours: 25*3=75 units.

Max CM=300*20+75*22=7650

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For the next three questions, further consider the following: Webster Corp. can rent additional
machines of any type (X, Y and/or Z) at a weekly price of $2400 each.

2. What would the new total contribution margin be, if Webster rents an additional machine Y?

New total throughput: $_____________

Contribution margin:
A: $30 - $10 = $20
B: $30 - $8 = $22

CM per hour
A: 20*4=80
B: 22*5=110

110>80 so B is ranked first; produce B then A.

Produce B to satisfy demand (300 units), using 300/5=60 hours. 60<100 so this is feasible.
Produce B with the remaining 40 hours: 40*4=160 units.

Max CM=300*22+160*20=9800

3. What investments should Webster Corp. make? (These investments are not mutually exclusive---
any combination of new machines can be rented.) Show your work.

Y is current constraint, must invest in that before anything else.

Invest only in y:
Max CM goes from 7650 to 9800. The difference is 9800-7650=2150<2400.
Not worth it to invest only in Y.

Z is next constraint, so check investment in both Y and Z:

This would allow fully satisfying demand (300 units of each).

Max CM goes from 7650 to 300*20+300*22=12600.

The difference is 12600-7650=4950>2*2400

Invest in Y and Z.

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4. Assume Webster Corp. can only rent one new machine, at the most. What investment should
Webster Corp. make? Justify your answer.

Invest in nothing, since CM only increases by 2150, and investment costs 2400.

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Part 8

T2F is a university café owned and operated by a student. While it has plans for expansion it currently
offers two products: (a) tea & coffee and (b) shakes. It employs 2 people: Mr. A, who looks after tea
& coffee and Mr. B who prepares and serves shakes & desserts.

Its costs for the first quarter of 2017 are as follows:

Category Cost in $
Mr. A salary 16,000
Mr. B salary 12,000
Rent 18,000
Electricity 9,000
Direct materials
Tea & coffee 7,000
Shakes 6,000
Entertainment 1,800

The lease is signed for another two years and the owner ensured that contracts for entertainment (music
rentals, internet wi-fi, and magazines) are in place for the same time.
Total tea and coffee sales and shakes sales were $50,000 & $60,000 respectively. Number of units of tea
or coffee sold were 10,000 while number of shakes sold were 8,000.
The owner is interested in finding out which product performed better and decides to allocate indirect
costs based on the number units sold.
a) Calculate the profits for both products.

Tea & Coffee Shakes Total

Revenue 50,000 60,000 110,000
Salaries 16,000 12,000 28,000
Rent 10/18*18,000=10,000 8/18*18,000=8,000 18,000
Electricity 10/18*9,000=5,000 8/18*9,000=4,000 9,000
Direct Material 7,000 6,000 13,000
Entertainment 10/18*1,800=1,000 8/18*18,000=800 1,800

Income 11,000 29,200 40,200

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b) The owner is considering starting to sell pastries. She estimates that for every 3 beverages (tea,
coffee, and shakes) sold, she will be able to sell one pastry at a price of $2.5. T2F will be able to
use the existing facilities, machines, and employees even after selling pastries. The purchase cost
of pastries to T2F will be $1.5 per pastry. Since many of the pastries have to be heated, the cost of
electricity will increase. The owner estimates that the cost of electricity varies in the volume of
units sold and is the same per unit of pastry, tea & coffee, and shakes.

Should the owner start selling pastries? Circle the correct answer below and provide support for
your calculations

YES NO

Solution:
The current cost of electricity per unit is
9,000/18,000 = 0.5

Therefore, the contribution margin per unit of pastries is given by

cm P = 2.5 – 1.5 – 0.5 = 0.5 > 0

The owner should start selling pastries since cmP > 0.

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Part 9
LoT makes three products – Fro, Sam, and Gan – in the same facility. LoT’s expected results for the year
are:

Fro Sam Gan Total

Sales $10,000 9,000 12,000 31,000
Variable costs 4,500 7,000 6,000 17,500
Contribution Margin 5,500 2,000 6,000 13,500
Allocated fixed costs 3,500 6,000 3,000 12,500
Net income 2,000 (4,000) 3,000 1,000

Allocated fixed costs represent general plant administration costs. Sam appears unprofitable and
management is currently considering discontinuing the line.
If LoT were to discontinue Sam, what would LoT’s expected net income be?
LoT expected net income after discontinuing Sam $________________________

When Sam is discontinued, LoT loses the contribution margin of 2,000. This brings the net
income to 1,000 – 2,000 = (1,000).

