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12 Chapter - Financial and Cost-Volume-Profit Models Chapter 12 Financial and Cost-Volume-Profit Models True / False Questions 1. Estimates of sales price, variable costs per unit and profit targets are examples of a model's parameter. TRUE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 3 2. Generally, changing a model's parameters will change the model's outcomes. TRUE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 3 3. When setting up a computer spread sheet model, the formulas in the analysis section should generally not contain the actual numerical values. TRUE AACSB: Technology AICPA BB: Critical Thinking AICPA FN: Leveraging Technology Difficulty: Medium Learning Objective: 3 4. The Theory of Constraints states that companies should emphasize the most productive aspects of the value chain, as they are the most profitable. FALSE AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making Difficulty: Medium Learning Objective: 7 12-1 Chapter 12 - Financial and Cost-Volume-Profit Models 5. If a company's sales mix changes from selling relatively high-margin items to relatively low-margin items, its break-even point will increase. TRUE AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making Difficulty: Medium Learning Objective: 2 6. Outsourcing should never be used to increase capacity because it defeats the theory of constraints. FALSE AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Decision Making Difficulty: Medium Learning Objective: 6 7. An assumption made by break-even analysis is that total revenues are constant. FALSE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 2 8. Operating Leverage is profit divided by the fixed cost. FALSE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 2 12-2 Chapter 12 - Financial and Cost-Volume-Profit Models 9. Product-level activities are required for an organization to have the capacity to produce goods and services. FALSE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 4 10. An increase in fixed costs will decrease the contribution margin. FALSE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 1 11. An increase in building insurance will result in an increase in the break-even point. TRUE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 2 12. If a company has a high level of operating leverage, a small decrease in sales will have a small effect on operating income. FALSE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 2 12-3 Chapter 12 - Financial and Cost-Volume-Profit Models 13. When a company has a scarce resource, they should allocate it all to the product that will provide the highest contribution margin per unit produced. FALSE AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making Difficulty: Medium Learning Objective: 5 14. Batch-level activities are performed to benefit multiple units of output equally and simultaneously. TRUE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 4 15. Contribution margin is defined as total sales revenue minus total variable costs. TRUE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 1 16. A strength of the CVP model is that it uses a single revenue driver and a single cost driver. FALSE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 2 12-4 Chapter 12 - Financial and Cost-Volume-Profit Models 17. If practical capacity exceeds demand, the process is a bottleneck. FALSE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 7 18. If demand exceeds practical capacity, the process is a bottleneck. TRUE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 7 19. At the break-even point, contribution margin and total fixed costs are equal. TRUE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 2 20. The salary of the company's president is an example of a fixed cost. TRUE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 1 21. Outsourcing can eliminate bottlenecks. TRUE AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making Difficulty: Easy Learning Objective: 7 12-5 Chapter 12 - Financial and Cost-Volume-Profit Models 22. The break-even point lies at the intersection of the total revenue line and the fixed cost line on a CVP graph. FALSE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 2 23. Sensitivity analysis shows how the CVP model will respond to changes in the original variables or even model assumptions. TRUE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 6 24. (Appendix B. Linear programming can be used to help a company best allocate their scarce resources. TRUE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 8 25. (Appendix B. The optimum point is a set of values that satisfies either the constraints or the objective function. FALSE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 8 12-6 Chapter 12 - Financial and Cost-Volume-Profit Models 26. An increase in the income tax rate will result in a decrease in the break-even point. TRUE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 4 27. Variable costs per unit will decrease with a change in sales volume. FALSE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 1 28. The theory of constraints applies to nonprofit organizations, since the primary goal of these organizations is not profit maximization. TRUE AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 6 Multiple Choice Questions 29. Which of the following is an example of a fixed cost? a. Direct materials used in production b. Sales commission where an employee is paid for each sale made C. Straight-line depreciation on equipment d. None of the above AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 1 12-7 Chapter 12 - Financial and Cost-Volume-Profit Models 30. How would an increase in fixed manufacturing costs and variable selling costs, respectively, affect the contribution margin? a. Not affect; Not affect b. Decrease; Decrease c. Decrease; Not affect D. Not affect; Decrease AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 1 31. An increase in the production volume within the relevant range will result in: a. An increase in the fixed cost per unit b. A proportionate increase in total fixed costs c. No change in the fixed cost per unit D. A decrease in the fixed cost per unit AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 1 32. Which of the following would be an example of a variable cost? a. Chief executive officer's salary b. Straight-line depreciation C. Direct materials used in production d. All of the above AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 1 12-8 Chapter 12 - Financial and Cost-Volume-Profit Models 33. Contribution margin is: a. Sales revenue minus cost of goods sold B. Sales revenue minus all variable costs c. Sales revenue minus variable production costs d. Sales revenue minus all variable and fixed costs AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 1 34. Bates Corp. has the following information for its candy line: Based on a market study, Bates estimates that it could increase the unit selling price by 15% and increase the unit sales volume by 10% if $100,000 was spent on advertising. Based on the analysis, what would Bates' operating income be from selling the candy if the decision is made to advertise? a. $337,500 b. $417,500 c. $497,500 D. $717,500 AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making Difficulty: Hard Learning Objective: 1 12-9 Chapter 12 - Financial and Cost-Volume-Profit Models 35. Cost-volume profit (CVP) analysis is a key factor in many decisions, including choice of product lines, pricing of products, marketing strategy, and use of productive facilities. A calculation used in a CVP analysis is the break-even point. Once the break-even point has been reached, operating income will increase by the: A. Contribution margin per unit for each additional unit sold b. Fixed cost per unit for each additional unit sold c. Variable cost per unit for each additional unit sold d. None of the above AACSB: Reflective Thinking AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 1 36. The breakeven point is decreased by: a. A decrease in sales price per unit b. An increase in variable costs per unit C. A decrease in fixed costs d. None of the above AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 2 37. Break-even analysis assumes that: a. Total revenue is constant B. Unit variable cost is constant c. Unit fixed cost is constant d. All of the above AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 2 12-10 Chapter 12 - Financial and Cost-Volume-Profit Models 38. The contribution margin at the breakeven point a. Is zero b. Is greater than variable costs c. Is less than total fixed costs D. Equals total fixed costs AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 2 39. At the break-even point of 1,500 units, variable costs are $60,000, and fixed costs are $30,000. What would operating income be if 1,501 units are sold? A. $20 b. $40 c. $90 d. $140 AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 2 40. Valdez and Sons has fixed costs of $90,000. Its contribution margin ratio is 60% and its one product sells for $60. What is its break-even point in sales dollars? a. $80,000 b. $90,000 C. $150,000 d. $200,000 AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 2 12-11 Chapter 12 - Financial and Cost-Volume-Profit Models 41. Bigelow Industries manufactures swim caps. Their operating leverage is 3. Each cap sells for $10 and has a contribution margin of $6. They expect to sell 37,500 swim caps. Their fixed costs are: a. $55,000 B. $75,000 c. $112,500 d. $150,000 AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 2 Use the following to answer questions 42-44: The product that Menorah Corp. currently sells, candle operas, has fixed costs of $20,000, a sales price of $10 per candle opera and a variable cost of $4 per candle opera. If the fixed costs were to increase by 8 percent and the sales price and variable costs were to increase by 10 percent, how would the breakeven point in units, the contribution margin per unit, and the contribution margin ratio be affected? 