CHAPTER 24 (FIN MAN); CHAPTER 9 (MAN) … Content...course of action compared with an alternative. ... decision. In addition, any costs of closing the store and preparing the store

1. a. Differential revenue is the amount of increase or decrease in revenue expected from a particular course of action compared with an alternative.

b. Differential cost is the amount of increase or decrease in cost expected from a particular course of action compared with an alternative.

c. Differential income is the difference between differential revenue and differential cost.

2. The differential income and costs of the lease option should be compared against selling the building.The differential revenue would be the lease revenue compared to the proceeds from sale. The differential expenses would be the costs associated with leasing the building, including maintenance,property tax, and insurance, compared to the expenses of selling, such as sales commissions. The opportunity cost of money should also be considered in the analysis.

3. If there is demand for the premium-grade product, the differential revenue (premium less commodity) may exceed the differential cost to process the product to premium grade.

4. A business should only accept business at a special price if the lower price will not contaminate the regular pricing for other customers or induce other customers to demand the special price. In addition,the business must be careful not to violate the Robinson-Patman Act, which prohibits uncompetitiveprice differences across different markets for the same product. Lastly, the business must consider the longer-term ramifications of offering discount business to a customer that may wish to order in the future.

5. It would be reasonable to purchase from the supplier if the fixed cost per unit was less than 50 cents.That is, if the fixed cost is less than 50 cents per unit, then the variable cost per unit would exceed the supplier’s price, making the supplier price more attractive.

6. Some of the financial considerations include the profitability of the store, including all the revenuesand the variable and fixed costs associated with the store, since they would all be differential to the decision. In addition, any costs of closing the store and preparing the store for disposal would need to be considered (legal costs, demolition costs, employee severance costs). Lastly, the opportunitycost of the value of the equipment and land (either in cash or rental income) should be considered. For example, if the opportunity value of the assets were $500 per month, then the store would need to have a profitability exceeding this amount to remain an attractive alternative.

7. In the long run, the normal selling price must be set high enough to cover all costs (both fixed andvariable) and provide a reasonable amount for profit.

8. In setting prices, managers should also consider such factors as the prices of competing products andthe general economic conditions of the marketplace.

CHAPTER 24 (FIN MAN); CHAPTER 9 (MAN)DIFFERENTIAL ANALYSIS AND PRODUCT PRICING

DISCUSSION QUESTIONS

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CHAPTER 24 Differential Analysis and Product Pricing

DISCUSSION QUESTIONS (Continued)

9. The target cost concept begins with a price that can be sustained in the marketplace, then subtracts a target profit, thus determining the target cost. The cost is made to conform to the price required in the market. In contrast, under cost plus, a markup is added to the cost. The resulting price is assumed to be acceptable in the market.

10. The proper measure of product value in a bottlenecked process is the contribution margin per bottleneck hour.



PE 24–1A (FIN MAN); PE 9–1A (MAN)

DifferentialLease Sell Effect

Machine Machine on Income(Alternative 1) (Alternative 2) (Alternative 2)

Revenues $243,000 $231,000 –$12,000Costs –16,900 –11,550 5,350Income (Loss) $226,100 $219,450 –$ 6,650

* $231,000 × 5%

Jerrod Company should lease the machine.

PE 24–1B (FIN MAN); PE 9–1B (MAN)


Equipment Equipment on Income(Alternative 1) (Alternative 2) (Alternative 2)

Revenues $84,600 $82,000 –$2,600Costs –7,950 –4,920 3,030Income (Loss) $76,650 $77,080 $ 430

* $82,000 × 6%

Timberlake Company should sell the equipment.

Differential AnalysisLease Equipment (Alt. 1) or Sell Equipment (Alt. 2)

March 23, 2014

PRACTICE EXERCISES

Differential AnalysisLease Machine (Alt. 1) or Sell Machine (Alt. 2)

January 12, 2014

*

*




DifferentialContinue Discontinue EffectProduct S Product S on Income

(Alternative 1) (Alternative 2) (Alternative 2)

Revenue $149,000 $ 0 –$149,000Costs:

Variable cost of goods sold –88,500 0 88,500Variable selling and admin.

expenses –24,500 0 24,500Fixed costs –40,000 –40,000 0

Income (Loss) –$ 4,000 –$40,000 –$ 36,000

Product S should be continued.


DifferentialContinue Discontinue EffectProduct B Product B on Income

(Alternative 1) (Alternative 2) (Alternative 2)Revenue $39,500 $ 0 –$39,500Costs:


expenses –16,500 0 16,500Fixed costs –15,000 –$15,000 0

Income (Loss) –$17,500 –$15,000 $ 2,500

Product B should be discontinued.

Differential AnalysisContinue Product B (Alt. 1) or Discontinue Product B (Alt. 2)

May 9, 2014

Differential AnalysisContinue Product S (Alt. 1) or Discontinue Product S (Alt. 2)

September 12, 2014




DifferentialMake Buy EffectBread Bread on Income


Unit costs:Purchase price $ 0 –$105 –$105Delivery 0 –12 –12Variable costs ($152 – $39) –113 0 113Fixed factory overhead –39 –39 0

Income (Loss) –$152 –$156 –$ 4

The company should make the bread.


DifferentialMake Buy Effect

Bottles Bottles on Income(Alternative 1) (Alternative 2) (Alternative 2)

Unit costs:Purchase price $ 0 –$35 –$35Freight 0 –5 –5Variable costs ($67 – $22) –45 0 45Fixed factory overhead –22 –22 0

Income (Loss) –$67 –$62 $ 5

The company should buy the bottles.

Differential AnalysisMake Bottles (Alt. 1) or Buy Bottles (Alt. 2)

March 30, 2014

Differential AnalysisMake Bread (Alt. 1) or Buy Bread (Alt. 2)

August 16, 2014




Continue Replace Differentialwith Old Old EffectMachine Machine on Income


Revenues:Proceeds from sale of old machine $ 0 $ 98,000 $ 98,000

Costs:Purchase price 0 –155,000 –155,000Direct labor (6 years) –408,000 –348,000 60,000

Income (Loss) –$408,000 –$405,000 $ 3,000

1 $68,000 × 6 years2 $58,000 × 6 years

The company should replace the old machine.



(Alternative 1) (Alternative 2) (Alternative 2)Revenues:

Proceeds from sale of old machine $ 0 $50,500 $50,500Costs:

Purchase price 0 –75,000 –75,000Direct labor (5 years) –56,000 –37,000 19,000

Income (Loss) –$56,000 –$61,500 –$ 5,500

1 $11,200 × 5 years2 $7,400 × 5 years

The company should continue with the old machine.

