ANSWERS: Chapter 7

7.2

Fixed costs are only fixed in the short-run, so any long-run decision may
have differential fixed costs. For instance, decisions affecting capacity would
include differential fixed costs.

7.5

Full cost information is appropriate for long-term pricing decisions.

7.14

The statement is true in general short-term decisions where there is excess

capacity. In a situation where the decision affects capacity, the statement
would not be true.

7.15

In the short-run, sales revenues need only cover the differential costs of
production and sale. From a short-run perspective so long as the sale
does not affect other output prices or normal sales volume, a below cost
sale may result in a net increase in income whenever revenues cover the
differential costs. However in the long-run, all costs must be covered or
management would not reinvest in the same type of assets. If the company
must continually sell below the full cost of production, the time will come to
replace those assets and it will most likely get out of that particular business.

7.19

In differential analysis, only alternative future cash flows are relevant for
decision making. Past costs may provide useful information, but they are
essentially sunk costs and not directly relevant to a decision.

7.23

Yes. Road-Runner should accept the special order. Operating profit will
increase $5,400 as shown below.
Special-Order Sales (400 X $30)......................................... $12,000
Less Variable Costs:
Manufacturing (400 X $15)................................ $ 6,000
Sales Commissions (400 X $1.50) ...................
600
6,600
Addition to Company Operating Profit .............................. $ 5,400

7.25

Donelan Products; target costing and pricing:

Price (20% X Price) = Highest acceptable costs
$50 $10 = $40
The highest acceptable manufacturing costs for which Donelan Products
would be willing to produce the lines is $40 per foot.

7.27

Amounts in thousands:

Revenues (Fees Charged)...

Operating Costs:
Cost of Services
(Variable) .......................
Salaries, Rent, and
General Administration
(Fixed)..............................
Total Operating
Costs.......................

Alternative: Status Quo:

Drop Super
Total
6 Motel
$ 350
$ 580

Operating Profit (Loss)........

305

517

55

55

360

572

$ (10)

Difference
$ 230 Lower

212 Lower

0
212 Lower
$ 18 Lower

Decision: Do not drop the Super 6 Motel account since profits would drop by
$18,000.
OR:

Lost revenues
Savings in variable costs
Decrease in operating profit

7.33

a.

($ 230,000)
212,000
($ 18,000)

Buy Make = Difference

Variable Costs.......................... $300,000 $250,000 = $50,000

Recommendation:
Ol Salt should make the sails. The fixed costs are not relevant to this
decision because they will be incurred regardless of the decision.
b.

Buy Make = Difference

Variable Cost ....... $300,000 $ 250,000 = $ 50,000 Higher
Less Revenue....... 80,000
-0= 80,000 Higher
Net Effect on
Costs................. $220,000 $ 250,000 = $ 30,000 Lower

Yes, it would affect the recommendation in Part a. Ol Salt should buy in

view of the rental opportunity.
Alternative Solutions:
(Simply compare make costs and buy costs. Choose the one with the lower
total costs.)
a.
Variable costs

Make Costs
$ 250,000

Buy Costs
$ 300,000

Decision: Make the sails since the company will save $50,000.

b.
Variable costs
Opportunity cost:
Rent of factory space

Make Costs
$ 250,000

Buy Costs
$ 300,000

80,000
$ 330,000

Decision: Buy the sails since the company will save $30,000.
7.37

Machine Time per Unit .............

Contribution Margin ..................
Contribution Margin per
Machine Hour ......................

Manual
0.4 hr.
$10.00

Electric
2.5 hr.
$16.00

Quartz
5.0 hr.
$22.00

$25.00a

$ 6.40b

$ 4.40c

a $25 = $10/0.4 hours

b $6.40 = $16/2.5 hours
c $4.40 = $22/5 hours
Timepiece Products should drop the Quartz line; it has the smallest
contribution margin per constrained resource.
7.55

Direct Material............................................
Direct Labor
Other variable costs .
Total ...

Variable
Cost per
500 Units
$ 90
80
30
$200

a. No, since the $220 price is higher than the incremental (variable) cost of
$200.
b. The company is indifferent. The $200 price is the same as the
incremental cost of $200.
c. Other alternative profitable uses would make the offer from Alta more
attractive.
7.61

a. Decreased SP, increased volume:

Incremental sales ($3M - $3.15M) .
$ 150,000
Incremental variable costs (500 x $400)
( 200,000)
Decrease in income .. $( 50,000)
b. Special order, no excess capacity:
Incremental revenue:
(500 x $300a) + $50,000 + $75,000b
- var. mfg cost $150,000c .
Lost sales to regular customers
500 x ($1,000 - $400)
Decrease in income ..

$ 125,000

( 300,000)
$( 175,000)

a Total unit variable mfg costs

b Share of Mar mfg costs 500/4,000 = 12.5% x (P200 x 3,000 vol for FC)
c Var mfg cost of $300 x 500 units

c. Special order, idle capacity:

Minimum unit price = ($300,000 var mfg + $75,000 shipping
+ $4,000 mktg) / 1,000 units
= $379
d. The mfg cost of the 200 units will be sunk costs. If these are sold,
the unit price should equal the incurring variable mktg cost of $100/unit.
e. Outsourcing:
Make costs = Var. mfg
$ 300
Opportunity cost:
Var. mktg ($100 x 20%)
20
Fixed mfg ($600k x 30%)/1k
180
Total make costs
$ 500
Decision:
Do not buy since the contractors price of $600 is higher.
f. Outsourcing:
CM from regular sales (2k units):
($1,000 - $400) x 2k $ 1,200,000
CM from low impact bikes:
($1,200 - $800) x 800
320,000
CM from those outsourced:
($1,000 - $80 var mktg) x 1k
920,000
Less: Outsourcing cost .
X
Profit . $ 2,440,000 X
CM from status quo (do not outsource):
($1,000 - $400) x 3k ..

$ 1,800,000

Therefore, X = $2,440,000 - $1,800,000 or $640,000

Unit cost = $640k / 1k = $640/unit maximum price
Decision: Accept the proposed $600 price/unit.
7.63
Case

If the Dry Goods Dept is closed:

Lost gross margin .. $( 62,500)
Savings on:
Payroll, direct labor, supervision ..
16,500
Commissions of sales staff ...
15,000
State taxes ..
1,500
Insurance on inventory ..
2,000
Interest for inventory carrying costs .
2,500
Decrease in profit .. $( 25,000)