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Chapter 9 - CHAPTER 9 COST APPLICATIONS THEORY AND...

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1 C HAPTER 9 COST APPLICATIONS : THEORY AND APPLICATIONS SOLUTIONS 9.17 Supplying a product with a negative profit margin product may be necessary to keep a large customer of the profitable products from going elsewhere. Making a negative profit margin product may also be good for business if it brings good reputation in the market place. For example, a restaurant can establish reputation in a community by catering to large not-for-profit charity events at or below cost so as to develop a clientele. 9.21 Research and development expenditures are typically not unit level costs. They are either firm- level costs or product-level costs. Moreover, benefits from research and development are uncertain both in terms of timing and magnitude. Finally, research and development costs are not readily identifiable with current production, just as material and labor costs are. So it does not make sense to “inventory” these costs! 9.29 Yes. From a performance evaluation perspective, the allocated costs will be treated by the manager as if they are variable costs. By finding ways in which to reduce the costs allocated to his/her unit, the manager can paint a better picture of his/her performance. Thus, in making short-term decisions, the manager’s natural incentive would be to not treat allocated costs as fixed costs even if they are truly fixed. 9.33 a. Each additional member from Acme pays $60 but would trigger additional variable costs of $35 per month. Thus, each “Acme” member would generate a contribution of $60 -$35 = $25 per month. The 200 additional members therefore increase Hercules’ contribution margin by 200 members × $25 per member per month = $5,000 per month . b. No, the answer in (a) is not a preferred way for Tom and Lynda to evaluate the proposal . The method would be correct if the costs and benefits associated with the proposal would be realized in the short-term. That is, accepting or denying the proposal would not change the magnitude of ‘capacity’ or fixed costs. However, accepting the proposal will almost surely change “fixed” costs. The proposal would increase membership by 20% (1,000 to 1,200 members) which means considerably more usage of the facilities. For example, cardio and strength training equipment would see more wear and tear, and more yoga classes might need to be scheduled. This means that costs associated with machine repair and replacement, as well as instructor salaries (fixed costs) would increase. Tom and Lynda must consider this change to make an effective decision.
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2 c. In this context, allocating the fixed costs over members might provide a better estimate of the long-term cost per member . The allocation is $40,000/1,000 = $40 per member per month. Added to the $35 in variable costs, the “total cost” of servicing is $75 per member per month. This estimate is a better approximation of the long-run cost of a member. With this estimate, Hercules would actually lose $15 per “Acme” member, of $3,000 per month if it accepts the proposal.
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