CHAPTER 12 TACTICAL DECISION MAKING

QUESTIONS FOR WRITING AND DISCUSSION

1. A tactical decision is short-run in nature; it involves choosing among alternatives with an immediate or limited end in view. A strategic decision involves selecting strategies that yield a long-term competitive advantage. 2. Depreciation is an allocation of a sunk cost. This cost is a past cost and will never differ across alternatives. 3. The salary of a supervisor in an accept or reject decision is an example of an irrelevant future cost. 4. If one alternative is to be judged superior to another alternative on the basis of cash-flow comparisons, then cash flows must be expressed as an annual amount (or periodic amount); otherwise, consideration must be given to the time value of the nonperiodic cash flows. 5. Disagree. Qualitative factors also have an important bearing on the decision and may, at times, overrule the quantitative evidence from a relevant costing analysis. 6. The purchase of equipment needed to produce a special order is an example of a fixed cost that is relevant. 7. Relevant costs are those costs that differ across alternatives. Differential costs are the differences between the costs of two alternatives. 8. Depreciation is a relevant cost whenever it is a future cost that differs across alternatives. Thus, it must involve a capital asset not yet acquired. 9. Past costs can be used as information to help predict future costs. 10. Yes. Suppose, for example, that sufficient materials are on hand for producing a part for two years. After two years, the part will be replaced by a newly engineered part. If there is no alternative use of the materials, then the cost of the materials is a sunk cost and not relevant in a make-or-buy decision. 19. 11. Complementary effects may make it more expensive to drop a product, as the dropped product has a negative impact on other products. A manager can identify alternatives by using his or her own knowledge and experience and by obtaining input from others who are familiar with the problem. No. Joint costs are irrelevant. They occur regardless of whether the product is sold at the split-off point or processed further. Yes. The incremental revenue is $1,400, and the incremental cost is only $1,000, creating a net benefit of $400. Regardless of how many units are produced, fixed costs remain the same. Thus, fixed costs do not change as product mix changes. No. If a scarce resource is used in producing the two products, then the product providing the greatest contribution per unit of scarce resource should be selected. For more than one scarce resource, linear programming may be used to select the optimal mix. If a firm is operating below capacity, then a price that is above variable costs will increase profits. A firm may sell a product below cost as a loss leader, hoping that many customers will purchase additional items with greater contribution margins. Grocery stores often use this strategy. Different prices can be quoted to customers in markets not normally served, to noncompeting customers, and in a competitive bidding setting. Linear programming is used to select the optimal product mix whenever there are multiple constrained scarce resources. An objective function is the one to be maximized (or minimized) subject to a set of constraints. A constraint restricts the possible values of variables appearing in the objective function. Usually, a constraint is con-

12.

13.

14.

15.

16.

17.

18.

20.

391

cerned with a scarce resource. A constraint set is the collection of all constraints for a given problem. 21. A feasible solution is a solution to a linear programming problem that satisfies the problems constraints. The feasible set of solutions is the collection of all feasible solutions.

22.

To solve a linear programming problem graphically, use the following four steps: (1) graph each constraint, (2) identify the feasible set of solutions, (3) identify all corner points in the feasible set, and (4) select the corner point that yields the optimal value for the objective function. Typically, when a linear programming problem has more than two or three products, the simplex method must be used.

392

EXERCISES 121
The correct order is: D, E, B, F, C, A.

122
Situation Flexible Resource A Forms & supplies Committed Resource Short Term Purchasing agents Telephone/internet fees Office equipment Paper supplies Advertising Lawn mower oil Committed Resource Multiple Periods

B C

Counter staff Food Utilities Substitute help Gasoline

Building and parking lot lease Power mower Weed eater Pickup truck

123
1. The two alternatives are to make the component in house or to buy it from the outside supplier. Alternatives Make Buy $ 2.95 0.40 1.80 $6.50 $ 5.15 $6.50 Differential Cost to Make $ 2.95 0.40 1.80 (6.50) $ (1.35)

2. Direct materials Direct labor Variable overhead Purchase cost Total relevant cost

Chesbrough should make the component in house because operating income will decrease by $27,000 ($1.35 20,000) if it is purchased from Berham Electronics.