Differential AnalysisContinue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)

April 11, 2014


February 18, 2014

1 2

1 2




Process DifferentialSell Further into Effect

Product T Product U on Income(Alternative 1) (Alternative 2) (Alternative 2)

Revenues, per unit $4.65 $5.30 $0.65Costs, per unit –3.90 –4.48 –0.58Income (Loss), per unit $0.75 $0.82 $0.07

* $3.90 + $0.58

The company should process further into Product U.



Product D Product E on Income(Alternative 1) (Alternative 2) (Alternative 2)

Revenues, per unit $36 $43 $7Costs, per unit –24 –33 –9Income (Loss), per unit $12 $10 –$2

* $24 + $9

The company should sell Product D without further processing.

Differential AnalysisSell Product D (Alt. 1) or Process Further into Product E (Alt. 2)

February 26, 2014

Differential AnalysisSell Product T (Alt. 1) or Process Further into Product U (Alt. 2)

August 2, 2014

*

*




DifferentialReject Accept EffectOrder Order on Income


Revenues, per unit $0.00 $39.00 $39.00Costs:

Variable manufacturing costs, per unit 0.00 –31.00 –31.00Export tariff, per unit 0.00 –9.75 –9.75

Income (Loss), per unit $0.00 –$ 1.75 –$ 1.75

* $39.00 × 25%

The company should not accept the special order.



(Alternative 1) (Alternative 2) (Alternative 2)Revenues, per unit $0.00 $7.20 $7.20Costs:

Variable manufacturing costs, per unit 0.00 –5.00 –5.00Export tariff, per unit 0.00 –1.08 –1.08

Income (Loss), per unit $0.00 $1.12 $1.12

* $7.20 × 15%

The company should accept the special order.

Differential AnalysisReject Order (Alt. 1) or Accept Order (Alt. 2)

March 16, 2014


October 23, 2014

*

*




$55 + $26$54*

* $80 – $26


$58 + $70$160*

* $230 – $70

PE 24–8A (FIN MAN); PE 9–8A (MAN)Product A Product B

Unit contribution margin……………………………………………… $24 $30÷ Testing hours per unit……………………………………………… 4 6Unit contribution margin per production bottleneck hour……… $ 6 $ 5

Product A is the most profitable in using bottleneck resources.

PE 24–8B (FIN MAN); PE 9–8B (MAN)Product K Product L

Unit contribution margin……………………………………………… $120 $100÷ Furnace hours per unit……………………………………………… 5 4Unit contribution margin per production bottleneck hour……… $ 24 $ 25

Product L is the most profitable in using bottleneck resources.

= 150%

= 80%

Markup percentage on product cost:Desired Profit + Selling and Admin. Exp.

Total Product Cost

Markup percentage on product cost:

Desired Profit + Selling and Admin. Exp.Total Product CostMarkup percentage on product cost:

Markup percentage on product cost:



Ex. 24–1 (FIN MAN); Ex. 9–1 (MAN)

a.


Machinery Machinery on Income(Alternative 1) (Alternative 2) (Alternative 2)

Revenues $255,000 $244,000 –$11,000Costs –23,800 –12,200 11,600Income (Loss) $231,200 $231,800 $ 600

* $244,000 × 5%

b. Sell the machinery. The net gain from selling is $600.

Ex. 24–2 (FIN MAN); Ex. 9–2 (MAN)Note to Instructors: This differential analysis is a “lease or buy ” decision, which is from the user perspective. The “lease or sell ” decision is from the perspective of the equipment owner. Thus, the analysis is similar to the text examples, but must be set up from the user’s, rather than the owner’s, perspective.

DifferentialLease Buy Effect

Equipment Equipment on Income(Alternative 1) (Alternative 2) (Alternative 2)

Costs:Purchase price $ 0 –$4,600 –$4,600Freight and installation 0 –590 –590Repair and maintenance (4 years) 0 –2,480 –2,480Lease (4 years) –7,200 0 7,200

Income (Loss) –$7,200 –$7,670 –$ 470

1 $620 × 4 years2 $1,800 × 4 years

The company should lease the equipment.

EXERCISES

Differential AnalysisLease Equipment (Alt. 1) or Buy Equipment (Alt. 2)

August 4, 2014

Differential AnalysisLease Machinery (Alt. 1) or Sell Machinery (Alt. 2)

April 16, 2014

1

2

*



Ex. 24–3 (FIN MAN); Ex. 9–3 (MAN)

a.

DifferentialContinue Discontinue EffectStar Cola Star Cola on Income


Revenues $290,000 $ 0 –$290,000Costs:

Variable cost of goods sold –131,750 0 131,750Variable operating expenses –155,250 0 155,250Fixed costs –75,000 –75,000 0

Income (Loss) –$ 72,000 –$75,000 –$ 3,000

1 (1 – 15%) × $155,0002 (1 – 25%) × $207,0003 (15% × $155,000) + (25% × $207,000)

b. Star Cola should be retained. As indicated by the differential analysis in part (a), the income would decrease by $3,000 if the product is discontinued.

Differential AnalysisContinue Star Cola (Alt. 1) or Discontinue Star Cola (Alt. 2)

January 21, 2014

1

2

3



Ex. 24–4 (FIN MAN); Ex. 9–4 (MAN)

a.

DifferentialContinue Discontinue Effect

Cups Cups on Income(Alternative 1) (Alternative 2) (Alternative 2)

Revenues $31,300 $ 0 –$31,300Costs:


expenses –10,020 0 10,020Fixed costs –9,200 –9,200 0

Income (Loss) –$ 2,200 –$9,200 –$ 7,000

1 $16,800 × (1 – 15%)2 $16,700 × (1 – 40%)3 ($16,800 × 15%) + ($16,700 × 40%)

b. The Cups line should be retained. As indicated by the differential analysis in part (a),the income will decrease by $7,000 if the Cups line is discontinued.

Differential AnalysisContinue Cups (Alt. 1) or Discontinue Cups (Alt. 2)

March 31, 2014

1

2

3



Ex. 24–5 (FIN MAN); Ex. 9–5 (MAN)Note to Instructors: Many students may be unfamiliar with the financial servicesindustry. This exercise provides an opportunity to introduce students to some basic terms and concepts used within the industry.

a. The “Investor Services” segment serves the retail customer, you and me. These are the brokerage, Internet, and mutual fund services used by individual investors. The “Institutional Services” segment includes the same services provided for financial institutions, such as banks, mutual fund managers, insurance companies, and pension plan administrators.

b. Variable costs in the “Investor Services” segment include:

1. Commissions to brokers

2. Fees paid to exchanges for executing trades

3. Transaction fees incurred by Schwab mutual funds to purchase and sell shares

4. Advertising

Fixed costs in the “Investor Services” segment include:

1. Depreciation on brokerage offices

2. Depreciation on brokerage office equipment, such as computers and computer networks

3. Property taxes on brokerage offices

c. Investor InstitutionalServices Services

(in millions) (in millions)

Income from operations………………………………………… $780 $443Plus depreciation………………………………………………… 93 52Estimated contribution margin………………………………… $873 $495

d. If one assumes that the fixed costs that serve institutional investors (computers, servers, and facilities) would not be sold but would be used by the other sector, then the contribution margin of $495 million would be an estimate of the reduced profitability. If the fixed assets were sold, then the operating income decline would approach $443 million. Since the institutional and retail investors use nearly the same assets, the $495 million answer is probably the better estimate.



