The decision rule is to accept a special order as long as it covers at least the variable costs if it does not replace regular business.. 4.12 Considerations for special orders are whe
Trang 1Chapter 4 Relevant Costs for Nonroutine Operating Decisions
LEARNING OBJECTIVES
Chapter 4 addresses the following questions:
Q1 What is the process for making nonroutine operating decisions?
Q2 How are decisions made to accept, reject, and price special orders?
Q3 How are decisions made to keep or drop products, segments, or whole businesses? Q4 How are decisions made to insource or outsource an activity (make or buy)?
Q5 How are decisions made for product emphasis and constrained resources?
Q6 What qualitative factors are important to nonroutine operating decisions?
Q7 What limitations and uncertainties should be considered when making nonroutine operating decisions?
These learning questions (Q1 through Q7) are cross-referenced in the textbook to individual exercises and problems
COMPLEXITY SYMBOLS
The textbook uses a coding system to identify the complexity of individual requirements in the exercises and problems
Questions Having a Single Correct Answer:
No Symbol This question requires students to recall or apply knowledge as shown in the
textbook
e This question requires students to extend knowledge beyond the applications
shown in the textbook
Open-ended questions are coded according to the skills described in Steps for Better Thinking (Exhibit 1.10):
Step 1 skills (Identifying)
Step 2 skills (Exploring)
Step 3 skills (Prioritizing)
Step 4 skills (Envisioning)
Trang 24-2 Cost Management
QUESTIONS 4.1 Future costs are relevant only if they differ between the decision alternatives
4.2 The magazine companies would want to cover their variable costs, but beyond that they
are assuming they can gain readership by letting students subscribe at a discount Then when the students graduate, they will continue to subscribe at the full rate, increasing the organization’s profits and readership The magazines also earn higher advertising fees with higher readership, so they receive additional revenue from student subscriptions In addition, it is unlikely that many students would subscribe without the discounts, so the companies are not replacing their regular business
4.3 If variable cost*40% is greater than or equal to the contribution margin on products for
which capacity is currently used, take the special order If the contribution margin on current products is higher, do not take the special order
4.4 Yes, it applies The decision rule is to accept a special order as long as it covers at least
the variable costs if it does not replace regular business It is usually presumed that the audience that is attracted to afternoon shows is different from the audience that is
attracted to regular times The pricing decision has to do with the fact that most costs are fixed, rather than variable Weekend internet specials for the airlines are similar Hotels
and restaurants in resort areas often reduce prices during the off-season
4.5 Constraints can be relaxed a number of ways If capacity is constrained, it can be
expanded by purchasing new equipment, space, and hiring more labor If there is a bottleneck, it can be relaxed by using it during all hours of operation, inspecting units before they go through the bottleneck to be certain only good units are produced by it, and by offloading demand to other machines or processes if possible Material
constraints are relaxed by changing the product design or by purchasing more materials
4.6 Quantitative information is data that can be used in a mathematical analysis Qualitative
information is information that is not numerical, that is, it cannot be quantified easily
4.7 Possible quantitative factors include the incremental cost of growing bedding plants and
the cost to purchase the plants from someone else Possible qualitative factors include: Timeliness of delivery
Quality of bedding plants
Whether the bedding plants are appropriate for this climate
Whether Grover can get the quantities of plants needed
Whether there are other wholesale nurseries to purchase from if this relationship does not work well
4.8 Qualitative factors that affect the decision to outsource include quality and timeliness of
delivery If the supplier market is competitive, it may be easy to ensure high quality because the organization can switch vendors when quality drops If only one or two
Trang 3Chapter 4: Relevant Costs for Nonroutine Operating Decisions 4-3
vendors supply the product or service, it may be difficult to ensure high quality Similar issues arise with ensuring timely deliveries of products or services that are outsourced
4.9 Managers examine the contribution margin per product, or per constrained resource to
determine the products that should be emphasized If there are no constraints, then the product with the highest contribution margin should be emphasized The products can be rank-ordered and emphasized in that order If resources are limited, a linear program can