393

124
1. Direct materials Direct labor Variable overhead Avoidable fixed overhead Purchase cost Total relevant cost 2. Alternatives Make Buy $ 2.95 0.40 1.80 1.85 $6.50 $6.50 $ 7.00 Differential Cost to Make $ 2.95 0.40 1.80 1.85 (6.50) $ (0.50)

Chesbrough should purchase the component from Berham Electronics because operating income will increase by $10,000 ($0.50 20,000).

125
1. Sales revenue Less: Variable expenses Contribution margin Less: Direct fixed expenses Segment margin Less: Common fixed expenses Operating income 2. Regulars $135,000 50,000 $85,000 3,000 $82,000 Seasonals $15,000 8,600 $6,400 1,200 $5,200 Total $150,000 58,600 $91,400 4,200 $ 87,200 60,000 $ 27,200

Dropping the seasonals line will reduce operating income by $5,200.

394

126
1. If Product C is dropped, profit will decrease by $15,000 since the avoidable direct fixed costs are only $55,000 ($80,000 $25,000). Depreciation is not relevant. A new income statement, assuming that C is dropped and demand for B decreases by 10 percent, is given below (amounts are in thousands). Sales revenue Less: Variable expenses Contribution margin Less: Direct fixed expenses Segment margin Less: Common fixed expenses Operating income A $1,800 1,350 $450 150 $300 B $1,440 900 $ 540 300 $ 240 Total $3,240 2,250 $990 450 $ 540 340 $ 200

2.

Operating income will decrease by $50,000 ($250,000 $200,000).

127
1. Direct materials Direct labor Variable overhead Relevant cost per unit $ 8.00 10.00 4.00 $22.00

Yes, Thomson should accept the special order, because operating income will increase by $68,000 [($24 $22) 34,000].

395

127
2.

Concluded

Additional revenue ($24 34,000) $816,000 Less: Direct materials ($8 34,000) 272,000 Direct labor ($10 34,000) 340,000 Variable overhead ($4 34,000) 136,000 Contribution margin $68,000 Additional packing cost ($6,000 7)* 42,000 Increase in income $26,000 * 34,000/5,000 = 6.8, which is rounded up to 7 to reflect the lumpy nature of the packing capacity (since additional capacity is purchased in 5,000 unit increments) Yes, the special order should be accepted because income will increase by $26,000.

128
1. Direct materials Direct labor Variable overhead Sales commission Relevant cost per unit $ 9.00 6.50 2.00 1.75 $19.25

No, Melton should not accept the special order, because operating income will decrease by $8,750 [($19.25 $18) 7,000]. 2. Direct materials Direct labor Variable overhead Relevant cost per unit $ 9.00 6.50 2.00 $17.50

Yes, Melton should accept the special order, because operating income will increase by $3,500 [($18.00 $17.50) 7,000].

396

129
1. Sales Costs Operating profit $ 293,000 264,000 $ 29,000 Sell $40,000 0 $40,000 Process Further $73,700 23,900 $49,800 Difference $33,700 23,900 $ 9,800

2. Revenues Further processing cost Operating income

The company should process Delta further, because operating profit would increase by $9,800 if it were processed further. (Note: Joint costs are irrelevant to this decision, because the company will incur them whether or not Delta is processed further.)

1210
1. 2. Contribution margin Pounds of material Contribution margin/pound ($30 2,000) + ($60 4,000) = $300,000 Juno $30 2 $15 Hera $60 5 $12

Norton should make the 2,000 units of Juno, then make Hera. 2,000 units of Juno 2 = 4,000 pounds 16,000 pounds 4,000 pounds = 12,000 pounds for Hera Hera production = 12,000/5 = 2,400 units Product mix is 2,000 Juno and 2,400 Hera. Total contribution margin = $204,000 = (2,000 $30) + (2,400 $60)

397

1211
1. Price Variable cost Contribution margin Machine hours Contribution margin/MHr. Basic $ 9.00 6.00 $ 3.00 0.10 $30.00 Standard $30.00 20.00 $10.00 0.50 $20.00 Deluxe $35.00 10.00 $25.00 0.75 $33.33

