Exam 1 - Practice Problems.pdf

# Bob has a philosophy of every product line paying for

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Bob has a philosophy of every product line paying for itself and is determined to cut his losses on rattles. Required : a) Determine whether Buffalo Bob should drop rattles from his product offerings. Support your answer with computations. b) An old miner has offered to buy every rattle “as is” without processing for \$0.50 per rattle (note: “as is” refers to the situation where Bob only removes the rattle from the snake and no processing costs are incurred). Assume that Bob processes the same number of snakes each season. Should Bob sell rattles to the miner? Support your answer with computations.

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Page 8 Accounting 102, Practice Problems - Exam 1 Solution: a. The cost of the snake is not relevant for this decision because Buffalo Bob will have the rattles even if he drops the rattles product line. Thus, the cost of the snake is sunk with respect to this decision. The allocated overhead costs are also irrelevant for this decision because Bob will still incur basic living expenses no matter what he does with the rattles (i.e., the costs are the same under both alternatives, so they are not relevant to the decision). The key question is whether the incremental profits from the rattles product line is positive: Revenue \$2,000 - Cost 600 (incremental processing costs only) Incremental profit \$1,400 The rattles product line should not be dropped. b. We first need to determine how many snakes Buffalo Bob processes each season, and then compare the revenue if the old miner buys the rattles to the incremental profit computed in (1a). The total costs of snakes this season was \$24,000, and Bob paid an average of \$10 per snake. Thus, Bob processed 2,400 snakes. For these snakes he earned an incremental profit of \$1,400 for the rattles. If he sells this many rattles to the old miner, he receives 2,400 rattles x \$0.50 = \$1,200. The rattles should not be sold to the old miner.