be used to determine the optimal sales mix if more than one constraint exists If only one resource is constrained, the product with the highest contribution margin under that constraint should be emphasized
4.10 Labor hours are the constraint for an accounting firm during tax time, and especially
professional labor Labor constraints can be relaxed by hiring more people, or by using computerized tax software to increase efficiency Some tasks, such as opening mail, filing, and entering data into programs, can be performed by temporary labor or relatively unskilled labor But some tasks require professional labor, which may be the binding constraint at times Many accounting professionals work very long hours during tax season to relax these types of constraints
4.11 A special order decision for a retail clothing factory might be uniforms for a ball team
It’s likely that the order would not replace regular business, unless they routinely sell uniforms Another short-term decision would be whether to keep or drop a particular line of clothing, such as a line of jeans with a special treatment to make them look worn after the popularity of this style of jeans wanes Another short-term decision would be whether to outsource administrative functions, such as payroll, or factory functions, such
as sewing certain garments If resources are constrained, product emphasis decisions under constrained resources need to be made If resources are not constrained, products need to be identified for emphasizing through advertising or promotions
4.12 Considerations for special orders are whether the order would replace regular business,
whether there is ample capacity, whether other customers might learn about a special pricing arrangement and demand the same price, and whether the price is above the variable cost plus any relevant fixed costs
Trang 44-4 Cost Management
EXERCISES 4.13 Yoklic Corporation
A The relevant information for this problem includes the variable costs to make and the purchase price to buy
Cost to make ($4.00 + $30.00 + $15.00) $49
B Yes, this new information changes the decision The cost to make is increased by the amount of fixed costs that will be eliminated if the part is purchased, which is $10
($50,000/5,000) per unit
Cost to make ($4.00 + $30.00 + $15.00 + $10) $59
C Two qualitative factors would be very important for Yoklic First, delivery times need to
be reliable Delivery delays can disrupt Yoklic’s ability to deliver products to its
customers on a timely basis In addition, quality is important Yoklic needs to be assured that the quality will meet its needs
4.14 Johnson and Sons
A Constrained resource problem The manager needs to decide whether or not to buy more juice from a neighbor
B The general rule is that managers can pay what they pay now plus up to the entire
contribution margin per constrained resource to relax a constraint Therefore, the
manager is willing to pay up to $3.00 ($2.50 contribution margin plus $0.50 variable cost)
C If the company can supply its total demand this year, it is likely to affect its demand next year If it cannot fill orders this year, customers may find another supplier
D Yes, quality is a concern If the neighbor’s juice is lower quality, customers will be disappointed and may not come back If the neighbor’s juice is much higher quality, customers may be disappointed later, and not come back Customers may even seek out the true supplier of this higher quality juice
E The timeliness of delivery could be a factor, and the reliability of the supplier is
important
Trang 5Chapter 4: Relevant Costs for Nonroutine Operating Decisions 4-5
4.15 Snowbird Snowboards
[Note: This problem requires application of knowledge from Chapter 3.]
A It is first necessary to categorize costs and create a cost function:
Fixed production $25,000 Variable selling and
Selling price per snowboard = $150,000/500 = $300
Mixing: 20*Chip Dip + 30*Soft Chunk < 4,000 minutes
Baking: 40*Chip Dip + 20*Soft Chunk< 6,000 minutes
Dipping: 15*Chip Dip < 2,000 minutes
Trang 64-6 Cost Management
The following reports are produced from Microsoft Excel Solver:
Answer Report
Target Cell (Max)
$A$6 Target Function 0 8250
Constraints
$B$9 Mixing 4000 0.75 4000 5000 333.3333333 $B$10 Baking 6000 0.875 6000 222.2222222 3333.333333 $B$11 Dipping 1875 0 2000 1E+30 125
A The optimal sales mix (from the answer report – final value under adjustable cells) is 125 batches of Dip and 50 batches of Soft
B Total contribution margin is $8,250 (answer report target function final value)
C From the sensitivity report, Mrs Meadows would be willing to pay $0.75 per minute (the shadow price) for mixing and $0.875 per minute (the shadow price) for baking
D From the answer report, mixing and baking are binding (under constraints – status)