Ex. 24–6 (FIN MAN); Ex. 9–6 (MAN)The flaw in the decision is the failure to focus on the differential revenues and costs, which indicate that operating income would be reduced by $59,000 if Children’s Shoes were discontinued. This differential income from sales of Children’s Shoes can be determined from the following differential analysis:

Continue Discontinue DifferentialChildren’s Children’s Effect

Shoes Shoes on Income(Alternative 1) (Alternative 2) (Alternative 2)

Revenues $235,000 $ 0 –$235,000Costs:

Variable cost of goods sold –130,000 0 130,000Variable selling and admin. expenses –46,000 0 46,000Fixed costs –76,000 –76,000 0

Income (Loss) –$ 17,000 –$76,000 –$ 59,000

*$41,000 + $35,000

Ex. 24–7 (FIN MAN); Ex. 9–7 (MAN)

a.

Make Buy DifferentialCarrying Carrying Effect

Case Case on Income(Alternative 1) (Alternative 2) (Alternative 2)

Costs:Purchase price $ 0.00 –$65.00 –$65.00Direct materials per unit –30.00 0.00 30.00Direct labor per unit –25.00 0.00 25.00Variable factory overhead per unit –3.75 0.00 3.75Fixed factory overhead per unit –6.25 –6.25 0.00

Income (Loss) –$65.00 –$71.25 –$ 6.25

1 $25.00 × 15%2 $10.00 – $3.75

b. Assuming there were no better alternative uses for the spare capacity, it would be advisable to manufacture the carrying cases because the cost savings would be $6.25 per unit. Fixed factory overhead is irrelevant, since it will continue whether the carrying cases are purchased or manufactured.

Differential AnalysisMake Carrying Case (Alt. 1) or Buy Carrying Case (Alt. 2)

July 19, 2014

Differential AnalysisContinue Children’s Shoes (Alt. 1) or Discontinue Children’s Shoes (Alt. 2)

1

2

*



Ex. 24–8 (FIN MAN); Ex. 9–8 (MAN)

a.

Lay Out Purchase DifferentialPages Layout Effect

Internally Services on Income(Alternative 1) (Alternative 2) (Alternative 2)

Revenues:Salvage of computer equipment $ 0 $ 9,000 $ 9,000

Costs:Purchase price of layout work 0 –325,000 –325,000Salaries –224,000 0 224,000Benefits –36,000 0 36,000Supplies –21,000 0 21,000Office expenses –39,000 0 39,000Office depreciation –28,000 –28,000 0Computer depreciation –24,000 –24,000 0

Income (Loss) –$372,000 –$368,000 $ 4,000

* 25,000 pages × $13 per page

b. The benefit from using an outside service is shown to be $4,000 greater than performing the layout work internally. The fixed costs (depreciationexpenses) in the budget are irrelevant to the decision. Thus, the work should be purchased from the outside on a strictly financial basis.

c. Before electing to terminate the five employees, the guild should consider the long-run impact of the decision. Specifically, future page layout rates may grow faster than the cost of internal salaries, thus favoring the use of employees over the long term. This would especially be the case if the outside company provided a low bid in order to win the initial business. In addition, the guild may wish to consider noneconomic factors, such as the ability to more directly control the quality and timing of the layout work by internal employees.

Differential AnalysisLay Out Pages Internally (Alt. 1) or Purchase Layout Services (Alt. 2)

February 22, 2014

*



Ex. 24–9 (FIN MAN); Ex. 9–9 (MAN)

a.



Revenues:Proceeds from sale of old

machine $ 0 $ 82,000 $ 82,000Costs:

Purchase price 0 –528,000 –528,000Variable production costs

(8 years) –1,336,000 –872,000 464,000Income (Loss) –$1,336,000 –$1,318,000 $ 18,000

1 $167,000 × 8 years2 $109,000 × 8 years

The company should replace the old machine.

b. The sunk cost is the $250,000 book value ($600,000 cost less $350,000 accumulateddepreciation) of the present machine. The original cost and accumulated depreciation were incurred in the past and are irrelevant to the decision to replace the machine.


Spetember 11, 2014

1 2



Ex. 24–10 (FIN MAN); Ex. 9–10 (MAN)

a.



Revenues:Sales (5 years)* $1,025,000 $1,025,000 $ 0

Costs:Purchase price 0 –180,000 –180,000Direct materials (5 years)* –360,000 –360,000 0Direct labor (5 years)* –255,000 0 255,000Power and maintenance (5 years)* –25,000 –90,000 –65,000Taxes, insurance, etc. (5 years)* –7,500 –20,000 –12,500Selling and admin. expenses

(5 years)* –225,000 –225,000 0Income (Loss) $ 152,500 $ 150,000 –$ 2,500

* Each annual revenue and cost is multiplied by five years.

b. The proposal should not be accepted.

c. In addition to the factors given, consideration should be given to such factors as: Do both present and proposed operations provide the same capacity? What opportunity costs are associated with alternative uses of the $180,000 outlay required to purchase the automatic machine? Is the product improved by using automatic machinery? Does the federal income tax have an effect on the decision?


May 4, 2014



Ex. 24–11 (FIN MAN); Ex. 9–11 (MAN)


Rough Cut Finished Cut on Income(Alternative 1) (Alternative 2) (Alternative 2)

Revenues, per 100 board ft. $586 $755 $169Costs, per 100 board ft. –412 –536 –124Income (Loss), per 100 board ft. $174 $219 $ 45

Oakridge Lumber Company should process further and sell finished-cut lumber.

Ex. 24–12 (FIN MAN); Ex. 9–12 (MAN)a.

ProcessSell Further into Differential

Regular Decaf EffectColumbian Columbian on Income

(Alternative 1) (Alternative 2) (Alternative 2)Revenues $55,320 $67,716 $12,396Costs –33,000 –43,230 –10,230Income (Loss) $22,320 $24,486 $ 2,166

1 $9.22 × 6,000 lbs.2 $11.88 × (6,000 lbs. × 95%)3 $5.50 × 6,000 lbs.4 $33,000 + $10,230

b. The differential revenue from processing further to Decaf Columbian is more than the differential cost of processing further by $2,166. Thus, Rise N’ Shine Coffee Company should sell and process further to Decaf Columbian.