The company should sell only the deluxe unit with contribution margin per machine hour of $33.33. Sealing can produce 20,000 (15,000/0.75) deluxe units per year. These 20,000 units, multiplied by the $25 contribution margin per unit, would yield total contribution margin of $500,000. 2. Produce and sell 12,000 deluxe units, which would use 9,000 machine hours. Then, produce and sell 50,000 basic units, which would use 5,000 machine hours. Then produce and sell 2,000 standard units, which would use the remaining 1,000 machine hours. Total contribution margin = ($25 12,000) + ($3 50,000) + ($10 2,000) = $470,000

1212
1. COGS + Markup(COGS) = Sales $144,300 + Markup($144,300) = $206,349 Markup($144,300) = $206,349 $144,300 Markup = $62,049/$144,300 Markup = 0.43, or 43% Direct materials Direct labor Overhead Total cost Add: Markup Initial bid $ 800 1,600 3,200 $ 5,600 2,408 $ 8,008

2.

398

1213
1. COGS + Markup(COGS) = Sales $1,000,000 + Markup($1,000,000) = $1,250,000 Markup($1,000,000) = $1,250,000 $1,000,000 Markup = $250,000/$1,000,000 Markup = 0.25, or 25% Price = $43,000 + (0.25 $43,000) = $53,750

2.

1214
1. Contribution margin Hours on lathe Contribution margin/hours on lathe Model A-4 $24 6 $ 4 Model M-3 $ 15 3 $ 5

Model M-3 has the higher contribution margin per hour of drilling machine use, so all 12,000 hours should be spent producing it. If that is done, 4,000 (12,000 hours/3 hours per unit) units of Model M-3 should be produced. Zero units of Model A-4 should be produced. 2. If only 2,500 units of Model M-3 can be sold, then 2,500 units should be produced. This will take 7,500 hours of drilling machine time. The remaining 4,500 hours should be spent producing 750 (4,500/6) units of Model A-4.

399

1215
1. Contribution margin Hours on lathe Contribution margin/hours on lathe Model 14-D $ 12 4 $ 3 Model 33-P $ 10 2 $ 5

Model 33-P has the higher contribution margin per hour of lathe use, so all 12,000 hours should be spent producing it. If that is done, 6,000 (12,000 hours/2 hours per unit) units of Model 33-P should be produced. Zero units of Model 14-D should be produced. 2. If only 5,000 units of Model 33-P can be sold, then 5,000 units should be produced. This will take 10,000 hours of lathe time. The remaining 2,000 hours should be spent producing 500 (2,000/4) units of Model 14-D.

1216
1. Let X = Number of Model 14-D produced Let Y = Number of Model 33-P produced Maximize Z = $12X + $10Y (objective function) 4X + 2Y 12,000 (lathe constraint) X 2,000 (demand constraint) Y 5,000 (demand constraint) X0 Y0

400

1216 Continued
2. Y 6,000 5,000 4,000 3,000 2,000 1,000 A 0 1,000 E 2,000 X 3,000 4,000 5,000 C

Solution: The corner points are points A, B, C, D, and E. The point of intersection of the linear constraints is obtained by solving the two equations simultaneously. Corner Point A B C D E X-Value 0 0 500 2,000 2,000 Y-Value 0 5,000 5,000 2,000 0 Z = $12X + $10Y $ 0 50,000 56,000 44,000 24,000

*The intersection values for X and Y can be found by solving the simultaneous equations:

401

1216 Concluded
Corner Point C: Y 4X + 2Y 4X + 2(5,000) 4X X = 5,000 = 12,000 = 12,000 = 2,000 = 500

Z = $12(500) + $10(5,000) = $56,000 Corner Point D: X 4X + 2Y 4(2,000) + 2Y 2Y Y = 2,000 = 12,000 = 12,000 = 4,000 = 2,000

Z = $12(2,000) + $10(2,000) = $44,000 Optimal solution is Point C, where X = 500 units and Y = 5,000 units. 3. At the optimal level, the contribution margin is $56,000.