E From the sensitivity report, the contribution margin for soft chunk could increase by $35 per batch to $75 ($40 +$35), and then the sales mix would change (see allowable increase
of objective coefficient for soft)
Trang 7Chapter 4: Relevant Costs for Nonroutine Operating Decisions 4-7
4.17 King Salmon Sales
A This is a keep or drop decision, where the options are whether or not to produce salmon this year
Price is $8 per lb ($800,000/100,000) and variable costs per pound are $5.60 [($200,000 + $20,000 + $30,000 + $300,000 + $10,000)/100,000] so contribution margin is $2.40 per lb At sales of 50,000 pounds, the contribution margin will be $2.4 x 50,000 =
$120,000 Fixed costs consist of administration, or $150,000 If King Salmon can avoid the fixed costs by not producing, the company should not produce this year However, if the fixed costs are unavoidable, then it should produce because the loss will be reduced from $150,000 to $30,000
B This is a constrained resource problem, and the general rule is that managers are willing
to pay what they pay now, plus up to the entire contribution margin Right now they are paying $2.00 per pound for fish and the contribution margin is $2.40, so they are willing
to pay up to $4.40 per pound for more fish This assumes that demand does not change and that future supply prices will not be affected by this decision
4.18 Emily
A Contribution margins per hour
HBM = ($49 – $5)*20 = $880 HBM2 = ($29 – $2.50)*30 = $795 HBM3 = ($29 – $2.50)*45 = $1,192.50 The development costs are sunk costs and are not included in the analysis
B First sell HBM3, then HBM, and then HBM2
C (Assume an 8 hour work day) First produce and sell 90 games of HBM3, which takes 2 hours (90 demand/45 per hour), then produce and sell HBM, which takes 6 hours (120 demand/20) There are no more hours left Since the contribution margin per hour for HBM2 is $795/hour, Emily could spend up to $795 per hour for 4 more hours to fill the demand of HBM2 If Emily is unable to hire part-time help, she would still be able to pay $3,180 (4 x $795) for an eight hour day and let the worker do other things for four hours
Trang 84-8 Cost Management
4.19 Wildlife Foods
The following reports are produced from Microsoft Excel Solver:
Answer report
Target Cell (Max)
$A$5 Target function 0 45,000
$B$10 Packaging 1500 $B$10<=4500 Not Binding 3000
$B$8 Mixing 6000 $B$8<=6000 Binding 0
$B$9 Sterilization 12000 $B$9<=12000 Binding 0
A Produce 15 batches of Fancy Flight and 30 batches of Multigrain
B Mixing and sterilization are binding
C Packaging and sterilization are binding The optimal mix changes to 45 batches of Fancy Flight and 10 batches of Multigrain
4.20 The Cone Head House
A This is a special order decision and the manager needs to set a price for the order
B The manager needs to know the variable cost and any relevant fixed costs Specifically, the variable costs are $530 for 1,000 cones and the special cover cost of $0.05 per cone The rent and store attendant are fixed costs and will not change if the special order is accepted, so they are irrelevant costs
C The minimum acceptable price is ($530/1,000) +$.05 = $0.58
D By selling cones at the breakeven price, new customers may eat the ice cream and come into the store to buy Brand recognition is increased The employees are not busy
otherwise
Trang 9Chapter 4: Relevant Costs for Nonroutine Operating Decisions 4-9
4.21 Cute Cookies
A The minimum price is the variable cost plus any additional fixed costs incurred to
produce the special order In this problem, variable cost is $0.75 + $0.05 per cover =
$0.80 per brownie
B Yes, the special order should be accepted The brownies can be made when workers are not busy, so capacity is not a problem CC may receive other orders in the future from parents of children at the school Good publicity may result for the company
C If other customers find that they are paying a lot more than the school, they may ask for price reductions If another special order came in that would be more profitable, but workers cannot fill the order, CC may regret having set the price at breakeven
4.22 Saguaro Systems
A This is an insource or outsource (make or buy) problem The manager can choose to make the speakers or buy them from a Mexican company The variable costs of making the system and any avoidable fixed costs are relevant, as is the outside purchase price
B Cost under each alternative is calculated below:
Saguaro should buy because the units are $50.40-$48.00 = $2.40 less expensive
C The managers will be indifferent at the volume where the cost in-house is the same as the cost of outsourcing:
$40X + $260,000 = $48X 8X = $260,000
X = 32,500 systems
D Will the vendor be reliable in timeliness of deliver and quality? Will the vendor increase the price for the next batch? Will Saguaro find an alternative use for the production that brings in a contribution margin? Will Saguaro be able to discontinue the contract if sales fall?