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Part 10
In late September 2017, Apple Inc. announced that it would be releasing two new models of its iPhone in
the fourth quarter of 2017: the iPhone X and the iPhone 8. In addition, it would continue to sell some of
the older models.
Below is a table containing price and cost estimates for the current two new iPhone models plus one older
model on a per unit basis.

iPhone X iPhone 8 iPhone 7

Sales price ($) 999 699 649
Direct materials ($) 581 248 247
Direct labor ($) 8 5 5
Packaging and shipping ($) 5 4 4
Total variable costs ($) 594 257 256
Contribution margin per phone ($) 405 442 393
Minutes of assembly labor (min) 6 4 3

Assume that Apple has a limited amount of assembly labor available. Which iPhone model should Apple
promote the most in its advertising and marketing initiatives? (Show your calculations to receive any
credit)
Apple should promote X 8 7

Solution:
The contribution margin per minute of skilled assembly labor is given by
X: 405/7 = 67.5
8: 442/4 = 110.5
7: 392/3 = 131
Apple should focus on the iPhone 7.

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Part 11

ABC Company produces and sells a single product called Spotless. Annual production capacity is
100,000 machine hours. It takes one machine hour to produce a unit of Spotless. Annual demand for
Spotless is expected to remain at 80,000 units. The selling price is expected to remain at $10 per unit.
Cost data for producing and selling 80,000 units of Spotless are as follows:

Variable costs per unit:

Direct materials $1.50
Direct labor $2.50
Variable manufacturing overhead $0.80
Variable selling expense $2.00
Fixed costs per unit:
Fixed manufacturing overhead $1.25
Fixed selling and administration $0.65
Total cost per unit: $8.70

a) ABC Company has 2,000 units of Spotless that were partially damaged in storage. It can sell
these units in their current state through regular channels at reduced prices. These 2,000 units will
be valueless unless sold this way. Sale of these units will not affect regular sales of Spotless.
What is the relevant unit cost for determining the minimum selling price for these units?

Relevant cost per unit ______________________ /unit

Solution:
Since the products have already been produced and have zero value if not sold, the only
relevant costs are the variable selling expenses that will be incurred to sell the products.
The minimum selling price is $2.

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b) ABC Company receives a one-time special order for 5,000 units of Spotless from Heinle
Company. Acceptance of this order will not affect the regular sales of 80,000 units. Variable
selling costs for each of these 5,000 units will be $1.00 per unit. What is the minimum that Heinle
Company needs to offer such that ABC would accept the offer?

Minimum necessary revenues from Heinle $_______________

Solution:
5,000 units x ($1.50 [DM] + $2.50 [DL] + $0.80 [VOH] + $1 [variable selling]) = $29,000

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Part 12
2DHigh Realty manages four apartment complexes in Manhattan. Shown below are summary income
statements for each apartment complex:

U V W X
Rental income ........... $900 $1,110 $2,147 $1,843
Expenses ................... 800 1,300 2,600 2,400
Operating income ...... $ 100 ($ 190) ($ 453) ($ 557)

Included in the expenses is $1,200 of corporate expenses that have been allocated to the apartment
complexes based on rental income. These common corporate expenses have to be incurred regardless of
how many apartment complexes 2DHigh Realty manages.
Which apartment complex(es) should 2DHigh Realty consider dropping? (circle each apartment complex
that should be dropped and provide calculations below)

U V W X

Total rental income = $900 + $1,110 + $2,147 + $1,843 = $6,000

Common expenses per $ of rental income = 1,200 / 6,000 = 0.2
Contribution margins
U: 100 + 900 * 0.2 = 280
V: (190) + 1,110 * 0.2 = 32
W: (453) + 2,147 * 0.2 = (23.6)
X: (557) + 1,843 * 0.2 = (188.4)

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Part 13
DMW uses 17,000 units of a component each year and currently considers whether to make it in house or
to buy it from an outside supplier. DMW currently makes the component at the following product cost per
unit:

Direct materials ......................................... $ 8.20

Direct labor ................................................ 8.30
Variable manufacturing overhead ............. 1.20
Fixed manufacturing overhead .................. 4.30
Product cost per unit .................................. $22.00

Assume that direct labor is a variable cost. Of the fixed manufacturing overhead, 70% is avoidable if the
component is bought from the outside supplier. In addition, making the component uses 2 minutes on the
machine that is the company’s current constraint. If the component were bought, this machine time would
be freed up for use on another product that requires 4 minutes on the constraining machine and that has a
contribution margin of $7.00 per unit.
At what price per unit is DMW indifferent between making and buying the component? $_______ / unit