Sell Regular Columbian (Alt. 1) or Process Further into Decaf Columbian (Alt. 2)October 6, 2014

Differential AnalysisSell Rough Cut (Alt. 1) or Process Further into Finished Cut (Alt. 2)

June 14, 2014

Differential Analysis

1 2

3 4



Ex. 24–12 (FIN MAN); Ex. 9–12 (MAN) (Concluded)c. The price of Decaf Columbian would need to decrease to $11.50 per pound

in order for the differential analysis to yield neither an advantage nor a disadvantage (indifference). This is determined as follows:

$2,1665,700 lbs.

The price of Decaf Columbian would need to be $0.38 lower, or $11.50, to yield no net differential income or loss. This is verified by the following differential analysis:

Sell DifferentialRegular Effect

Columbian on Income(Alternative 1) (Alternative 2)

Revenues $55,320 $10,230Costs –33,000 –10,230Income (Loss) $22,320 $ 0

* $11.50 × (6,000 lbs. × 95%)

(Alternative 2)Decaf Columbian

$22,320–43,230$65,550

Further into

=

ProcessOctober 6, 2014

Net Advantage of Further ProcessingVolume of Decaf Columbian

Differential AnalysisSell Regular Columbian (Alt. 1) or Process Further into Decaf Columbian (Alt. 2)

= $0.38 per lb.

*



Ex. 24–13 (FIN MAN); Ex. 9–13 (MAN)



Revenues $0 $576,000 $576,000Costs:

Variable manufacturing costs 0 –522,000 –522,000Income (Loss) $0 $ 54,000 $ 54,000

1 18,000 units × $32 per unit2 18,000 units × $29 per unit

b. The additional units can be sold for $32 each, and since unused capacity is available, the only costs that would be added if this additional production were accepted are the variable costs of $29 per unit. The differential revenue is therefore $32 per unit, and the differential cost is $29 per unit. Thus, the net gain is $3 per unit × 18,000 units, or $54,000.

c. $29.01. Any selling price above $29 (variable costs per unit) will produce a positive contribution margin.

Ex. 24–14 (FIN MAN); Ex. 9–14 (MAN)Total costs………………………………………………………………………………… $375,000Less fixed costs………………………………………………………………………… 112,500Total variable costs……………………………………………………………………… $262,500

Variable cost per unit:$262,500 ÷ 25,000 batteries = $10.50

The lowest bid should be sufficient to cover the variable cost of $10.50 per unit.


November 12, 2014

1

2



Ex. 24–15 (FIN MAN); Ex. 9–15 (MAN)

a.



Revenues $0 $1,840,000 $1,840,000Costs:

Direct materials 0 –760,000 –760,000Direct labor 0 –320,000 –320,000Variable factory overhead 0 –288,000 –288,000Variable selling and admin.

expenses 0 –55,000 –55,000Shipping costs 0 –130,000 –130,000Certification costs 0 –142,000 –142,000

Income (Loss) $0 $ 145,000 $ 145,000

1 20,000 tires × $92 per tire2 20,000 tires × $38 per tire3 20,000 tires × $16 per tire4 20,000 tires × ($24 per tire × 60%)5 20,000 tires × [($20 per tire × 45%) – ($125 × 5%)*]6 20,000 tires × $6.50 per tire

* 5% × $125. The avoided sales commission should not be computed on the basisof the $92 price to Euro Motors, but on the existing domestic sales price of $125.

Goodman should accept the special order from Euro Motors.

$145,00020,000

b. = $92.00 – $7.25 = $84.75


January 21, 2014

$92 –

1

2

3

4

5

6



Ex. 24–16 (FIN MAN); Ex. 9–16 (MAN)a. Desired profit = $200,000 × 15% = $30,000

b. Cost amount (product cost) per unit: $27,000 ÷ 800 units = $33.75

$30,000 + $24,000$27,000

= 200%

d. Cost amount (product cost) per unit……………………………………………… $ 33.75Markup ($33.75 × 200%)……………………………………………………………… 67.50Selling price…………………………………………………………………………… $101.25

Ex. 24–17 (FIN MAN); Ex. 9–17 (MAN)a. Desired profit = $1,200,000 × 30% = $360,000

b. Cost amount (product cost) per unit: $2,500,000* ÷ 10,000 units = $250

* ($215 manufacturing variable cost per unit × 10,000 units) + $350,000 manfacturingfixed cost

$750,000$2,500,000

= 30%

d. Cost amount per unit………………………………………………………………… $250Markup ($250 × 30%)………………………………………………………………… 75Selling price…………………………………………………………………………… $325

Markup Percentage

Markup Percentage =

Markup Percentage =

Markup Percentage = $360,000 + $140,000 + $250,000$2,500,000

Desired Profit +

Desired Profit +

c. Markup Percentage =Total Selling and Administrative Expenses

Total Manufacturing Costs

Markup Percentage

c.Total Selling and Administrative Expenses


Markup Percentage =

Markup Percentage =

$360,000 + $140,000 + ($25 × 10,000)$2,500,000



Ex. 24–18 (FIN MAN); Ex. 9–18 (MAN)a. The price will be set at the estimated market price required to remain

competitive, or $28,000. Under the target cost concept, the market dictatesthe price, not the markup on cost.

b. The required profit margin of 20% of the estimated $28,000 price implies a$22,400 target product cost as follows:

Target Product Cost = $28,000 – ($28,000 × 20%)

Target Product Cost = $28,000 – $5,600

Target Product Cost = $22,400

Since the estimated manufacturing cost of $23,200 exceeds the target costof $22,400, Toyota must reduce $800 from its total costs in order tomaintain competitive pricing within its profit objectives.

Note to Instructors: Target costing provides pressure to keep costs competitive. The method assumes that the company may not be able to successfully add a markup to its costs because the resulting price may be too high in the marketplace. For example, merely adding the 25% markup on the $23,200product cost would result in an uncompetitive price of $29,000. The target costconcept moves backward by taking the price as given and then determining the cost that is required for a given profit objective.



Ex. 24–19 (FIN MAN); Ex. 9–19 (MAN)$460 – $230

$230

$230$460

$400 revised selling price × 50% = $200 amount of markup on target productcost

$400 selling price – $200 markup = $200 target product cost

(Also, $200 × 100% = $200 markup on product cost; $200 + $200 = $400 sellingprice)

b. Required cost reduction: $230 – $200 = $30

$3060 min.

$3060 min.

Direct material reduction: 20.00 17.00

3. Injection molding productivity improvement:Direct labor improvement (25%* × 40% × $40) $4.00Factory overhead improvement (25%* × 48% × $15) 1.80 5.80

Total savings per unit

* Improving the cycle time from four minutes to three minutes is a 25% reduction.

The total savings exceeds the required target cost reduction by $0.30. Thus,these improvements are sufficient to meet the target cost.

$30.30

× 15 min. =

× 6 min. =

$ 7.50

$(3.00)Additional inspection:

1.c.