1217
1. Let X = Number of Product A produced Let Y = Number of Product B produced Maximize Z = $30X + $60Y (objective function) 2X + 5Y 6,000 (direct material constraint) 3X + 2Y 6,000 (direct labor constraint) X 1,000 Y 2,000 X0 Y0

402

1217 Concluded
2. Y

3,000

2,000

1,000 D C A 0 B 1,000 2,000 3,000 X

Solution: The corner points are the origin, the points where X = 0, Y = 0, and where two linear constraints intersect. The point of intersection of the two linear constraints is obtained by solving the two equations simultaneously. Corner Point A B C D X-Value 0 1,000 1,000 0 Y-Value 0 0 800 1,200 Z = $30X + $60Y $ 0 30,000 78,000* 72,000

*The values for X and Y are found by solving the simultaneous equations: X = 1,000 2X + 5Y = 6,000 2(1,000) + 5Y = 6,000 Y = 800 Z = $30(1,000) + $60(800) = $78,000 Optimal solution: X = 1,000 units and Y = 800 units 3. At the optimal level, the contribution margin is $78,000.

403

1218 1. The amounts Heath has spent on purchasing and improving the Silverado are irrelevant because these are sunk costs. Alternatives Restore Silverado Buy Dodge Ram $2,400 400 1,700 $(9,400) 12,300 $4,500 $ 2,900

2. Cost Item Transmission Water pump Master cylinder Sell Silverado Cost of new car Total

Heath should sell the Silverado and buy the Dodge Ram because it provides a net savings of $1,600. Note: Heath should consider the qualitative factors. If he restored the Silverado, how much longer would it last? What about increased license fees and insurance on the newer car? Could he remove the stereo and put it in the Dodge Ram without decreasing the Silverados resale value by much?

1219
1. Direct materials Direct labor Variable overhead Fixed overhead Purchase cost Total relevant costs Make $360,000 120,000 100,000 88,000 $668,000 Buy $640,000 ($16 40,000) $640,000

Sherwood should purchase the part. 2. 3. Maximum price = $668,000/40,000 = $16.70 per unit Income would increase by $28,000 ($668,000 $640,000).

404

1220
1. Direct materials Direct labor Variable overhead Purchase cost Total relevant costs Make $360,000 120,000 100,000 $580,000 Buy $640,000 ($16 40,000) $640,000

Sherwood should continue manufacturing the part. 2. Maximum price = $580,000/40,000 = $14.50 per unit 3. Income would decrease by $60,000 ($640,000 $580,000).

405

PROBLEMS 1221
Steps in Austins decision: Step 1: Define the problem. The problem is whether to continue studying at his present university, or to study at a university with a nationally recognized engineering program. Identify the alternatives. Events A and B. (Students may want to include event Ipossible study for a graduate degree. However, future events indicate that Austin still defined his problem as in Step 1 above.) Identify costs and benefits associated with each feasible alternative. Events C, E, F, and I. (Students may also list E and F in Step 5they are included here because they may help Austin estimate future income benefits.) Total relevant costs and benefits for each feasible alternative. No specific event is listed for this step, although we can intuit that it was done, and that three schools were selected as feasible since event J mentions that two of three applications met with success. Assess qualitative factors. Events D, E, F, G, and H. Make the decision. Event J is certainly relevant to this. (What did Austin ultimately decide? He decided that a qualitative factor, his possible future with his long-time girl friend was most important and stayed at his current school. After graduation, he was hired by a major aeronautical engineering firm. By the way, he and his girl friend broke up shortly after his decision to stay was made. )

Step 2:

Step 3:

Step 4:

Step 5: Step 6:

406

1222
1. Cost Item Direct materialsa Direct laborb Variable overheadc Fixed overheadd Purchase coste Total
a

Make $372,000 102,600 30,400 58,000 $563,000

Buy $550,000 $550,000

($80 3,000) + ($165 800) $27 3,800 c $8 3,800 d $26,000 + $32,000 e ($130 3,000) + ($200 800)
b

Net savings by purchasing: $13,000. Powell should purchase the crowns rather than make them. 2. Qualitative factors that Powell should consider include quality of crowns, reliability and promptness of producer, and reduction of workforce. It reduces the cost of making the crowns to 531,000, which is less than the cost of buying. (563,000 32,000) Cost Item Direct materials Direct labor Variable overhead Fixed overhead Purchase cost Total Make $419,000 124,200 36,800 58,000 $638,000 Buy $640,000 $640,000

3.