42. Breakeven point in units a. Increases B. Decreases c. Does not change d. Cannot be determined AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 2 12-12 Chapter 12 - Financial and Cost-Volume-Profit Models 43. Contribution margin per unit A. Increases b. Decreases c. Does not change d. Cannot be determined AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 2 44. Given these changes, to earn a profit of $10,000, the company must sell how many candle operas. (Remember they cannot sell partial candle operas) a. 3,273 B. 4,788 c. 7,182 d. 1,516 AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 2 45. If production volume increases within the relevant range, variable costs per unit will _____ and total fixed costs will __________ a. Decrease; decrease b. Increase; not change c. Not change; increase D. Not change; not change AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 2 12-13 Chapter 12 - Financial and Cost-Volume-Profit Models 46. Gamba Corp. sells its product for $30. Variable costs are $10 per unit. At the current volume of 40,000 units sold per year, the company is just breaking even. Given these data, the annual fixed costs are: a. $400,000 B. $800,000 c. $1,200,000 d. None of the above AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 2 47. Ramirez Corp. sells a product for $10 per unit. The fixed costs are $240,000 and the unit variable costs are 60% of the selling price. What sales would be necessary in order for Flom Corp. to realize a profit of 10% of sales? A. $800,000 b. $420,000 c. $80,000 d. $140,000. (CPA adapted) AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Hard 48. Reyes Company produces a product that sells for $50. Variable manufacturing costs are $22 per unit. Fixed manufacturing costs are $7 per unit based on the current level of activity, and fixed selling and administrative costs are $4 per unit. A sales commission of 10% of the selling price is paid on each unit sold. The contribution margin per unit is: a. $28 B. $23 c. $21 d. $12 AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 2 12-14 Chapter 12 - Financial and Cost-Volume-Profit Models 49. A high level of operating leverage indicates a company has: a. High fixed costs and high variable costs b. Low levels of committed costs relative to variable costs C. High levels of committed costs relative to the contribution margin d. Low levels of committed costs relative to the contribution margin AACSB: Reflective Thinking AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 2 50. (Appendix B. Elite Company has unlimited demand for either Candy Coin or Candy Bars. However, they have a limited capacity of machine hours to produce either product. Candy Coins sells for $10 per unit, has a variable cost of $6 per unit and it takes 6 minutes to produce one unit. Candy Bars sells for $15 per unit, has a variable cost of $3 per unit and it takes 10 minutes to produce one unit. Which of the following decisions would maximize Elite's net income? a. Allocate all machine hours to the production of Candy Coins B. Allocate all machine hours to the production of Candy Bars c. Allocate 50% of the machine hours to Candy Coins and 50% to Candy Bars d. Allocate 75% of the machine hours to Candy Coins and 25% to Candy Bars AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 7 51. When using a computer spreadsheet model it is necessary to a. Gather information b. Model relationships among parameters c. Separate parameters and formulas D. All of the above AACSB: Analytic, Technology AICPA BB: Critical Thinking AICPA FN: Leveraging Technology Difficulty: Easy Learning Objective: 3 12-15 Chapter 12 - Financial and Cost-Volume-Profit Models 52. A company that desires after tax income of $1,000,000 with a 40% tax rate, needs a before tax income of a. $2,000,000 b. $1,600,000 c. $1,433,333 D. $1,666,667 AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 4 Use the following to answer questions 53-56: (CMA adapted) Ruben Corporation manufactures and sells T-shirts imprinted with college names and slogans. Last year, the shirts sold for $7.50 each, and the variable cost to manufacture them was $2.25 per unit. The company needed to sell 20,000 shirts to break even. The net income last year was $5,040. Ruben's expectations for the coming year include the following: The sales price of the T-shirts will be $9 Variable costs to manufacture will increase by one-third Fixed costs will increase by 10% The income tax rate of 40% will be unchanged 53. The selling price that would maintain the same contribution margin ratio as last year is: a. $8.25 b. $9.00 c. $9.75 D. $10.00 AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 4 12-16 Chapter 12 - Financial and Cost-Volume-Profit Models 54. The number of T-shirts Ruben Corporation must sell to break even in the coming year is: a. 17,500 B. 19,250 c. 20,000 d. 22,000 AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making Difficulty: Hard Learning Objective: 4 55. Sales for the coming year are expected to exceed last year's by 1,000 units. If this occurs, Ruben's sales volume in the coming year will be: a. 21,000 units B. 21,960 units c. 22,600 units d. 23,400 units AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making Difficulty: Hard Learning Objective: 4 56. If Ruben Corporation wishes to earn $22,500 in net income for the coming year, the company sales volume in dollars must be: a. $213,750 B. $207,000 c. $229,500 d. $257,625 AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making Difficulty: Hard Learning Objective: 4 12-17 Chapter 12 - Financial and Cost-Volume-Profit Models 57. Chocolate Extreme sells both hard candy and chocolate candy. The current sales mix is 2 units of hard candy for every 3 units of chocolate