2.

Direct labor reduction:

or,

a.

=

Historical markup percentage on product cost: = 100%

50% of selling price



Ex. 24–20 (FIN MAN); Ex. 9–20 (MAN)Determine the contribution margin per furnace hour as follows:

Revenue……………………………………… $43,000 $49,000 $56,500Variable cost………………………………… 34,000 28,000 26,500Contribution margin……………………… $ 9,000 $21,000 $30,000÷ Divide by number of units……………… 5,000 units 5,000 units 5,000 unitsUnit contribution margin………………… $ 1.80 $ 4.20 $ 6.00

Unit contribution margin per furnace hour*………………………… $ 0.30 $ 0.70 $ 0.50

* Calculated as follows:

$1.806 hours

$4.206 hours

$6.0012 hours

Emphasize Type 10. In a production-constrained environment, Type 10 generates the most unit contribution margin per hour of furnace resource and, thus, is the most profitable. While Type 20 has the largest profit per unit ($4.40) and unit contribution margin ($6.00), these would not be the correct metrics for determining the product to emphasize in the marketing campaign, assuming the furnace is abottleneck resource.

Type 10: = $0.70 per furnace hour


Type 5 Type 10 Type 20




Ex. 24–21 (FIN MAN); Ex. 9–21 (MAN)a. Large Medium Small Total

Units produced…………………… 3,000 3,000 3,000

Revenues…………………………… $552,000 $480,000 $300,000 $1,332,000Less variable costs………………… 390,000 360,000 228,000 978,000Contribution margin……………… $162,000 $120,000 $ 72,000 $ 354,000Less fixed costs…………………… 85,000Income from operations………… $ 269,000

b. The Small glass product is the most profitable in a bottleneck operation, demonstrated as follows:

Large Medium Small

Contribution margin………………………………… $54 $40 $24÷ Autoclave hours per unit………………………… 3 2 1Unit contribution margin per production

bottleneck hour…………………………………… $18 $20 $24



Appendix Ex. 24–22 (FIN MAN); Appendix Ex. 9–22 (MAN)a. Total costs:

Variable ($240 × 10,000 units)……………………………………………… $2,400,000Fixed ($350,000 + $140,000)………………………………………………… 490,000

Total………………………………………………………………………………… $2,890,000

Cost amount per unit: $2,890,000 ÷ 10,000 units = $289

Desired ProfitTotal Costs

$360,000$2,890,000

Markup percentage = 12.46% (rounded)

* $1,200,000 × 30% = $360,000

c. Cost amount per unit…………………………………………………………… $289Markup ($289 × 12.46%)………………………………………………………… 36Selling price………………………………………………………………………… $325

Appendix Ex. 24–23 (FIN MAN); Appendix Ex. 9–23 (MAN)a. Total variable costs: ($240 × 10,000 units)………………………………… $2,400,000

Cost amount per unit: $2,400,000 ÷ 10,000 units = $240

$850,000$2,400,000

Markup percentage = 35.42%

* $1,200,000 × 30% = $360,000

c. Cost amount per unit…………………………………………………………… $240Markup ($240 × 35.42%)………………………………………………………… 85Selling price………………………………………………………………………… $325

b.

b. Markup percentage =

Markup percentage =

Markup percentage =

Desired Profit + Total Fixed CostsTotal Costs

$360,000 + $350,000 + $140,000$2,400,000

Markup percentage =

Markup percentage =

*

*



Prob. 24–1A (FIN MAN); Prob. 9–1A (MAN)

1.

Operate DifferentialRetail Invest in EffectStore Bonds on Income


Revenues $1,264,000 $172,800 –$1,091,200Costs:

Costs to operate store –928,000 0 928,000Cost of equipment less

residual value –165,000 0 165,000Income (Loss) $ 171,000 $172,800 $ 1,800

1 (8 yrs. × $85,000) + (8 yrs. × $73,000)2 6% × $180,000 × 16 yrs.3 $58,000 × 16 yrs.4 $180,000 – $15,000

2. The proposal to operate the retail store should be rejected.

3. Total estimated revenue from operating store…………… $1,264,000Total estimated expenses to operate store:

Costs to operate store, excluding depreciation……… $928,000Cost of store equipment less residual value………… 165,000 1,093,000

Total estimated income from operating store*…………… $ 171,000

* The $171,000 income could also be determined by subtracting the $1,800 differential loss fromoperating the store as derived in part (1) from the $172,800 of investment income forgone by electing to operate the store.

Differential AnalysisOperate Retail Store (Alt. 1) or Invest in Bonds (Alt. 2)

October 1, 2014

PROBLEMS

1 2

3

4




1.



RevenuesProceeds from sale of old machine $ 0 $ 26,800 $ 26,800

CostsPurchase price 0 –111,000 –111,000Annual manufacturing costs

(6 yrs.) –127,800 –38,400 89,400Income (Loss) –$127,800 –$122,600 $ 5,200

1 $21,300 × 6 years2 $6,400 × 6 years

Note: Revenues and nonmanufacturing operating expenses are not affected by thedecision to replace the old machine, and thus are not included in the analysis. Ifthey were included, both alternatives would include them, causing the differentialeffect on income to net to zero for both items. Depreciation is ignored because it is a sunk cost for the old machine and is incorporated in the purchase price for the new machine.

Universal Graphic Printing Co. should replace the old machine with the new machine.

2. Other factors to be considered include:

a. Are there any improvements in the quality of work turned out by the new machine?

b. What effect does the federal income tax have on the decision?

c. What opportunities are available for the use of the $84,200 of funds ($111,000 less $26,800 proceeds from the old machine) that are required to purchase the new machine?

After considering such factors as those listed above, the net cost reduction anticipatedover the six-year period may not be sufficient to justify the replacement. For example, if there is an opportunity to invest the $84,200 ($111,000 – $26,800) of additional funds required for the replacement in a project that earns a return of 4% (assumed forillustration), the amount of the return over the six-year period would be $20,208 ($84,200 × 4% × 6), which is more advantageous than the replacement, other factors being equal.


April 30, 2014

1 2




1.

DifferentialPromote Promote Effect

Moisturizer Perfume on Income(Alternative 1) (Alternative 2) (Alternative 2)

Revenues $1,152,000 $1,040,000 –$112,000Costs:*

Direct materials –192,000 –260,000 –68,000Direct labor –72,000 –80,000 –8,000Variable factory overhead –48,000 –80,000 –32,000Variable operating expenses –336,000 –260,000 76,000Sales promotion –150,000 –150,000 0

Income (Loss) $ 354,000 $ 210,000 –$144,000

1 24,000 units × $482 20,000 units × $52

* Costs, except sales promotion, are the costs per unit multiplied by the increase in unit volume for each cosmetic. Fixed costs are not relevant to the decision, so are not included.