4.

Powell should produce its own crowns if demand increases to this level because the fixed overhead is spread over more units.

407

1223 1. @ 600 lbs. Revenuesa Bagsb Shippingc Grindingd Bottlese Total

a b

Process Further $30,000 (408) (1,500) (3,000) $25,092

Sell $9,000 (39) (90) $8,871

Difference $21,000 39 (318) (1,500) (3,000) $16,221

600 10 $5 = $30,000; $15 600 = $9,000 $1.30 (600/20) c [(10 600)/25] $1.70 = $408; $0.15 600 = $90 d $2.50 600 e 10 600 $0.50 Primack should process rhinime further. 2. $16,221/600 = $27.035 additional income per pound $27.035 265,000 = $7,164,275

1224
1. Sales Less: Variable expenses Contribution margin Less: Direct fixed costs* Segment margin (loss) Less: Common fixed costs Operating income System A $45,000 20,000 $25,000 526 $24,474 System B $ 32,500 25,500 $ 7,000 11,158 $ (4,158) Headset $8,000 3,200 $4,800 1,016 $3,784 Total $ 85,500 48,700 $ 36,800 12,700 $ 24,100 18,000 $ 6,100

*$45,000/$85,500 $18,000 = $9,474; $10,000 $9,474 = $526 $32,500/$85,500 $18,000 = $6,842; $18,000 $6,842 = $11,158 $8,000/$85,500 $18,000 = $1,684; $2,700 $1,684 = $1,016

408

1224 Concluded
2. Sales Less: Variable expenses Contribution margin Less: Direct fixed costs Segment margin Less: Common fixed costs Operating income System B should be dropped. 3. Sales Less: Variable expenses Contribution margin Less: Direct fixed costs Segment margin Less: Common fixed costs Operating income System A $45,000 20,000 $25,000 526 $24,474 System C $ 26,000 13,000 $ 13,000 11,158 $ 1,842 Headset $7,200 2,880 $4,320 1,016 $3,304 Total $78,200 35,880 $42,320 12,700 $29,620 18,000 $11,620 System A $58,500 26,000 $32,500 526 $31,974 Headset $6,000 2,400 $3,600 1,016 $2,584 Total $64,500 28,400 $36,100 1,542 $34,558 18,000 $16,558

Replacing B with C is better than keeping B, but not as good as dropping B without replacement with C.

409

1225
1. Steve should consider selling the part for $1.85 because his divisions profits would increase by $12,800: Accept Reject Revenues (2 $1.85 8,000) $29,600 $0 Variable expenses 16,800 0 Total $12,800 $0 Pats divisional profits would increase by $18,400: Revenues ($32 8,000) Variable expenses: Direct materials ($17 8,000) Direct labor ($7 8,000) Variable overhead ($2 8,000) Component (2 $1.85 8,000) Total relevant benefits 2. Accept $ 256,000 (136,000) (56,000) (16,000) (29,600) $ 18,400 Reject $0 0 0 0 0 $0

Pat should accept the $2 price. This price will increase the cost of the component from $29,600 to $32,000 (2 $2 8,000) and yield an incremental benefit of $16,000 ($18,400 $2,400). Steves division will see an increase in profit of $15,200 (8,000 units 2 components per unit $0.95 contribution margin per component).

3.

Yes. At full price, the total cost of the component is $36,800 (2 $2.30 8,000), an increase of $7,200 (= 2 8,000 0.45) over the original offer. This still leaves an increase in profits of $11,200 ($18,400 $7,200). (See the answer to Requirement 1.)