candy. Hard candy has a contribution margin of $4 per unit, while chocolate candy has a contribution margin of $2 per unit. If fixed cost are $420,000 what are the total units sold at the break-even point (rounded)? a. 56,000 units of hard candy and 84,000 units of chocolate candy B. 60,000 units of hard candy and 90,000 units of chocolate candy c. 67,200 units of hard candy and 100,800 units of chocolate candy d. 72,000 units of hard candy and 108,000 units of chocolate candy AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 4 58. Spreadsheets are a useful tool in financial modeling because they a. Eliminate all errors b. Reduce the need to gather information C. Allow for multiple scenarios d. All of the above AACSB: Analytic AICPA BB: Critical Thinking, Leveraging Technology Difficulty: Medium Learning Objective: 3 Use the following to answer questions 59-60: HiCal Candies, a candy producer using an activity based costing system, sells 20,000 almond chocolate bars per month at $2 per bar. Unit level costs are $0.50 per bars; facility costs are $5,000 per month; six set-ups are required per month at a cost of $500 per set-up. Product level activities for the moth consist of $200 per month for product maintenance, $800 per month for product promotion. 12-18 Chapter 12 - Financial and Cost-Volume-Profit Models 59. What are HiCal's monthly higher level costs? a. $5,000 b. $8,000 C. $9,000 d. $19,000 AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 4 60. What is HiCal's break-even quantity (rounded)? a. 3,334 b. 5,334 C. 6,000 d. 12,667 AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 4 61. The cost of operating an employee fitness center is an example of a: a. Unit-level activity b. Batch-level activity c. Product-level activity D. Facility-level activity AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 4 12-19 Chapter 12 - Financial and Cost-Volume-Profit Models 62. You are given the following information concerning scarces resources of a particularly high skilled computer expert an in for an audit firm The best use of the computer expert's time is to work on a. Audit Clients B. Tax Clients c. Write Up Clients d. All clients will lead to equal profitability AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 6 63. Which of the following should be maximized when allocating a scarce resource among various production alternatives? a. Gross margin per unit b. Contribution margin per unit C. Contribution margin per unit of scarce resource d. Sales volume AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 6 12-20 Chapter 12 - Financial and Cost-Volume-Profit Models 64. Ketchem All Detective Agency is evaluating their system. They gathered the information below Practical capacity is 75% for each process Which process is most likely to be a current bottleneck.? a. Interviews b. Research C. Pursuit d. Travel AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Hard Learning Objective: 7 Use the following to answer questions 65-66: Mighty Chocolate manufactures three chocolate bars; plain, almond and crispy. Because of their outstanding quality. Mighty can sell all of the bars they produce. Select (per gross) data follows. 12-21 Chapter 12 - Financial and Cost-Volume-Profit Models 65. Which of the following is true? a. It is most profitable for Mighty to produce all Plain Bars B. It is most profitable for Mighty to produce all Almond Bars c. It is most profitable for Mighty to produce all Crispy Bars d. None of the above AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 7 66. Molding time is limited to 180 hours per month. If fixed cost per month are $2,000, what should Mighty do to maximize profit? a. Product 144 gross of Plain Bars B. Produce 225 gross of Almond Bars c. Produce 360 gross of Crispy Bars d. Produce 70 gross of Plain Bars, 70 gross of Almond Bars and 70 gross Crispy Bars AACSB: Analytic AICPA BB:: Critical Thinking Difficulty: Medium Learning Objective: 7 67. According to the theory of constraints, bottlenecks can be found in a. The manufacturing process b. The distribution process c. The market D. All of the above AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Easy Learning Objective: 7 12-22 Chapter 12 - Financial and Cost-Volume-Profit Models Use the following to answer questions 68-69: Melnick Enterprises manufactures two products, boat wax and car wax, in two departments, the Mixing Department and the Packaging Department. The Mixing Department has 800 hours per month available, and the Packaging Department has 1,200 hours per month available. Production of the two products cannot exceed 36,000 pounds. Data on the two products follow: 68. (Appendix B. The objective function for the linear program Melnick would use to determine the optimal monthly production of each wax would be: a. Z = 150B + 200C b. 2B + 1.5C is greater than or equal to 36,000 c. 2B + 1.5C is less than 36,000 D. Z = 200B + 150C AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 8 69. (Appendix B. The mixing constraint for the Melnick linear program would be: a. 2.4M + 6P is greater than or equal to 36,000 b. 5B + 2.4C is greater than or equal to 800 C. 5B + 2.4C is less than or equal to 800 d. 5B + 2.4C = 800 AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 8 12-23 Chapter 12 - Financial and Cost-Volume-Profit Models Essay Questions 70. What is a financial model? Give an example of one. View Full Document