Essence of Esther should promote moisturizer.

2. The sales manager’s tentative decision should be opposed. The sales manager erroneously considered the full unit costs instead of the differential (additional) revenue and differential (additional) costs. An analysis similar to that presented in part (1) would lead to the selection of moisturizer for the promotional campaign, since this alternative will contribute $144,000 ($354,000 – $210,000) more to operating income than would be contributed by promoting perfume.

Differential AnalysisPromote Moisturizer (Alt. 1) or Promote Perfume (Alt. 2)

August 21, 2014

1 2




1.

ProcessFurther into Differential

Sell Raw Refined EffectSugar Sugar on Income


Revenues, per batch $58,800 $73,920 $15,120Costs, per batch –35,000 –56,000 –21,000Income (Loss), per batch $23,800 $17,920 –$ 5,880

1 $1.40 per pound × 42,000 pounds2 $2.20 per pound × (42,000 pounds ÷ 1.25)3 $0.35 per pound × 100,000 pounds4 $35,000 + ($0.50 per pound × 42,000 pounds)

2. Dominican Sugar Company should not process raw sugar further to produce refined sugar, since profits would be reduced by $5,880 per batch.

Differential AnalysisSell Raw Sugar (Alt. 1) or Process Further into Refined Sugar (Alt. 2)

March 24, 2014

1 2

3 4



Prob. 24–5A (FIN MAN); Prob. 9–5A (MAN)1. $225,000 ($1,500,000 × 15%)

2. a. Total manufacturing costs:Variable ($200* × 5,000 units)…………………………………………………… $1,000,000Fixed factory overhead………………………………………………………… 250,000Total………………………………………………………………………………… $1,250,000Cost amount per unit: $1,250,000 ÷ 5,000 units…………………………… $ 250

* $120 + $30 + $50

$550,000$1,250,000

Markup Percentage = 44%

c. Cost amount per unit…………………………………………………………… $250Markup ($250 × 44%)……………………………………………………………… 110Selling price……………………………………………………………………… $360

Markup Percentage =

Markup Percentage =

Markup Percentage =

b. Markup Percentage =

$225,000 + $150,000 + ($35 × 5,000 units)

Total Selling and Administrative ExpensesDesired Profit +


$1,250,000

$225,000 + $150,000 + $175,000$1,250,000



Prob. 24–5A (FIN MAN); Prob. 9–5A (MAN) (Continued)3. (Appendix)

a. Total costs:Variable ($235 × 5,000 units)……………………………………………… $1,175,000Fixed ($250,000 + $150,000)………………………………………………… 400,000

Total………………………………………………………………………………… $1,575,000

Cost amount per unit: $1,575,000 ÷ 5,000 units…………………………… $ 315


$225,000$1,575,000

Markup Percentage = 14.29% (rounded)

c. Cost amount per unit…………………………………………………………… $315Markup ($315 × 14.29%)………………………………………………………… 45Selling price……………………………………………………………………… $360

4. (Appendix)a. Variable cost amount per unit: $235

Total variable costs: $235 × 5,000 units = $1,175,000

$625,000$1,175,000

Markup Percentage = 53.19%

c. Cost amount per unit…………………………………………………………… $235Markup ($235 × 53.19%)………………………………………………………… 125Selling price……………………………………………………………………… $360

5. The cost-plus approach price of $360 should be viewed as a general guideline for establishing long-run normal prices. Other considerations, such as the price of competing products and general economic conditions of the marketplace, could lead management to establish a short-run price more or less than $360.

Markup Percentage =

Markup Percentage =

Desired Profit + Total Fixed CostsTotal Variable Costs

$225,000 + $250,000 + $150,000$1,175,000

b.


Markup Percentage =

Markup Percentage =



Prob. 24–5A (FIN MAN); Prob. 9–5A (MAN) (Concluded)6. a.



Revenues $0 $180,000 $180,000Costs:

Variable manufacturing costs 0 –160,000 –160,000Income (Loss), per unit $0 $ 20,000 $ 20,000

1 800 units × ($235 – $35*)* Excluding variable selling and administrative expenses

b. The proposal should be accepted.


August 3, 2014

1



Prob. 24–6A (FIN MAN); Prob. 9–6A (MAN)1. High Good Regular

Grade Grade Grade

Selling price……………………………………………… $280 $270 $250Variable conversion cost per unit…………………… $180 $165 $150Direct materials cost per unit………………………… 90 84 80

$270 $249 $230Contribution margin per unit………………………… $ 10 $ 21 $ 20

* $15 × 12 process hours = $180** $15 × 11 process hours = $165

*** $15 × 10 process hours = $150

2. The contribution margin per unit may give false signals when an organization has production bottlenecks. Instead, Hercules should use the contribution margin per bottleneck hour to determine relative product profitability, as follows:

High Good RegularGrade Grade Grade

Contribution margin per unit………………………… $10 $21 $20÷ Furnace (bottleneck) hours per unit……………… 4 3 2.5Contribution margin per furnace hour……………… $2.50 $7.00 $8.00

The Good Grade steel has the largest contribution margin per unit ($21); however, the Regular grade has the largest contribution margin per furnace hour ($8). Thus, using production bottleneck analysis indicates that the Regular Grade is actually more profitable at a $8.00 contribution margin per furnace hour than High Grade’s $2.50 or Good Grade’s $7.00 contribution margin per furnace hour. Therefore, the company would want to sell product in the following preference order:

1. Regular Grade2. Good Grade3. High Grade

* ** ***



Prob. 24–1B (FIN MAN); Prob. 9–1B (MAN)

1.

DifferentialOperate Invest in Effect

Warehouse Bonds on Income(Alternative 1) (Alternative 2) (Alternative 2)

Revenues $3,640,000 $518,000 –$3,122,000Costs:

Costs to operate warehouse –2,450,000 0 2,450,000Cost of equipment less

residual value –665,000 0 665,000Income (Loss) $ 525,000 $518,000 –$ 7,000

1 (7 yrs. × $280,000) + (7 yrs. × $240,000)2 5% × $740,000 × 14 years3 $175,000 × 14 years4 $740,000 – $75,000

2. The proposal to operate the warehouse should be accepted.

3. Total estimated revenue from operating warehouse………… $3,640,000Total estimated expenses to operate warehouse:

Costs to operate warehouse, excluding depreciation…… $2,450,000Cost of warehouse equipment less residual value……… 665,000 3,115,000

Total estimated income from operating warehouse*………… $ 525,000

* The $525,000 income from operations could also be determined by adding the $7,000 differential income from operating the warehouse as derived in part (1) to the $518,000 of investment income forgone by electing to operate the warehouse.

Differential AnalysisOperate Warehouse (Alt. 1) or Invest in Bonds (Alt. 2)

July 1, 2014

1 2

3

4




1.