Trang 104-10 Cost Management
4.23 The Feed Barn
A This is a special order decision The manager needs to price the order The manager’s
options are to accept or reject the special order
B The variable cost of production and any incremental fixed costs associated with the order need to be determined
C Minimum price for Premium = $8 x 1,000 + $2,000 = $10,000 for the order
D Although the problem states that this sale will not affect domestic sales, it is uncertain
whether that means sales volumes, prices, or both Therefore, the manager needs to know whether domestic customers will know the price set for this sale They may demand the same price The manager needs to know whether there is enough capacity to produce this order without replacing regular business The manager also needs to know whether this customer is part of Feed Barn’s regular business
4.24 Horton and Associates
[Note: This problem requires application of knowledge from Chapter 3.]
A The following solution assumes that labor is a fixed cost The average contribution
margin per unit is used below to solve for the breakeven, but the contribution margin
ratio could also be used
Variable cost per unit:
Product line fixed cost per unit:
Multiply Per Unit Amounts x Volume:
Trang 11Chapter 4: Relevant Costs for Nonroutine Operating Decisions 4-11
Total Fixed Costs:
The overall corporate breakeven in revenues is:
Total fixed costs/Contribution margin ratio
= $400,000 /($510,000/$995,000)
= $780,392
B To calculate the breakeven in units for Loser, the first step is to calculate the avoidable
fixed costs for the product line and the contribution margin per unit:
Avoidable fixed costs:
Total variable cost per unit (see Part A) 45
The breakeven point in units for Loser is calculated by dividing its avoidable fixed costs
by its contribution margin per unit:
$25,000/$50 = 500 units
C One potentially important qualitative factor is whether dropping one product would affect the sales of the other product Another factor is employee morale if the company lays off personnel A third factor is whether prices of inputs on any other products could change because the company reduces its purchase quantities, and any other potential responses
from vendors Students may think of other qualitative factors
4.25 Kallapur and Trombley Cotton Growers
A The problem gives no information about resource constraints, so this solution assumes
there are none Therefore, managers should emphasize the product with the highest
contribution margin: Emphasize Premium first (contribution margin = $800), then Fancy (contribution margin = $720), and then Regular (contribution margin = $600)
B For Premium and Fancy, contribution margin minus avoidable fixed costs is positive For Regular, contribution margin minus avoidable fixed costs is negative $125, indicating
that operating income would increase by $125 per unit if this product were dropped That
Trang 13Chapter 4: Relevant Costs for Nonroutine Operating Decisions 4-13
PROBLEMS 4.26 Rightway Printers
A This is a special order problem with a capacity constraint The manager chooses whether
to take the special order or not, but capacity limits will be exceeded if the order is taken
B Relevant information for the decision includes the variable cost, the contribution margin, and the selling price for regular business The problem does not provide the selling price per book for regular business Additional information that would be needed includes relevant qualitative factors
C The manager can pay up to $1.50 per book, plus the amount of variable cost that is
related to capacity, to relax the constraint
D Capacity makes a difference in the minimum price that can be set If Riteway is close to capacity limits, it would replace regular business with the special order and need to price the order the same as regular business that it would forego to take the order In this problem, 5% of capacity would be used for regular business, and 5% would be excess capacity So, the special order would need to be priced high enough to replace the lost contribution margin of the 5% of regular business
E Usually when operations get close to capacity limits, costs go up Bottlenecks are more common, there is congestion in the plant, and production slows down These costs need
to be considered when setting a price for a special order that will move an organization out of its normal operating range (relevant range) In addition, managers need to think about whether the business will lose some customers because demand cannot be filled
4.27 The Vernom Corporation
A The firm should make the tubes because the estimated cost to manufacture the tubes is less than the cost to purchase them:
Cost to purchase tubes ($1.80 * 100,000) $180,000
Avoidable costs to manufacture tubes:
Total overhead is projected at $300,000 ($3 x 100,000 boxes), of which
$200,000 is fixed Therefore, variable overhead must be $100,000, or $1.00 per box
Trang 14Avoidable cost to manufacture:
Variable manufacturing cost ($1.70 * 125,000) $212,500
D The company should make 100,000 tubes and purchase 25,000, based on the following cost comparison:
Cost to make 100,000 and purchase 25,000:
E Control over quality of the tubes, convenient delivery schedules, and control over future price increases would be factors that favor insourcing
4.28 Jazzy Cases