financial model is a simulation of reality. It allows an organization to test the interaction of economic variables. Such models require that a company's operating and financial relationships be determined and mathematically integrated through a series of equations with other factors that affect company decisions. These relationships may include the cost of goods sold percentage, the time to collect accounts receivables, inventory turnover ratios, and the relative sales mix. The model is then processed to allow the user to determine the effect of different variables on the business. For example, we could determine the effect on the company's financial statements from a change in credit policy. These models allow a company to study the financial impact of a business decision before the decision is made. An example of a financial model is the cost-volume-profit (CVP) model. This model summarizes the effects of volume changes on a company's costs, revenues, and profit. This analysis can be extended to cover the impact on profit of changes in selling prices, costs, tax rates, and the sales mix. The CVP model can be used to answer questions such as, "Should we drop a product line or business unit?" and "Should we produce a particular good internally or acquire it from outside the company?" AACSB: Reflective Thinking AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 1 12-24 Chapter 12 - Financial and Cost-Volume-Profit Models 71. Yoni Corporation manufactures skateboards and is in the process of preparing next year's budget. The pro forma income statement for the current year is presented below: Compute the following: (1) What is contribution margin per unit? __________ (2) What is the breakeven point in units? __________ (3) Assume that for the coming year, the management of Yoni anticipates a 10 percent increase in the sales price, a 12 percent increase in variable costs, and a $45,000 increase in fixed expenses. What would be the breakeven point in units for the coming year? _____ Answer: (1) $30 - $5.00 - $3.00 - $1.50 - $4.00 = $16.50. (2) $350,000/$16.50 = 21,213 units (rounded up) (3) $395,000/$17.88 = 22,092 units (rounded) AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Hard Learning Objective: 1 Learning Objective: 2 12-25 Chapter 12 - Financial and Cost-Volume-Profit Models 72. Maya Zuck produces diving gear. Last Year, Ms Zuck sold 175,000 diving sets at $100. Total costs were $13,500,000 of which $10,500,000 were unit level costs and the remaining costs of were thought to be fixed. Ms Zuck is considering the purchase of an automated manufacturing system. The salesman selling the system tells her that her cost are not truly fixed. Below are the current costs and related activities as well as the changes resulting from the new system. Additionally, the new system will reduce unit level costs by 10%. Use a computer spreadsheet to model the system. Using the spread sheet, determine profit if the same number of units are sold at the same price 12-26 Chapter 12 - Financial and Cost-Volume-Profit Models Answer: AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Hard Learning Objective: 3 12-27 Chapter 12 - Financial and Cost-Volume-Profit Models 73. Bachman Corp. produces three products. Data concerning the selling prices and unit costs of the three products appear below: The fixed costs incurred in the factory are $100,000 per year. Demand for the three products exceed the company's productive capacity. The machine time is the constraint, with only 3,000 minutes of machine time available this week. Required: (1) Given the machine time constraint, which product would be emphasized? (2) Assuming that there is still unfilled demand for the product that the company should emphasize in part (1) above, up to how much should the company be willing to pay for an additional hour of machine time? Answer: (1) Product C should be emphasized because it has the greatest contribution margin per unit of scarce resource. (2) If additional machine time would be used to produce more of Product C, the time would be worth 60 minutes per hour X $3.00 per minute = $180 per hour. AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 4 12-28 Chapter 12 - Financial and Cost-Volume-Profit Models 74. (CMA adapted) Mac Company manufactures and sells adjustable canopies that attach to motor homes and trailers. The market covers both new unit purchases as well as replacement canopies. Mac developed its 2000 business plan based on the assumption that canopies would sell at a price of $400 each. The variable costs for each canopy were projected at $200, and the annual fixed costs were budgeted at $100,000. Mac's after-tax profit objective was $240,000; the company's effective tax rate is 40 percent. While Mac's sales usually rise during the second quarter, the May financial statements reported that sales were not meeting expectations. For the first five months of the year, only 350 units had been sold at the established price, with variable costs as planned, and it was clear that the 2000 after-tax profit projection would not be reached unless some actions were