Revenues:Proceeds from sale of old machine $ 0 $12,900 $12,900

Costs:Purchase price 0 –57,000 –57,000Annual manufacturing costs

(6 yrs.) –74,400 –20,400 54,000Income (Loss) –$74,400 –$64,500 $ 9,900

1 $12,400 × 6 years2 $3,400 × 6 years

Note: Revenues and nonmanufacturing operating expenses are not affected by thedecision to replace the old machine, and thus are not included in the analysis. If they were, both alternatives would include them, causing the differential effect on income to net to zero for both items. Depreciation is ignored because it is a sunk cost for theold machine and is incorporated in the purchase price for the new machine.

Flint Tooling Co. should replace the old machine with the new machine.

2. Other factors to be considered include the following:

a. Are there any improvements in the quality of work turned out by the new machine?

b. What effect does the federal income tax have on the decision?

c. What opportunities are available for the use of the $44,100 of funds ($57,000 less $12,900 proceeds from the old machine) that are required to purchase the new machine?

After considering such factors as those listed above, the net cost reduction anticipated over the six-year period may not be sufficient to justify the replacement. For example, if there is an opportunity to invest the $44,100 ($57,000 – $12,900) of additional funds required for the replacement in a project that earns a return of 3% (assumed for illustration), the amount of the return over the six-year period would be $7,938 ($44,100 × 3% × 6). However, this is less than differential income determined in part (1), suggesting the proposal to replace is still preferred.


November 8, 2014

1 2




1.

DifferentialPromote Promote Effect

Tennis Shoe Walking Shoe on Income(Alternative 1) (Alternative 2) (Alternative 2)

Revenues $595,000 $700,000 $105,000Costs:*

Direct materials –133,000 –224,000 –91,000Direct labor –56,000 –84,000 –28,000Variable factory overhead –49,000 –35,000 14,000Variable operating expenses –42,000 –70,000 –28,000Sales promotion –100,000 –100,000 0

Income (Loss) $215,000 $187,000 –$ 28,000

1 7,000 shoes × $852 7,000 shoes × $100

* Costs, except sales promotion, are the costs per unit multiplied by the increase in unit volume for each shoe. Fixed costs are not relevant to the decision, so are not included.

Sole Mates Inc. should promote tennis shoes.

2. The sales manager’s tentative decision should be opposed. The sales manager erroneously considered the full unit costs instead of the differential (additional) revenue and differential (additional) costs. An analysis similar to that presented in part (1) would lead to the selection of tennis shoes for the promotional campaign, since this alternative will contribute $28,000 ($215,000 – $187,000) more to operating income than would be contributed by promoting walking shoes.

Differential AnalysisPromote Tennis Shoe (Alt. 1) or Promote Walking Shoe (Alt. 2)

June 19, 2014

1 2




1.

ProcessFurther into Differential

Sell Rolled EffectIngot Aluminium on Income


Revenues, per ton $88,000 $140,800 $52,800Costs, per ton –52,500 –102,100 –49,600Income (Loss), per ton $35,500 $ 38,700 $ 3,200

1 $1,100 per ton × 80 tons2 $2,200 per ton × (80 tons ÷ 1.25)3 $105 per ton × 500 tons4 $52,500 + ($620 per ton × 80 tons)

2. International Aluminum Co. should decide to process aluminum ingot further, rather than sell aluminum ingot, since profits would be increased by $3,200 per batch ifingot was processed further into rolled aluminum.

Differential AnalysisSell Ingot (Alt. 1) or Process Further into Rolled Aluminum (Alt. 2)

February 5, 2014

1 2

3 4



Prob. 24–5B (FIN MAN); Prob. 9–5B (MAN)1. $60,000 ($600,000 × 10%)

2. a. Total manufacturing costs:Variable ($52* × 10,000 units)…………………………………………………… $520,000Fixed factory overhead………………………………………………………… 180,000Total………………………………………………………………………………… $700,000Cost amount per unit: $700,000 ÷ 10,000 units…………………………… $ 70

* $32 + $12 + $8

$210,000$700,000

Markup Percentage = 30%

c. Cost amount per unit…………………………………………………………… $70Markup ($70 × 30%)……………………………………………………………… 21Selling price……………………………………………………………………… $91

Markup Percentage =

Markup Percentage =

Markup Percentage =


$60,000 + $80,000 + ($7 × 10,000 units)

Total Selling and Administrative ExpensesDesired Profit +


$520,000 + $180,000

$60,000 + $80,000 + $70,000$700,000



Prob. 24–5B (FIN MAN); Prob. 9–5B (MAN) (Continued)3. (Appendix)

a. Total costs:Variable ($59 × 10,000 units)…………………………………………………… $590,000Fixed ($180,000 + $80,000)……………………………………………………… 260,000Total………………………………………………………………………………… $850,000

Cost amount per unit: $850,000 ÷ 10,000 units…………………………… $85.00


$60,000$850,000

Markup Percentage = 7.06%

c. Cost amount per unit…………………………………………………………… $85Markup ($85.00 × 7.06%)………………………………………………………… 6Selling price……………………………………………………………………… $91

4. (Appendix)a. Variable cost amount per unit: $59.00

Total variable costs: $59 × 10,000 units = $590,000

$320,000$590,000

Markup Percentage = 54.24% (rounded)

c. Cost amount per unit…………………………………………………………… $59Markup ($59 × 54.24%)…………………………………………………………… 32Selling price……………………………………………………………………… $91

5. The cost-plus approach price of $91 should be viewed as a general guideline forestablishing long-run normal prices. Other considerations, such as the price ofcompeting products and general economic conditions of the marketplace, couldlead management to establish a short-run price more or less than $91.

Markup Percentage =

Markup Percentage =

Desired Profit + Total Fixed CostsTotal Variable Costs

$60,000 + $180,000 + $80,000$590,000

b.


Markup Percentage =

Markup Percentage =



Prob. 24–5B (FIN MAN); Prob. 9–5B (MAN) (Concluded)6. a.



Revenues $0 $91,200 $91,200Costs

Variable manufacturing costs 0 –83,200 –83,200Income (Loss), per unit $0 $ 8,000 $ 8,000

1 1,600 units × $572 1,600 units × ($59 – $7*)

* Excluding variable selling and administrative expenses

b. The proposal should be accepted.


