HOMEWORK 3 (Total Possible Points: 100)

You MUST show your work!

Problem 1: Special Order (10 points)

Garys Company produces high quality shirts. Shirts must be well made because of frequent washings. Currently, Gary sells 10,000 shirts at $60 each with the capacity to produce 11,000 shirts. Gary is considering a special order for 1,800 shirts at a price of $40. Currently, Gary has the following costs:

Unit Costs	$200,000
Facility Costs	$140,000

If Gary accepts the special order, they will incur an additional $2 per shirt in foreign currency transaction costs. No other product or facility costs will change.

Determine the impact of the special order on Garys operating income.

Problem 2: Make or Buy (10 points)

Bobs Auto manufactures cars and currently uses only 50% of its manufacturing facility to make 30,000 cars per year. Bob could rent the unused portion of its plant and receive $3,000 a month. Alternatively, the company could utilize more of its facility by producing its own tires. It currently purchases tires at $30 per set of four. If Bob produces the tires, it would incur $12 per set for direct materials, $10 for direct labor, and $24 for overhead (30% is avoidable).

Should the company make or buy the tires?

Problem 3: Keep or Drop a Product (20 points total)

Bern, Inc. is considering dropping one product line due to continuing losses. If the product line is discontinued, then Bern could avoid $111,300 per year in fixed costs. Revenue and cost data for the product line for the past year follow:

Sales (20,000 units)	$300,000
Variable costs	180,000
Contribution margin	120,000
Fixed costs	140,000

a. From a purely economic perspective, Bern would be indifferent between discontinuing or continuing the product line at 18,550 units of annual sales. Why? (10 points)

b. Suppose that if the product line were dropped, the production and sale of other products would increase so as to generate a $15,000 increase in the contribution margin received from the other products. If all other conditions are the same (and the fixed cost reduction of $111,300 is still applicable), what is the change in annual operating income from dropping the product line? (10 points)

Problem 4: Keep or Drop a Service (10 points total)

Viena is a regional firm that offers audit, tax, and consulting services. The partners are concerned about the profitability of their audit business, and a closure decision might be forthcoming. If the firm drops the audit activities, it might do more tax work. Only 30 percent of facility costs associated with auditing disappears by dropping the auditing function. More tax work can increase tax revenues by 40 percent, but tax service-level costs also increase by 40 percent. Total facility cost is unchanged whether or not tax work is increased. Segmented income statements for these three product lines follow.

Auditing Tax Consulting

Sales $300,000 $500,000 $600,000

Service-level cost $250,000 $300,000 $350,000

Shared facility cost $50,000 $60,000 $80,000

Operating income (loss) $0 $140,000 $170,000

• Determine which alternative Viena should choose: (1) keep the auditing (2) drop the auditing line without increasing tax work or (3) drop auditing and increase tax work. (10 points)

Problem 5: Direct Method and Step-Down Method (20 points total)

Mike's Battery Company has two service departments, Maintenance and Personnel. Maintenance Department costs of $320,000 are allocated on the basis of budgeted maintenance-hours. Personnel Department costs of $80,000 are allocated based on the number of employees. The costs of operating departments A and B are $160,000 and $240,000, respectively. Data on budgeted maintenance-hours and number of employees are as follows:

	Support Departments	Production Departments
	Maintenance Department	Personnel Department	A	B
Budgeted costs	$320,000	$80,000	$160,000	$240,000
Budgeted maintenance-hours	NA	800	960	640
Number of employees	40	NA	160	480

Using the direct method, what amount of Maintenance Department costs will be allocated to Department B? (10 points)

Using the step-down method, what amount of Maintenance Department cost will be allocated to Department B if the service department with the highest percentage of interdepartmental support service is allocated first? (10 points)

Problem 6: Performance Evaluation (30 points total)

Division A of Gwinnett Company, produces wedges. Division Zs manager has discretion in pricing and other decisions. Division Z is expected to generate a minimum required rate of return of at least 18% on its operating assets. The division has average operating assets of $900,000. The wedges are sold for $8 each. Variable costs are $3 per wedges, and fixed costs total $390,000 per year. The division has a capacity of 120,000 wedges each year.

How many wedges must Division Z sell each year to generate the desired rate of return on its assets? (10 points)

Number of wedges: ___________

• Assume that Division Zs current ROI equals the minimum required rate of 18%. The divisional manager wants to increase the selling price per wedge by 5%. Market studies indicate that an increase in the selling price would cause sales to drop by 15,000 units each year. However, operating assets could be reduced by $65,000 due to decreased needs for accounts receivable and inventory. Compute the new ROI if these changes are made. (10 points)

ROI: __________

• Refer to the original data (i.e. used for question A.). Assume again that the Divisions current ROI equals the required rate of 18%. Rather than increase the selling price, the sales manager want to reduced the selling price by 10%. Market studies indicate that this would fill the plant to capacity. In order to carry the greater level of sales, however, operating assets would increase by $28,000. Compute ROI if these changes are made. (10 points)