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122 ACCY Spring 2009 Notes for the final exam:
Practice Final Exam
Check Web CT for your grade status Friday afternoon. There will be no take-home portion you get the 25 points credit. The in-class portion consists of your choice of three problems from four problems on the exam at 25 points each. The final exam problems will be very similar to the problems in this practice final exam. You can have two pages two sheets, both sides of notes for the exam. Anything you want on the pages. If you want to include the practice final exam on those notes, that is fine. You can have your Horngren textbook too. I will bring a few copies. Practice Final Exam You have four problems here with solutions. Problem #1: New Hope Corporation manufactures replacement windshield wiper blades for the U.S. domestic market, and is recognized in the industry for quality and product design innovations. New Hope has just received a patent for a superior rubberized plastic wiper insert and wants you to help plan several strategic directions for manufacturing and distributing the new product. (1) Incremental material, labor and variable overhead costs to produce and distribute the new blade insert total $0.073 per blade. Incremental fixed costs of production and distribution total $62,500 per month. Marketing research indicates that New Hope can raise the price of their new product by $0.37 per package of two blade inserts. What would be the package breakeven sales for the new blade inserts? (2) Without prejudice to your answer to Part 1, assume the annual breakeven sales for the new blade is 276,000 packages. Calculate the incremental profit New Hope should earn with projected sales of 316,000 packages. (3) Assume once again the annual 276,000 package breakeven sales in Part 2. If sales are expected to range between 280,000 and 300,000 packages annually, what added information or refinement of information would you want before recommending production and distribution of the new wiper blades? Answers: (1)
In c re m e n ta l p ric e p e r p a c k a g e L e s s in c re m e n ta l c o s t, 2 b la d e s @ $ 0 .0 7 3 In c re m e n ta l c o n trib u tio n m a rg in p e r p a c k a g e
$ 0 .3 7 0 .1 4 6 $ 0 .2 2 4
Incremental fixed cost $62,500/$0.224 = BEP, 279,018 packages (2) Projected sales, 316,000 packages Breakeven sales, 276,000 packages
S a le s a b o v e B E P x C M per package P ro je c te d c o n trib u tio n 4 0 ,0 0 0 p a c k a g e s $ 0 .2 2 4 $ 8 ,9 6 0
(3) Since projected sales are significantly lower than the estimate in Part 2 ($896 at 280,000 packages and $5,376 at 300,000 packages vs. $8,960 at sales of 316,000 packages), more risk is involved. One might ask what is the company's minimum rate of return on the investment, how accurate are the sales projections and cost figures. Presenting projected sales as a range is valid, but one should also specify an expected sales figure within that range. b47a402cfe5c0ca8d3acb5eff68ddaeb18878a3d.doc 1
ACCY 122 Spring 2009 Practice Final Exam Problem #2: Nebrow Inc. purchased a polishing machine for $600,000 six years ago. The firm expected to use the machine for 10 years with no residual value at the end of the tenth year. The machine has been generating annual cash revenue of $460,000 and incurring annual cash operating costs of $210,000. The firm is considering the purchase of a new digital polishing machine for $800,000 that will have annual cash revenues of $690,000 and annual cash operating costs of $180,000. The new machine is useful for four years. The firm uses the straight-line method with no salvage value to depreciate all of its assets and is at 40% tax bracket. Required: What is the annual incremental after-tax cash flow from the new polishing machine? Answer: Item Cash revenues Operating costs: Cash operating costs Depreciation Total operating costs Operating income Income tax Cash flow difference Alternative solution Incremental operating income: Incremental depreciation Incremental (difference in) net after-tax cash flow from operations Current Machine $460,000 $210,000 60,000 $270,000 $190,000 76,000 $114,000 New Machine $690,000 $180,000 200,000 $380,000 $310,000 124,000 $186,000 Cash Flow Difference $230,000 30,000
$186,000 - $114,000 = $72,000 $200,000 - $60,000 = 140,000 $212,000
Problem #3: Max Ltd. Produces kitchen tools, and operates several divisions as profit centers. Division M produces a product that it sells to other companies for $16 per unit. It is currently operating at its full capacity of 45,000 units per year. Variable manufacturing cost is $9 per unit, and variable marketing cost is $3 per unit. The company wishes to create a new division, Division N, to produce an innovative new tool that requires the use of Division B's product (or one very Division similar). N will product 30,000 units. Currently, Division N can purchase a product equivalent to Division M's from Company X for $15 per unit. However, Max Ltd. is considering transferring the necessary product from Division M. Required 1) Assume the transfer price is $12 per unit. How would this affect the purchasing costs of Division N? How would this affect the profits of Division M? How would this affect Max Ltd. as a whole? 2.) What if the transfer price was $13 per unit?
