7-1. The Muscle-Man Company manufactures forklift tractors, and it supplies some parts to other manufacturers of forklifts. It fabricates most of the component parts but buys the engines, hydraulic systems, wheels, and tires from suppliers. Demand estimates indicate that Muscle- Man should increase its production level from 60 forklift units monthly to 70 units monthly. Sufficient slack exists in most departments to allow this increase, except that production of 10 extra chassis assemblies could be attained only by reallocating labor and equipment from fork- assembly manufacture to chassis-assembly manufacture. The fork-assembly department currently produces 90 units monthly, and it supplies the 30 surplus units to other manufacturers at $188 each. With the expanded production level, 70 forks would be required, but the labor and equipment responsible for the remaining 20 units is thought to be just sufficient to produce the 10 extra chassis assemblies. Alternatively, the extra chassis assemblies could be purchased from a supplier, and the lowest quote is from Fenton Fabricators, for $305 per unit. The costs of the chassis and fork departments for a representative month were as follows:
Costs | DEPARTMENT Chassis Fork | |
Direct materials | $ 4,650 | $ 2,070 |
Direct labor | 6,300 | 4,050 |
Depreciation | 750 | 500 |
Allocated burden of fuel, electricity, office, and other overheads (200% of direct labor) | 12,600 | 8,100 |
Total | $24,300 | $14,720 |
Production level | 60 | 90 |
(a) Should Muscle-Man make or buy the ten extra chassis assemblies?
(b) What qualifications would you add to your decision?
7-2. The Crombie Castings Company produces two products, A and B, for which pertinent data are as follows for the past month:
A | B | |
Sales (units) | 840,000 | 220,000 |
Price per unit ($) | 2.50 | 4.25 |
Materials cost ($) | 386,400 | 105,600 |
Direct labor ($) | 529,200 | 277,200 |
Overheads($) | 567,893 | 297,467 |
CCC’s plant and labor are operating at full capacity, but the company is unable to meet the demand for product A, which is thought to be one million units per month. One way to meet the demand for A would be to reduce the output of product B and to shift resources to the production of A. For each unit reduction in the output of B, the firm could produce two units of A with the labor that is released. Note that average variable costs are constant in both production processes. Alternatively, CCC could contract out to have product A manufactured by another firm in the same industry and sold as if this product were from the CCC plant. Donald, Dodge, and Draper, a firm that holds a minor share of the same markets and has considerable
excess capacity, was approached on this issue. DDD is willing to sign a contract to supply the extra 160,000 units of A at a price of $2.25 per unit.
How should CCC resolve this problem? Support your answer with discussion of the various issues involved.
7-3. Commodore Candies produces a three-pound box of chocolates which it sells at a price of $6.75 to various retail outlets. Commodore’s output capacity for this product is 10,000 units per month with a one-shift operation, but it can produce more using overtime labor, which has a premium of 15 percent over regular labor cost. Variable overhead expenses would be 10 percent higher per unit of output for overtime production. Average variable costs are constant from 8,000 to 10,000 units and are then constant at the higher level. Costs of production for the current months’ output of 8,000 units are as follows:
Total Costs ($) | |
Raw materials | 9,600 |
Direct labor | 17,600 |
Variable overhead | 9,200 |
Fixed overhead | 14,500 |
Today Commodore is faced with a decision problem. A large retail chain has offered to purchase a bulk order of 4,000 units at $6 per unit, to be delivered within thirty days. Should Commodore take this order? Support your answer with discussion of the issues involved. Defend any assumptions that you make.
7-4. The XYZ Company produces and sells a product directly to consumers at a price of $6 per unit. Sales have been increasing at 10 percent per month, and this trend is expected to continue. Average variable costs are expected to remain constant at the current levels. The company’s maximum output capacity is 200,000 with the present investment in plant and equipment. Following is a summary record of the firm’s January production and cost levels:
January | |
Sales (units) | 171,661 |
Materials ($) | 211,143 |
Direct labor ($) | 520,133 |
Indirect factory labor ($) | 110,500 |
Office and administration salaries ($) | 64,000 |
Light and heat ($) | 12,116 |
Other fixed expenses($) | 24,680 |
A national mail-order company has asked XYZ to consider the following deal: 10,000 units of the product, to be ready at the end of February, at the price of $5 per unit.
(a) Should XYZ accept the order from the mail-order company?
(b) What strategy do you suggest?
(c) Support your answer with discussion of the various issues involved.
7-5. A large department store has called for bids for the following contract: A truck plus its driver must be available, given one day’s notice, whenever the store’s own trucks are fully utilized, to deliver goods to suburban households. The number of days for which a truck will be required is twenty, and the number of miles is expected to be 4,000 for the coming year.