Relevant cost per unit:

Direct materials ................................................ $ 8.20

Direct labor ....................................................... 8.30
Variable manufacturing overhead .................. 1.20
Fixed manufacturing overhead ($4.30 × 0.70)
........................................................................ 3.01
Relevant manufacturing cost ........................... $20.71
Add contribution margin lost* ........................ 3.50
$24.21

*$7.00 ÷ 4 minutes = $1.75 per minute; $1.75 per minute × 2 minutes = $3.50

Alternatively,
In house:
(17,000 × $22) + opportunity cost (8,500 minutes × $7) = $433,500
Outsource:
(17,000 × x) + ($4.30 × 17,000 × 0.3)
(17,000 × x) + ($4.30 × 17,000 × 0.3) = $433,500  x = $24.21

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Part 14
Ollo Inc. produces and sells three types of belts: A, B, and C. The firm’s CFO has obtained the following
forecasted data for the month of October, 2019

A B C
Number of belts expected to be sold 50,000 250,000 200,000

Selling price per belt $10 $8 $4

Variable cost per belt $7 $6 $3

Machine hours required to produce one belt 0.2 0.15 0.1

For each product line, Ollo will not produce more belts than it could sell. Ollo’s fixed costs are $537,000
per month.

a) Assume that because of emergency repairs and maintenance, only 50,000 machine hours
will be available to produce belts during October. Further, assume that there will be no
additional costs to Ollo for the emergency repairs and maintenance. Determine the number of
belts of each type that Ollo should produce (and sell) in October, in order to maximize its profits
for the month.

Number of belts to be produced and sold in October

A ___________ B ___________ C ___________

A B C
cm/mhr 3/0.2 = $15 2/0.15 = $13.33 1/0.1 = $10
Produce 1st Produce 2nd Produce 3rd

mhr required to meet

demand 10,000 37,500 20,000

distribution of available
mhr (= 50,000) 10,000 37,500 2,500
Belts Produced 50,000 250,000 25,000

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b) An outside machine rental company has learned of Ollo’s problem and has offered to rent
its machines equivalent to those that are subject to the emergency repairs and maintenance
at a cost of $11 per hour. What should Ollo do to maximize its profits given this
opportunity??

Solution:
From 2 above, the machine would only be used to produce additional Type C belts.
But,
Hourly rental cost = $11/hr > CM/MHR = $10

 Ollo should not rent the machine

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Part 15
Webster Corp. produces and sells fake spider webs for Halloween decorations. Production of webs
requires three operating processes using machines X, Y and Z.
Per pounds, spider webs require 5 minutes on machine X, 20 minutes on machine Y and 12 minutes on
machine Z. Each machine can be operated for a maximum of 25 hours per week.
One pound of webs sell for $30 and requires $8 of direct materials and $18 of indirect labor. Labor costs
are considered committed costs. Demand for webs is 300 pounds per week.
Webster Corp. can rent machines of types X, Y, and/or Z that provide 50 hours of additional machine
time for the respective machine at a weekly price of $1,800 each. The investments are not mutually
exclusive---any combination of new machines can be rented. For example, Webster can rent 50 hours of
X time and 50 hours of Y time for a total of $3,600.

What investments should Webster Corp. make?

(circle each type of machine that should be rented and provide calculations)
X Y Z None

Solution:

Pounds of webs that could be produced on each machine

Machine X: (60/5) * 25 = 300 pounds
Machine Y: (60/20) * 25 = 75 pounds
Machine Z: (60/12) * 25 = 125 pounds

alternatively
Time required to fulfill demand:
Machine X: (5/60) * 300 = 25 hours
Machine Y: (20/60) * 300 = 100 hours
Machine Z: (12/60) * 300 = 60 hours

Y is the binding constraint, must invest in that before anything else. X provides enough capacity
to satisfy demand, will never invest in X.

Throughput margin: $30 - $8 = $22

Invest only in Y:
Max margin goes from 22*75 = 1,650 to 22*125 = 2,750. The difference is 2,750-
1,650=1,150<1,800. Not worth it to invest only in Y.

Z is next constraint, so check investment in both Y and Z:

This would allow the following production on each machine
Machine X: (60/5) * 25 = 300 pounds
Machine Y: (60/20) * 75 = 225 pounds
Machine Z: (60/12) * 75 = 375 pounds

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Y is the binding constraint again.

Max margin goes from 22*75 = 1,650 to 22*225= 4,950.

The difference is 4,950-1,650=3,300 < 2*1,800

Do not invest in any machines.

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