A 90,000 x 2 = 18,000 hours per year of idle capacity For 3 months, there are 4,500 hours available If the number of machine hours needed for either order or the combined order exceeds current capacity, the price needs to be the same as the regular price for those units
B The company needs 5,000 hours for this order (20,000 cases x 0.25 hours per case) For the first 4,500 hours used, the Penny Wise order just needs to cover its variable costs, since these 18,000 cases (4,500 hrs/0.25 hrs per case = 18,000 cases) are made with idle capacity The variable costs per case are $2.25 for raw materials + $3.00 for direct labor
Trang 15Chapter 4: Relevant Costs for Nonroutine Operating Decisions 4-15
Therefore, the minimum acceptable price is computed as follows:
Minimum acceptable price per case ($112,000/20,000 cases) $5.60
The special order price is $5.75 per case, so the order would yield an incremental
contribution of $3,000 ($0.15 per case x 20,000 cases)
C The Star-Mart order for 8,000 cases would use 4,000 hours (8,000 cases x 0.5 hours per case) Since this quantity is under the capacity limit, the company needs only to cover the incremental costs of this order The contribution margin per case for the Star-Mart order
is $7.50 – ($3.25+$3.00) = $1.25 per case However, there are additional fixed costs to be incurred for this order Therefore, the accept/reject decision takes this form:
Incremental revenue for 8,000 cases (8,000 x $7.50) $60,000 Incremental costs for 8,000 cases:
Variable costs [8,000 x ($3.25+$3.00)] $50,000 Set-up & equipment costs ($1,500+$2,500) 4,000 54,000
D The following are alternatives:
(1) reject both offers (2) accept only the Penny-Wise order (3) accept only the Star-Mart order (4) accept both the Penny-Wise and Star-Mart orders Option (1) is not the best alternative because results for part (B) show that the advantage
of option (2) over option (1) is $3,000, and results computed in (C) show that the
advantage of option (3) over option (1) is $6,000 To consider option (4), suppose Jazzy first uses 4,000 hours of idle capacity to produce the Star-Mart order (since it has a higher contribution for the order than does the Penny-Wise order) This leaves 500 hours of idle capacity Since the Penny-Wise order will use 5,000 hours, 4,500 hours would be taken from regular production Would this be profitable?
Incremental revenue for 20,000 cases (20,000 x $5.75) $115,000 Incremental costs:
Opportunity cost: Loss of contribution margin
on 17,000 regular cases [($9-$5.50)*17,000] 59,500 164,500 Disadvantage of accept both (option 4) over
Therefore (ignoring qualitative concerns), Jazzy should accept only the Star-Mart order, which provides an incremental contribution of $6,000
Trang 16Will there be enough capacity?
How will these sales affect customer relations and future sales?
F The company cannot know whether it will obtain other orders that would be larger and more lucrative than these two orders Managers do not know whether their current capacity levels will hold for regular business; capacity could increase or decrease Demand for one product could increase greatly, for example around Valentine’s Day, because that product was a ―hot‖ consumer item Also, there is more uncertainty in the cost estimates for the Star-Mart order than for the Penny-Wise order because these cases are somewhat different than any cases Jazzy currently manufactures In addition, fixed costs could change as the manufacturing plant becomes more congested (see part G)
G The managers need to know whether the fixed costs will change as operations get closer
to capacity constraints The company is likely to incur increasing costs of congestion as production quantities get closer to the capacity limits For example, bottlenecks will increase, machines might break down more frequently, and workers may not be as
efficient Such problems increase the variable costs per unit Inventory levels and wait times for product in process might increase
H & I There is no one answer to these parts Sample solutions and a discussion of typical student responses will be included in assessment guidance on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg) Here is a list of points that students could address in the memo:
Describe the four options and the quantitative results shown in parts A through D Remind management that they must consider the qualitative information and provide some examples of qualitative information they should take into account, making sure that management knows this is only a partial list and they should try
to think of more
Be explicit about the uncertainties in the estimates and discuss how they could affect the quantitative analyses and interpretation of results
Trang 17Chapter 4: Relevant Costs for Nonroutine Operating Decisions 4-17
+ 1/2 of standard unit's allocated costsa
a
Depreciation on the equipment used for standard sales is not included on the
assumption that the equipment is used only to produce the standard sales product There is insufficient information to estimate the amount of power and "other" costs which would be required by the new units Therefore full cost is inexact and could
Opportunity cost of the special order is $6,700/2 = $3,350 for the lost contribution
margin from foregone standard unit sales
4 Relative to the order, depreciation on the equipment for the standard sales is a sunk cost Rent and the fixed portion of heat and light would also be sunk costs