You are the manager of the Clark Rent-a-Truck Company and have a number of trucks that you rent out on a day-to-day basis. One truck is a little older than the others, and it is always the last to be rented out because it does less for public relations than the new trucks. In the absence of a contract with the department store, you expect this older truck to be rented out two-thirds of the 300 “rental days” this coming year. Your normal rental charge is $25.00 per day plus $0.35 per mile.
You estimate the costs of operating the older truck to be as follows, assuming 10,000 miles of rental over the coming year:
-A
Depreciation $ 80Q
Interest on investment in truck 360
License fees and taxes 125
Insurance 440
Parking fees (permanently rented space) 300
Gasoline 1,367~2>
Oil, grease, and preventive maintenance 600
-Repairs 1,450
Allocated overheads 1,650
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You can hire a driver on one-day’s notice for $50 per day. A one-time cost of $400 will be involved in fitting the truck with a special loading ramp required by the contract. This ramp will not interfere with the normal use of the truck.
On the basis of this information, and making whatever assumptions you feel are necessary and reasonable, calculate your incremental costs of undertaking this contract.
7-6. Corcoran Calculators Incorporated is one of the leading manufacturers in the electronic calculator industry. Management is now considering plans for the production of the company’s latest development—the minicomputer. The company already manufactures most of the parts, but the design of the new fuse trays would require the additional expenditure of $23,000 for special auxiliary equipment, which has a useful life of only two years and has no scrap value. The marketing department has estimated that sales would require the production of 4,500 fuse trays the first year and 7,000 the following year.
The company has the option of either producing these trays in house or having them supplied by an outside electronics specialist at a cost of $32.50 per tray. Corcoran would incur additional storage and carrying costs associated with this latter alternative of $26,000 during the first year and $40,000 during the following year.
The breakdown of the in-house manufacturing expenses for the 11,500 units is expected to be as follows:
Unit Cost
Labor | $10.00 | |
Raw materials and components | 20.00 | |
Variable overhead | 4.00 | |
Fixed cost | ||
Existing equipment | $3.50 | |
New equipment | 2.00 | 5.50 |
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The company’s opportunity discount rate is 15 percent. The payments to the supplier would be made in a lump sum at the end of each of the two years. If the units were produced in house, there would be a continual outflow of funds as they are produced, although the special equipment would have to be paid for immediately.
(a) Assuming that the increased production will have a negligible effect on the present operation of the plant, what would your recommendation be on the question of making or buying the fuse trays?
(b) State any qualifications you might wish to make.
7-7. The Tico Taco Company has estimated the following total variable cost function from cost and output data pairs observed over the past ten weeks:
TVC = 435.85 - 1.835Q 2 + 3.658Q 3
where TVC represents thousands of dollars and Q represents thousands of boxes of tacos produced. TTC is currently producing 2,000 boxes weekly and is considering expanding its output to 2,200 boxes weekly. To do so, it will have to hire another taco machine operator ($400 per week) and lease another taco machine ($200 per week).
(a) Estimate the incremental costs of the extra 200 boxes weekly.
(b) State all the assumptions and qualifications which underlie your answer to part (a).
7-8. You are the manager of a ski resort. Based on industry projections of this season’s demand, your competitive position, and your estimates of costs, you have set the lift ticket price at $8 per day. Because of the variability of demand between weekdays, weekends, and holidays, you hire labor on the basis of the expected demand for each particular day, based on past years’ records and on current snow conditions. Extra labor is readily available on a day-to-day basis from the pool of local “ski bums.”
You employ one lift attendant for every 250 tickets sold, in addition to a basic staff of four lift attendants. Ski-patrol persons are required at the rate of one for every 400 tickets sold in addition to the two patrol persons who are required regardless of ticket sales volume. All other labor employees connected with the skiing operation are required regardless of sales volume. Lift attendants are hired at the rate of $25 per day plus a free lift ticket to be used subsequently. Ski-patrol persons receive $30 per day plus a free meal in your restaurant that evening.
Your restaurant serves only one standarized meal, an “all you can eat” buffet for $3 per person. Based on expected demand fluctuations, you have hired various people on a full-time and part-time basis for the season. The $3 price represents the average cost of materials and direct labor plus a 50 percent markup to contribute to restaurant overheads and profits. Unexpected fluctuations in demand can be handled, since you keep a large inventory of supplies and can hire temporary labor at short notice. There is, however, an additional $10-per-person cost for this temporary labor, since these people are handled through an employment agency and require transportation to the restaurant. To maintain your standard of meals and service, you hire kitchen staff at the rate of one person for every 45 meals expected to be sold and serving staff at the rate of one person for every 80 meals expected to be sold.