410

1226
1. Salesa Less: Variable expensesb Contribution margin Less: Direct fixed expensesc Divisional margin Less: Common fixed expensesc Operating (loss)
a

$ 3,751,500 2,004,900 $ 1,746,600 1,518,250 $ 228,350 299,250 $ (70,900)

Based on sales of 41,000 units Let X = Units sold $83X/2 + $100X/2 = $3,751,500 $183X = $7,503,000 X = 41,000 units $83/1.25 = $66.40 20.00 $46.40 5.00 $51.40 Manufacturing cost Fixed overhead Per internal unit variable cost Selling Per external unit variable cost

Variable costs = ($46.40 20,500) + ($51.40 20,500) = $2,004,900

c

Fixed selling and admin: $1,100,000 $5(20,500) = $997,500 Direct fixed selling and admin: 0.7 $997,500 = $698,250 Direct fixed overhead: $20 41,000 = $820,000 Total direct fixed expenses = $698,250 + $820,000 = $1,518,250 Common fixed expenses = 0.3 $997,500 = $299,250 Keep $ 3,751,500 (2,004,900) (1,518,250) $ 228,350 Drop $ (2,050,000)* 100,000 $(1,950,000)

2. Sales Variable costs Direct fixed expenses Annuity Total

*$100 20,500 (The units transferred internally must be purchased externally.) The company should keep the division.

411

1227
1. Napkins: CM/machine hour = ($2.50 $1.50)/1 = $1.00 Tissues: CM/machine hour = ($3.00 $2.25)/0.5 = $1.50 Tissues provide the greatest contribution per machine hour, so the company should produce 400,000 packages of tissues (200,000 machine hours times 2 packages per hour) and zero napkins. 2. Let X = Boxes of napkins; Y = Boxes of tissues a. Z = $1.00X + $0.75Y (objective function) X + 0.5Y 200,000 (machine constraint) X 150,000 (demand constraint) Y 300,000 (demand constraint) X 0 Y 0

412

1227 Concluded
b. and c. (in thousands) Y

400 300 200 100 A 0 Corner Point A B C* D* E *Point C: X = 150,000 X + 0.5Y = 200,000 150,000 + 0.5Y = 200,000 Y = 100,000 B 100 X-Value 0 150,000 150,000 50,000 0 200 300 Y-Value 0 0 100,000 300,000 300,000 Point D: Y = 300,000 X + 0.5Y = 200,000 X + 0.5(300,000) = 200,000 X = 50,000 400 Z = $1.00X + $0.75Y 0 150,000 225,000 275,000* 225,000 C X D E

The optimal mix is D: 50,000 packages of napkins and 300,000 boxes of tissues. The maximum profit is $275,000.

413

1228
1. Product 401 (500 units): Labor hoursa Machine hoursb Product 402 (400 units): Labor hoursc Machine hoursd Product 403 (1,000 units): Labor hourse Machine hoursf Total labor hours Total machine hours
a

Dept. 1 1,000 500 400 400 2,000 2,000 3,400 2,900

d e

Dept. 2 1,500 500 800 400 2,000 2,000 4,300 2,900

Dept. 3 1,500 1,000 2,000 1,000 3,500 2,000

Total 4,000 2,000 1,200 800 6,000 5,000 11,200 7,800

2 500; 3 500; 3 500 b 1 500; 1 500; 2 500 c 1 400; 2 400

1 400; 1 400 2 1,000; 2 1,000; 2 1,000 f 2 1,000; 2 1,000; 1 1,000

The demand can be met in all departments except for Department 3. Production requires 3,500 labor hours in Department 3, but only 2,750 hours are available.

414

1228 Continued
2. Product 401: CM/unit = $196 $103 = $93 CM/DLH = $93/3 = $31 CM/unit = $123 $73 = $50 Requires no hours in Department 3. CM/unit = $167 $97 = $70 CM/DLH = $70/2 = $35

Direct labor hours needed (Dept. 3): 3 500 = 1,500 Product 402: Product 403:

Direct labor hours needed (Dept. 3): 2 1,000 = 2,000 Production should be equal to demand for Product 403 because it has the highest contribution margin per unit of scarce resource. After meeting demand, any additional labor hours in Department 3 should be used to produce Product 401 (2,750 2,000 = 750; 750/3 = 250 units of 401). Contribution to profits: Product 401: 250 $93 = Product 402: 400 $50 = Product 403: 1,000 $70 = Total contribution margin 3. $ 23,250 20,000 70,000 $113,250

Let X = Number of Product 401 produced Let W = Number of Product 402 produced = 400 units Let Y = Number of Product 403 produced Max. Z = $93X + $70Y + $50(400) (objective function) 2X + Y 1,500 (machine constraint) 3X + 2Y 2,750 (labor constraint) X 500 (demand constraint) Y 1,000 (demand constraint) X0 Y0