taken. Mac's president assigned a management committee to analyze the situation and develop several alternative courses of action. The following mutually exclusive alternatives were presented to the president: Alternative 1: Reduce the sales price by $40. The sales organization forecasts that with the significantly reduced sales price, 2,700 units can be sold during the remainder of the year. Total fixed and variable unit costs will stay as budgeted. Alternative 2: Lower variable costs per unit by $25 through the use of less expensive raw materials and slightly modified manufacturing techniques. The sales price will also be reduced by $30, and sales of 2,200 units for the remainder of the year are forecast. Alternative 3: Cut fixed costs by $10,000 and lower the sales price by 5 percent. Variable costs per unit will be unchanged. Sales of 2,000 units are expected for the remainder of the year. Required: (A) If no changes are made to the selling price or cost structure, determine the number of units that Mac Company must sell: (1) in order to break even. (2) to achieve its after-tax profit objective. (B) Determine which one of the alternatives Mac Company should select to achieve its annual after-tax profit objective. Be sure to support your selection with appropriate calculations. 12-29 Chapter 12 - Financial and Cost-Volume-Profit Models Answer: (A) (1) In order to break even, Mac Company must sell 500 units. This amount represents the point where revenue equals total costs. Revenue = Variable costs + Fixed costs $400X = $200X + $100,000 $200X = $100,000 X = 500 units. (2) In order to achieve its after-tax profit objective, Mac must sell 2,500 units. This amount represents the point where revenue equals total costs plus the pretax profit objective. Revenue = Variable costs + Fixed costs + Pretax profit $400X = $200X + $100,000 + [$240,000/(1 - .4)] $400X = $200X + $100,000 + $400,000 $200X = $500,000 X = 2,500 units (B) To achieve its annual after-tax profit objective, Mac Company should select Alternative 1, where the sales price is reduced by $40, and 2,700 units are sold during the remainder of the year. This alternative results in the highest profit and is the only alternative that equals or exceeds the company's profit objective. Alternative 1 Revenue = ($400)(350) + ($360)(2,700) = $1,112,000. Variable cost = $200 x 3,050 = $610,000. Operating profit = $1,112,000 - $610,000 - $100,000 = $402,000. After-tax profit = $402,000 x (1 - .4) = $241,200. Alternative 2 Revenue = ($400)(350) + ($370)(2,200) = $954,000. Variable cost = ($200)(350) + ($175)(2,200) = $455,000. Operating profit = $954,000 - $455,000 - $100,000 = $399,000. After-tax profit = $399,000 x (1 - .4) = $239,400. Alternative 3 Revenue = ($400)(350) + ($380)(2,000) = $900,000. Variable cost = $200 x 2,350 = $470,000. Operating profit = $900,000 - $470,000 - $90,000 = $340,000. After-tax profit = $340,000 x (1 - .4) = $204,000. AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Hard Learning Objective: 4 Learning Objective: 5 12-30 Chapter 12 - Financial and Cost-Volume-Profit Models 75. A large school desires to earn $20,000 for a new playground. They are considering the following two projects. Cost Information Project A - Candy Bar Sale The bars sell for $2.00 per bar. Project B - Cookie Sale Advertising is provided by supplier The cookies sell for $6 per box. (1) For each project, compute the number of items that must be sold to earn the desired profit. (2) Recommend on project and explain your answer. Identify other information you would obtain to improve the quality of your decision. Answer: Project A (1) Required bars to be sold $20,000=$2X-.75X-1,000 X=number of bars = 16,800 Project B Required boxes of cookies to be sold $20,000=$6X-4.20X-1,600 X= number of boxes = 12,000 12-31 Chapter 12 - Financial and Cost-Volume-Profit Models (2) Items to be considered Selling bars, they will need to sell more items than if they sell cookies - depending upon the energy of the sales force it may be easier to sell fewer items. Each bar will deliver a greater percentage of money toward profit than so people will be making a greater contribution for each dollar spent. How will these sales impact other fundraising projects - if people spend $6 on a box of cookies, will they still be willing to contribute in other ways? Are any other scare resources involved? AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Decision Making Difficulty: Medium Learning Objective: 2 76. (CMA adapted) Rum Company has developed a new product that will be marketed for the first time during the next fiscal year. Although Rum's Marketing Department estimates that 35,000 units could be sold at $36 per unit, Rum's management has allocated only enough manufacturing capacity to produce a maximum of 25,000 units of the new product annually. The fixed costs associated with the new product are budgeted at $475,000 for the year. The variable costs of the new product are $16 per unit. Required: (1) How many units of the new product must Rum sell during the next fiscal year in order to breakeven on the product? __________ (2) What is the profit Rum would earn on the new product if all the manufacturing capacity allocated by management is used and the product is sold for $36 per unit? __________ (3) The Marketing Department would like more manufacturing capacity to be devoted to the new product. What would be the percentage increase in net income for the new product if its unit sales could be expanded by 10% without any increase in fixed expenses and without any change in the unit selling price and unit variable cost? ___________ (4) Rum's management has stipulated that the new product must earn a profit of at least $125,000 in the next fiscal year. What unit selling price would achieve this target profit if all of the manufacturing capacity allocated by management is used and all of the output can be sold at that selling price? _____ 12-32 Chapter 12 - Financial and Cost-Volume-Profit Models Answer: (1) $475,000/$20 = 23,750 units. (2) (3) (4) Sales = Variables expenses + Fixed expenses + Target profit 25,000X = ($16 X 25,000) + $475,000 + $125,000 where X is the selling price 25,000X = $400,000 + $475,000+$125,000 X = $1,000,000/25,000 = $40 AACSB: Analytic, Reflective Thinking AICPA BB: Critical Thinking, Marketing AICPA FN: Decision Making Difficulty: Hard Learning Objective: 6 12-33 Chapter 12 - Financial and Cost-Volume-Profit Models 77. (Appendix B. Sax Corp. manufactures two products, pudding and cake mixes, in two departments, the Mixing Department and the Packaging Department. The Mixing Department has 1,800 hours per month available, and the Packaging Department has 2,100 hours per month available. Production of the two products cannot exceed 40,000 pounds. Data on the two products follow: Required: (1) What is the objective function for the linear program Sax would use to determine the optimal monthly production for each product? ___________ (2) What is the mixing constraint for the Sax linear program? __________ (3) What is the packaging constraint for the Sax linear program? ______ Answer: (1) Z = $200P + 100C. (2) 6.0P + 3.0C is less than or equal to 1,800. (3) 4.2P + 3.6C is less than or equal to 2,100. AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 7 12-34 Chapter 12 - Financial and Cost-Volume-Profit Models 78. (Appendix B) What is linear programming and what are its basic components? Answer: Linear programming is a financial model that helps an organization determine how to best allocate its scarce resources. Examples of scarce resources are labor and machine time. Because an organization generally has a finite amount of labor and machine time available for its use, its management must best determine how to use these scarce resources to maximize the organization's profit. Management should focus on the good or service that has the greatest payoff (ie, contribution) per unit of scarce resource. The situation becomes more complex if the organization has two or more scarce resources in a decision situation. Linear programming can be used when an organization has two or more scarce resources to allocate. Linear programming shows how to best allocate scarce resources among alternative courses of action, meaning that contribution margin is maximized or cost is minimized. The linear programming model consists of the following components: (1) Objective function - a mathematical expression to be maximized or minimized. Typically, the objective function involves the maximization of profit per unit produced. (2) Constraints - restrictions on the objective function. An example would be that only so many machine hours are available to produce our products. (3) Feasible solution space - a set of values that satisfies the constraints. This could consist of more than one solution point. (4) Optimum point - a set of values that satisfies the constraints and the objective function. This is the point that would be chosen in the allocation of resources. This point would maximize the total profit. AACSB: Analytic AICPA BB: Critical Thinking Difficulty: Medium Learning Objective: 7 12-35 Chapter 12 - Financial and Cost-Volume-Profit Models 79. (Computer Required) Marvelous Motels, located in small Midwestern town is considering a remodeling plan that will turn some of their rooms into luxury suites. Using the profit planning model, consider the information below to evaluate the three proposed scenarios. Company owners expect a target profit of $2,000,000. 12-36 Chapter 12 - Financial and Cost-Volume-Profit Models Required: What is the profit (ignoring taxes) if a) The company converts 50 rooms into 10 suites (assume the occupancy rate remains constant) b) The company converts 75 rooms into 15 suites (assume the occupancy rate remains constant) c) The company converts 100 rooms into 20 suites (assume the occupancy rate remains constant) Answer: Spreadsheets follow (a) Profit $2,827,800 (b) Profit $2,455,500 (c) Profit $2,083,200 12-37 Chapter 12 - Financial and Cost-Volume-Profit Models Profit planning model with multiple products and cost activities 12-38 Chapter 12 - Financial and Cost-Volume-Profit Models 12-39 Chapter 12 - Financial and Cost-Volume-Profit Models Profit planning model with multiple products and cost activities 12-40 Chapter 12 - Financial and Cost-Volume-Profit Models Profit planning model with multiple products and cost activities 12-41 Chapter 12 - Financial and Cost-Volume-Profit Models Difficulty: Medium Learning Objective: 8 12-42 ...