Today you received a phone call from the Students' Association of a nearby University which is asking around various ski resorts for the following deal: Ten busloads of students (500 in total) will come to your resort on Friday of next week if they can get a lift ticket and a meal for $4 per person. Your expected sales for that Friday, before this possibility arose, were 1,500 lift tickets and 900 meals.
Should you give the students the deal they are asking for? Explain your decision and state any possible qualifications to that decision.
7-9. The Wyndham Wool Company is considering two alternative strategies to increase its profitability and net worth. Strategy A is to set up a string of retail outlets for exclusive distribution of Wyndham’s Scottish kilts, sweaters, jackets, blankets, scarves, and so on. Plan B is to wholesale these items to a limited number of high-quality department stores. The probability distribu-
tions of contribution for each strategy are shown in the following table. Wyndham’s cost of capital is 15 percent per annum.
STRATEGY A | STRATEGY B | |||
Contribution ($) | Probability | Contribution ($) | Probability | |
Current period | -600,000 | 1.0 | -100,000 | 1.0 |
200,000 | 0.3 | 50,000 | 0.5 | |
Year 1 | 400,000 | 0.5 | 100,000 | 0.3 |
600,000 | 0.2 | 150,000 | 0.2 | |
400,000 | 0.3 | 100,000 | 0.4 | |
Year 2 | 600,000 | 0.4 | 200,000 | 0.5 |
800,000 | 0.3 | 300,000 | 0.1 |
(a) Calculate the expected present value of the contribution from each of the proposed strategies.
(b) Supposing Wyndham to be risk averse, which strategy would you recommend?
(c) State all the assumptions and qualifications that underlie your recommendation. Is your recommendation especially sensitive to any of these?
7-10. The Yankee Jack Company operates a tourist service business in a New England seaside resort area. Wishing to capitalize on the expanding tourist potential of the region, the firm is considering two alternatives. The first is the creation of a wildlife and animal farm, mostly oriented to children and tourists from the big city, and the second is an amusement park, which would cater more to teenagers and young adults. The probability distributions of contribution for both alternatives are shown below. Yankee Jack has accumulated sufficient funds to finance either venture, and the money is currently earning 9 percent per annum in government treasury bills.
WILDLIFE FARM | AMUSEMENT PARK | |||
Contribution ($) | Probability | Contribution ($) | Probability | |
Current period | -200,000 | 1.0 | -285,000 | 1.0 |
50,000 | 0.1 | 100,000 | 0.3 | |
Year 1 | 100,000 | 0.6 | 150,000 | 0.5 |
150,000 | 0.3 | 200,000 | 0.2 | |
100,000 | 0.2 | 150,000 | 0.3 | |
Year 2 | 200,000 | 0.5 | 300,000 | 0.5 |
300,000 | 0.3 | 450,000 | 0.2 |
(a) Calculate the expected present value of contribution and its standard deviation for each of the two alternatives.
(b) Conduct sensitivity analysis with respect to the opportunity discount rate involved in the calculation above.
(c) Which alternative would you advise Yankee Jack proceed with, and why?
(d) State all assumptions and qualifications that underlie your analysis.
Davidson, S., J. S. Schindler, C. P. Stickney, and R. L. Weil. Managerial Accounting—An Introduction to Concepts, Methods, and Uses, chaps. 4-6. Hinsdale, Ill.: The Dryden Press, 1978.
Greer, H. C. “Anyone for Widgets?” Journal of Accountancy, April 1966. (Despite its title, this paper contains an excellent discussion of relevant and irrelevant costs.)
Harrington, D. H. “Costs and Returns: Economic and Accounting Concepts,” Agricultural Economics Research, 35 (October 1983), pp. 1-8.
Haynes, W. W., and W. R. Henry. Managerial Economics: Analysis and Cases (3rd ed.), chaps. 2 and 5. Dallas, Tex.: Business Publications, 1974.
Horngren, C. T. Cost Accounting: A Managerial Emphasis (5th ed.), chaps. 2 and 3. Englewood Cliffs, N.J.: Prentice-Hall, Inc., 1982.
_. Introduction to Management Accounting (5th ed.), chaps. 2-5. Englewood Cliffs,
N.J.: Prentice-Hall, Inc., 1981.
Pappas, J. L., and E. F. Brigham. Managerial Economics (3rd ed.), chap. 8. Hinsdale, Ill.: The Dryden Press, 1979.
Simon, J. L. Applied Managerial Economics, chaps. 8 and 9. Englewood Cliffs, N.J.: Prentice- Hall, Inc., 1975.
Webb, S. C. Managerial Economics, chap. 5. Boston: Houghton Mifflin, 1976.