415

1228 Concluded
Corner Point A B C D E X 0 500 500 250 0 Y 0 0 500 1,000 1,000 W 400 400 400 400 400 Z = $93X + $70Y + $50W $ 20,000 66,500 101,500 113,250* 90,000

*The optimum output is: Product 401: 250 units Product 402: 400 units Product 403: 1,000 units At this output, the contribution to profits is $113,250. Y

1,500

1,000

D E

500

A 0

B 500 1,000

416

1229
1. Cost Item Purchase cost Variable manufacturing costs Lease Supervisor salary Total relevant costs *$7 2,000 Purchase cost Variable manufacturing costs Lost contribution margin Total relevant costs Drop B and Make $14,000 34,000 $48,000 Lease and Make $14,000* 27,000 10,000 $51,000 Buy $50,000 $50,000

Note: The $38,000 of direct fixed expenses is the same across all alternatives. The most favorable alternative is to drop B and make the subassembly. 2. Analysis with complementary effect: Lost sales for A Cost of making componentb Reduction of other variable costsc Lost contribution margin for B Cost to purchased Total relevant costs
a b a

Make $ 9,000 13,160 (1,800) 34,000 $54,360

Buy $50,000 $50,000

0.06 $150,000 0.94 2,000 $7.00 c 0.06($80,000 $50,000); since sales decrease by 6 percent if the component is manufactured, the other variable costs (those other than the cost of the component) will decrease proportionately. d If the buy alternative is chosen, there is no reduction in sales and the same number of components will be needed. The correct decision now is to keep B and buy the component.

417

1229 Concluded
3. Variable manufacturing costs Lease Supervisor salary Purchase cost Total relevant costs
a b

Lease and Make $19,600a 27,000 10,000 $56,600

Buy $70,000b $70,000

$7 2,800 $25 2,800

Drop B and Make Lost sales from A $ 9,000 18,424 Variable cost of manufacturinga Reduction of other variable costsb (600) Loss in contribution margin for B 34,000 Purchase cost Total relevant costs $60,824
a b

0.94 2,800 $7.00 0.06 ($80,000 $70,000)

The correct decision now is to lease and make the component.

418

1230
1. To maximize the companys profitability, Sportway should purchase 9,000 tackle boxes from Maple Products, manufacture 17,500 skateboards, and manufacture 1,000 tackle boxes. This combination of purchased and manufactured goods maximizes the contribution per direct labor hour, as calculated below. Unit contribution: Purchased Tackle Boxes $86.00 (68.00) (4.00) $14.00 none none Manufactured Tackle Boxes Skateboards $ 86.00 $ 45.00 (17.00) (18.75) (6.25) (11.00) $ 33.00 1.25 $ 26.40 (12.50) (7.50) (2.50) (3.00) $ 19.50 0.50 $ 39.00

Selling price Less: Direct material Direct labor Variable overheada Mktg. and admin.b Contribution margin DLH/unit Contribution margin/hour
a

Variable overhead per unit

Tackle boxes: Direct labor hours = $18.75/$15.00 = 1.25 hours Overhead/DLH = $12.50/1.25 = $10.00 Capacity = 8,000 boxes 1.25 = 10,000 hours Total overhead = 10,000 hours $10 = $100,000 Total variable overhead = $100,000 $50,000 = $50,000 Variable overhead per hour = $50,000/10,000 = $5.00 Variable overhead per box = $5.00 1.25 = $6.25 Skateboards: Direct labor hours = $7.50/$15.00 = 0.5 hour Variable overhead per skateboard = $5.00 0.5 = $2.50
b

$6 of selling and administrative costs are fixed.

419

1230 Concluded
Optimal Use of Sportways Available Direct Labor Unit DLH Quantity Contrib. per Unit Item Total hours 10,000 Skateboards 17,500 $19.50 0.50 Make boxes 1,000 33.00 1.25 Buy boxes 9,000 14.00 Total CM Less: Contribution margin from manufacturing 8,000 boxes (8,000 $33) Improvement in CM 2. Total DLH 8,750 1,250 Balance of DLH 1,250 Total Contrib. $341,250 33,000 126,000 $500,250 264,000 $236,250

Some qualitative factors to be considered include quality and reliability of vendor, quality of market data for skateboards, and problems in switching from tackle boxes to skateboards in the Plastics Department.