September 5, 2014

1

2



Prob. 24–6B (FIN MAN); Prob. 9–6B (MAN)1. Ethylene Butane Ester

Selling price……………………………………………… $170 $155 $130Variable conversion cost per unit…………………… $ 40 $ 40 $ 30Direct materials cost per unit………………………… 115 88 85

$155 $128 $115Contribution margin per unit………………………… $ 15 $ 27 $ 15

* $10 × 4 process hours = $40** $10 × 3 process hours = $30

2. The contribution margin per unit may give false signals when an organization has production bottlenecks. Instead, Wilmington Chemical Company should use the contribution margin per bottleneck hour to determine relative product profitability as follows:

Ethylene Butane Ester

Contribution margin per unit………………………… $15 $27 $15÷ Reactor (bottleneck) hours per unit………………… 1.50 1.0 0.5Contribution margin per reactor hour……………… $10 $27 $30

Unlike the analysis in part (1), this analysis shows ester to be the most profitable product, rather than butane. The reason is that ester delivers more contribution margin per bottleneck hour than does ethylene or butane ($30 vs. $10 and $27).

* * **



CP 24–1 (FIN MAN); CP 9–1 (MAN)No, it would be unethical for Aaron to attend the meeting. Such a meeting would be considered price fixing and would be a violation of federal law. Thus, Aaron’s attendance would be a criminal act. His actions would also discredit his reputation and that of the profession.

CP 24–2 (FIN MAN); CP 9–2 (MAN)The contribution margin is $4 ($22 – $18) per dozen on the special order. Thus, Varden’s manager can contribute to fixed costs by accepting the order. However, there are some additional considerations the manager must consider before accepting this order.

1. Have we ever done business overseas? Exports require additional administrative activities. Have these additional administrative costs been considered in the differential analysis?

2. Will the customer sell the golf balls overseas, or will they re-label the golf balls and have them imported back into the United States? Such a situation would cause Varden to be competing against itself.

3. Is it likely that other customers will learn of the “special deal” the overseas company received and demand equal treatment? That is, is there a risk that we’ll spoil the pricing structure in the domestic market?

4. Will the overseas customer want to do business in the future, or is this just a single sale? If the overseas customer is expected to purchase more golf balls in the future, then it is likely that the customer will come to expect the $22 price in the future.

5. Is there a possibility of another customer being willing to purchase the golf balls at the $35 price? If so, Varden may not want to commit capacity to the overseas customer. Once the capacity is committed, it will be difficult to sell to anyone else.

6. Will we help the overseas customer establish a presence in the overseas golf ball market where we may wish to compete in the future?

CASES & PROJECTS



CP 24–3 (FIN MAN); CP 9–3 (MAN)First, Marriott has excess capacity for this day, so it should be willing to acceptadditional customers. The Priceline.com customer generates incremental revenue that will not reduce other business. Given this, however, the price must at least cover variable cost, or else Marriott will incur a loss. The variable cost per room night is shown below.

Housekeeping labor cost………………………………………………………………… $38Cost of room supplies (soap, paper, etc.)……………………………………………… 8Laundry labor and material cost………………………………………………………… 10Utility cost (mostly air conditioning)…………………………………………………… 5Total variable cost per day per room…………………………………………………… $61

These costs are mostly avoidable, or variable to room nights. This answer assumes that the maid and laundry staff hours are highly flexible and can be staffed to demand. Likewise, the air conditioning and lights can be turned off if the room is not rented for the night, saving most of the utility cost. The desk staff and hotel depreciation are either sunk (depreciation) or mostly fixed to the number of room nights. Therefore, they are not relevant to accepting this business. The total variable costs are $61 per night, so the $85 customer bid should be accepted.

Note to Instructors: There could be some discussion about the degree that some of these costs are fully variable. For example, it’s likely that some utility cost must be incurred for the room, whether it is occupied or not. Likewise, the housekeeping and laundry staff hours may not be as flexible to demand as assumed here. There should be very little question about the room supplies (full variable) or the hotel depreciation (sunk). Regardless of the assumptions, the decision would remain the same.



CP 24–4 (FIN MAN); CP 9–4 (MAN)a. Juanita believes that the fixed costs should be treated as a sunk cost and

ignored in the pricing decision. In essence, Juanita is suggesting that the new computer model be treated as an incremental decision. However, the new model is not a special incremental decision. It is a core product that must contribute to covering fixed costs. If the product price does not cover fixed costs and provide a profit, then Diamond Computer Company will not be competitive in the long term. In the long term, the price must cover all costs, plus a profit markup. Thus, Juanita’s solution to the pricing decision is not a good one.

b. Target costing provides a different perspective to the pricing issue. Under target costing, Diamond Computer Company should begin with the price the market is willing to pay, which is $1,250. This price should then be reduced by the required profit markup. This would yield a target cost of $1,000 ($1,250 ÷ 1.25), which is $200 lower than the present product cost. The new target cost should be established as a cost reduction target. The company should vigorously improve the product design and processes in order to achieve a $1,000 product cost. In this way, the company can compete profitably.

Target costing takes the market price as given and adjusts the cost in order to yield the required profitability. This approach is best used in highly competitive product markets where declining prices require cost reduction in order to compete.



CP 24–5 (FIN MAN); CP 9–5 (MAN)a. This activity is designed to have students access a number of products and

services on the Internet to see their commercial potential. Each of the listed sites will provide product descriptions and pricing.

The list of costs in the products will not be determined at the Internet site but must be assumed. Some examples include:

Delta Air Lines—Airline tickets Fixed or Variable?Fuel………………………………………………………………… VCrew salaries…………………………………………………… FPlane depreciation……………………………………………… FLanding fees……………………………………………………… VTravel agent commissions…………………………………… VLease costs (gates)……………………………………………… FGround salaries………………………………………………… FEquipment depreciation……………………………………… F

Assume that the activity base is the number of passenger miles for determining fixed and variable costs. Employee salaries for an airline are relatively fixed, and only become variable when there are significantchanges to the flight schedule.

Amazon.com—Books Fixed or Variable?Cost of books (purchased for resale)……………………… VWeb page design and programming………………………… FComputer depreciation………………………………………… FOrder handling and packing wages………………………… VFreight…………………………………………………………… V

Assume that the activity base is the number of books sold for determining fixed and variable costs.

Dell Inc.—Personal computers Fixed or Variable?Cost of computers (dl, dm, and foh)………………………… V (mostly)Web page design and programming………………………… FAdvertising……………………………………………………… FOrder handling and packing wages………………………… VFreight…………………………………………………………… VBundled software*……………………………………………… V

* Depends on contract terms with software vendor

Assume that the activity base is the number of PCs sold for determining fixed and variable costs. One could argue that advertising might be variable.



CP 24–5 (FIN MAN); CP 9–5 (MAN) (Concluded)b. The product with the largest markup on variable cost is the airline ticket. The

portion of variable cost to total cost for an airline flight will be much smaller (more fixed cost) than the other two products. Thus, the markup on variable cost will be a greater percent. As a result, the airline product has a larger contribution margin, but it also has a larger fixed cost to cover. This creates larger operating leverage (and risk) than the other two products.


Documents

CHAPTER 24 (FIN MAN); CHAPTER 9 (MAN) … Content...course of action compared with an alternative. ... decision. In addition, any costs of closing the store and preparing the store