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UNIVERSITY OF CALIFORNIA HAAS SCHOOL OF BUSINESS EWMBA 201A—Economic Analysis for Business Decisions Fall 2009 Felix Várdy ANSWERS - Problem Set #3 Doing these problems is optional. The solutions to these questions will be posted by Friday, September 18 and discussed in section Saturday, September 19. As always, the educational value of these exercises will be maximized if you attempt to answer these questions before you look at the answers. Question 1 After a bitter takeover battle, in which the previous management of SC Enterprises was ousted because of their annoying habit of giving away a large fraction of the firm's output on December 25 th instead of selling it, Biff Banyon has been installed as CEO. SC Enterprises—a large toy manufacturing concern—currently operates out of a single building, built in 1978 for $300 million in cash. Given its out-of-the- way location, it is believed that no one would buy it were the building put up for sale. SC Enterprises makes four toy lines: puzzles, teddy bears, dolls, and toy guns. Each toy line has its own assembly line and elves who work on that assembly line. The lines, however, all go through the same packaging and shipping department. Each type of toy takes the same time and same amount of materials to be processed through packaging and shipping (e.g., a puzzle and a teddy bear both take the same time to be processed and use the same amount of packaging materials). The previous management's accounting for these toy lines is shown below. Annual Accounting at SC Enterprises [All figures in millions. Numbers in parentheses represent negative amounts.] Puzzles Teddy Bears Dolls Toy Guns SC Enterprises Number sold 1 1 1 2 5 Revenue $9.9 $20 $20 $11.8 $61.7 Direct elf-hours 1 1 1 1 4 @ $4 per hour $4 $4 $4 $4 $16 Other direct costs $0 $0 $0 $0 $0 Overhead* $7.5 $7.5 $7.5 $7.5 $30 Profit ($1.6) $8.5 $8.5 $0.3 $15.7 * Overhead includes total expenditures on packaging and shipping ($20 million) and cost of the building ($10 million — calculated using 30-year straight-line depreciation). Overhead is allocated on the basis of direct elf-hours (e.g., if a line uses 25% of all direct elf-hours, then $7.5 million [= .25 x $30 million] of overhead is allocated to that line). a) What is the annual economic cost of operation (direct plus overhead costs) for SC Enterprises?
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EWMBA 201a Fall 2009—Várdy The accounting figures likely overstate economic costs by the $10 million depreciation. Since the building has no resale value and likely deteriorates
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