420

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1. Pamela should not have told Roger about the deliberations concerning the Power Department. She is obligated by Standard II-1 to keep information confidential except when disclosure is authorized or legally required. She had been explicitly told to keep the details quiet but deliberately informed the head of the unit affected by the potential decision. By revealing the information, Pamela also initiated an activity that would prejudice her ability to carry out her duties ethically (III-2). 2. The romantic relationship between Pamela and Roger sets up a conflict of interest for this particular decision, and Pamela should have withdrawn from any active role in it. However, she should definitely provide the information she currently has about the cost of eliminating the Power Department. This is required by standard IV-2, which states that all relevant information that could reasonably be expected to influence an intended users understanding should be disclosed. Moreover, she has the obligation to communicate information fairly and objectively (IV-1). These ethical requirements, however, do not in any way prevent Pamela from discussing the qualitative effects of eliminating the Power Department. The effects on workers, community relations, reliability of external service, and any ethical commitments the company may have to its workers should all enter into the decision. If I were Pamela, I would communicate the short-term quantitative effects and express my concerns about the qualitative factors. I might also project what the costs of operating internally would be for the next five years and compare that with estimates of the costs of external acquisition.

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MEMO TO: Central University President DATE: November 15, 2008 SUBJECT: Decentralization of Continuing Education In recommending whether to centralize or decentralize continuing education (CE), I have first focused on the economic implications. The income statements, showing a favorable trend for CE, are misleading, at least in terms of their implications for centralization. Tuition revenues will be present whether we centralize or decentralize and, therefore, are not relevant to the decision. Department heads are already heavily involved in scheduling and staffing off-campus and evening courses, and individual faculty are largely responsible for generating our noncredit offerings. Thus, it would be difficult to argue that decentralizing CE would have any adverse impact on the level of tuition revenues. In a similar vein, one can argue that the operating costs for evening and noncredit courses and the direct costs for off-campus offerings are also irrelevant. These costs, which consist of instructional wages, rental of facilities, and supplies, will be incurred regardless of whether CE is centralized or decentralized. This leaves two categories of costs, indirect costs and administration, which affect the decision. These categories include advertising, secretaries, assistants, and other support personnel. If we choose to decentralize, all of these costs, with the exception of the directors salary and advertising, can be avoided. Furthermore, because the director will be teaching in her department, some of her salary is avoidable as well ($20,000). The total avoidable costs are outlined as follows. Administrationa Indirectb Total
a b

$ 82,000 410,000 $492,000

[$112,000 ($50,000 $20,000)] = $82,000 Indirect costs Advertising = $440,000 $30,000

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I have retained the budget for advertising and would recommend that this amount be allocated to the individual colleges in proportion to the evening and offcampus revenues generated by each college. As you can see, the savings from decentralization are significant. This presumes, of course, that the overhead of the individual units will not increase because of the added responsibilities. I have discussed this matter with my department heads and with the deans of the other colleges. They all seem to feel that the additional administrative work can be easily absorbed by their existing staff. Thus, it seems that the promised savings are real. In choosing to decentralize, however, we do lose some intangible benefits. First, we no longer have one individual who can be contacted by outside parties. Instead, we have numerous individuals involved. This may prove to be frustrating for some of those whom we serve, and it is possible that they will perceive a drop in service quality. There is also a risk that some units will not exert the effort needed to provide good service. Accountability is more diffuse, and some department heads may feel that they have more than enough to do without continuing education. This problem can be alleviated to some extent by localizing the CE responsibility at the college level, rather than at the departmental level. I am personally convinced that a decentralized CE will work as well, if not better, than our current arrangement. Given our current budgetary crisis, I would rather risk reducing the quality of service for CE than risk reducing the quality of service for our main programs. Therefore, I strongly recommend that CE be decentralized and that the savings from this action be used to maintain the quality of our oncampus programs.

RESEARCH ASSIGNMENTS 1233

Answers will vary.

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Answers will vary.

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