ACCY 122 Spring 2009 Practice Final Exam Answer: 1) Division N needs 30,000 units. Outsourced, this would cost $450,000 ($15 x 30,000). Purchased from Division M, this would cost $360,000 ($12 x 30,000). Transferring would save $90,000. Division M is operating at capacity. They currently make $4 per unit ($16 - $9 - $3) sold to outside customers. This means they make $180,000 ($4 x 45,000) per year. If they transferred 30,000 units to Division N, they would only make a margin of $3 per unit, and lose $30,000 per year. As a whole, the company would save $80,000 ($90,000 - $10,000) if transfer pricing @ $12 per unit was used. 2) Purchased from Division M, this would cost $390,000. Transferring would save Division N $60,000. At $13, the new transfer profit margin would be $4 per unit. This is the same as the profit margin for selling to outside customers, so Division M would be indifferent about selling to outside customers versus transferring to Division N. As a whole, transferring pricing @ $13 per unit would save Max Ltd. $60,000. Problem #4: Old Castle Vineyard produces premium wine. Its success in the industry is due to its quality, although all of its customers, wine shops and specialty grocery stores, are very cost conscious and negotiate for price cuts on all large orders. Noting that the wine industry is becoming increasingly competitive, Old Castle is looking for a way to meet the challenge. It is negotiating with Eastern Seasons, a regional specialty grocery store, to purchase a large order of wine. Old Castle is currently producing at under-capacity and would like to keep its production facilities gain better economies of scale by increasing production. Eastern Seasons has agreed to a large order but only at a price of $25 per bottle. The special order can be purchased in one batch with available capacity. Old Castle prepared these data: Next month's operating information (per unit, for 10,000 units, made in 10 batches of 1,000 each) Sales price Per unit costs Variable manufacturing costs Batch-level costs Variable marketing costs Fixed manufacturing costs Fixed marketing costs Special order information Sales Sales price per unit $45 19 5 8 5 2 2,000 $35
No variable marketing costs are associated with this order, but Old Castle has spent $2,500 during the past two months trying to get Eastern Seasons to purchase the special order. Required How much will the special order change Old Castle's total operating income?
ACCY 122 Spring 2009 Answer: (1.) Data Regular customers Price per bottle Current production & sales (in units) Variable costs per unit Variable manufacturing Costs per batch Number of batches for special order Batch level costs/unit Special Order Price Bottles
Practice Final Exam
$45.00 10,000 $19.00 5,000 1 $2.50
= $5 per bottle* 1,000 bottles per batch = $5,000/2,000
Plant Capacity: capacity is available and no other uses for the plant capacity are expected. Solution Total relevant manufacturing costs (variable costs per unit plus batch costs per unit) 19 + $2.50 = $21.50 Accept the offer. The price paid is greater than the cost to manufacture. $35 >$21.50 The special order will increase operating income by $27,000 = 2,000 x ($35 - $21.50) or 2,000 x ($35 - $19) - $5,000. Note that this answer relies on the availability of production capacity. The answer might be different if Old Castle is at full capacity and the sale of the special order would require Old Castle to lose some amount of current sales. For a good in-class assignment, ask the class to answer the question again, assuming Old Castle is at full capacity. We now assume that a total of $10,000 units will be produced (full capacity) and that 10 batches will be used, as before; thus, batch level costs will be the same, with or without the special order, so batch level costs are now irrelevant and can be ignored.
C o n trib u tio n o f s p e c ia l o rd e r 2 ,0 0 0 x ( $ 3 5 - $ 1 9 ) L e s s : L o s t c o n trib u tio n o n lo s s o f re g u la r s a le s : 2 ,0 0 0 x ( $ 4 5 - $ 1 9 - $ 8 ) N e t lo s s o f th e s p e c ia l o rd e r u n d e r fu ll c a p a c ity $ 3 2 ,0 0 0 3 6 ,0 0 0 ( $ 4 ,0 0 0 )