Topic Two

Topic Two - Topic Two CHAPTER 11 DECISION MAKING AND...

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Topic Two- CHAPTER 11 DECISION MAKING AND RELEVANT INFORMATION 11-17 (20 min.) Relevant and irrelevant costs . 1. Make Buy Relevant costs Variable costs \$180 Avoidable fixed costs 20 Purchase price ____ \$210 Unit relevant cost \$200 \$210 Dalton Computers should reject Peach’s offer. The \$30 of fixed costs are irrelevant because they will be incurred regardless of this decision. When comparing relevant costs between the choices, Peach’s offer price is higher than the cost to continue to produce. 2. Keep Replace Difference Cash operating costs (4 years) \$80,000 \$48,000 \$32,000 Current disposal value of old machine (2,500) 2,500 Cost of new machine ______ 8,000 (8,000) Total relevant costs \$80,000 \$53,500 \$26,500 AP Manufacturing should replace the old machine. The cost savings are far greater than the cost to purchase the new machine. 11-18 (15 min.) Multiple choice. 1. (b) Special order price per unit \$6.00 Variable manufacturing cost per unit 4.50 Contribution margin per unit \$1.50 Effect on operating income = \$1.50 × 20,000 units = \$30,000 increase 2. (b) Costs of purchases, 20,000 units × \$60 \$1,200,000 Total relevant costs of making: Variable manufacturing costs, \$64 – \$16 \$48 Fixed costs eliminated 9 Costs saved by not making \$57 Multiply by 20,000 units, so total costs saved are \$57 × 20,000 1,140,000 Extra costs of purchasing outside 60,000 Minimum overall savings for Reno 25,000 Necessary relevant costs that would have to be saved in manufacturing Part No. 575 \$ 85,000

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11-32 (20 min.) Opportunity costs. 1. The opportunity cost to Wolverine of producing the 2,000 units of Orangebo is the contribution margin lost on the 2,000 units of Rosebo that would have to be forgone, as computed below: Selling price Variable costs per unit: Direct materials Direct manufacturing labor Variable manufacturing overhead Variable marketing costs Contribution margin per unit Contribution margin for 2,000 units \$20 \$ 2 3 2 4 11 \$ 9 \$ 18,000 The opportunity cost is \$18,000. Opportunity cost is the maximum contribution to operating income that is forgone (rejected) by not using a limited resource in its next-best alternative use.
2. Contribution margin from manufacturing 2,000 units of Orangebo and purchasing 2,000 units of Rosebo from Buckeye is \$16,000, as follows: Manufacture Orangebo Purchase Rosebo Total Selling price Variable costs per unit: Purchase costs Direct materials Direct manufacturing labor Variable manufacturing costs Variable marketing overhead Variable costs per unit Contribution margin per unit Contribution margin from selling 2,000 units of Orangebo and 2,000 units of Rosebo \$15 2 3 2 2 9 \$ 6 \$12,000 \$20 14 4 18 \$ 2 \$4,000 \$16,000 As calculated in requirement 1, Wolverine’s contribution margin from continuing to manufacture 2,000 units of Rosebo is \$18,000. Accepting the Miami Company and Buckeye offer will cost Wolverine \$2,000 (\$16,000 – \$18,000). Hence, Wolverine should refuse the Miami Company and Buckeye Corporation’s offers. 3. The minimum price would be \$9, the sum of the incremental costs as computed in requirement 2. This follows because, if Wolverine has surplus capacity, the opportunity cost = \$0. For the short-run decision of whether to accept Orangebo’s offer, fixed costs of Wolverine are irrelevant. Only the incremental costs need to be covered for it to be worthwhile for Wolverine to accept the Orangebo offer.

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This note was uploaded on 08/27/2009 for the course FINM 3405 taught by Professor Philipgray during the Three '09 term at Queensland.

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Topic Two - Topic Two CHAPTER 11 DECISION MAKING AND...

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