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ACT 5140 ? Accounting for Decision Makers

HW #6 ? Chapter 4

Directions: Answer all 4 questions. Please submit your work in Word or PDF formats only. You can submit an Excel file to support calculations, but please ?cut and paste? your solutions into the Word or PDF file. Be sure to show how you did your calculations. Also, please be sure to include your name at the top of the first page of your file. The assignment is due by 11:59 PM on October 7, 2016. Please run spell check and proofread your answers.

Question #1

Consider the following information, prepared based on a monthly capacity of 500,000 units:

Category	Cost per Unit
Variable manufacturing costs	$21
Fixed manufacturing costs	$4
Variable selling costs	$5
Fixed selling costs	$3

Capacity cannot be added in the short run and the firm currently sells the product for $43 per unit.

The company is currently producing 440,000 units per month. A potential customer has contacted the firm and offered to purchase 50,000 units this month only. The customer is willing to pay $36 per unit. Since the potential customer approached the firm, there will be no variable selling costs incurred. Should the company accept the special order? Why or why not? Be specific.

b) Assume the same facts as in part a, except that the company is producing 500,000 units per month. Should the company accept the special order? Why or why not? Be specific.

c) List and describe other factors (not those addressed in parts a and b) that should be taken into consideration when deciding whether to accept a special order? Be specific in your responses.

Question #2

Consider the following information, prepared based on monthly production and sales of 100,000 units:

Category	Cost per Unit
Variable manufacturing costs	$45.00
Variable marketing costs	$12.00

The firm has total fixed costs of $3,000,000 and currently sells the product for $120 per unit.

Assume the company is producing and selling 100,000 units per month. It is considering an arrangement where an outside manufacturer would produce and ship the product directly to customers. Under this arrangement, variable marketing costs would decrease 70% per unit and $2,100,000 in fixed costs would be avoided. What is the maximum amount per unit the company would be willing to pay to the outside manufacturer?

List and describe other factors that should be taken into consideration when deciding whether to accept this offer. Be specific in your responses.

Question #3

A consulting company performs a ?basic? market analysis for a client. It incurs costs of $100,000 in performing the analysis and plans to sell the report to the client for $250,000. After reviewing the initial report, the client asks the firm if it is willing to do a more extensive report. The client offers to pay $450,000 for a more extensive report. If the more extensive report is done, the client will NOT pay the $250,000. If the consulting firm estimates it will require $210,000 in additional expenses to complete the more extensive report, should it agree to do the more extensive report? Why or Why not? Be specific in your response.

Question #4

Assume an engineering company provides services for three types of clients. Each service requires a different amount of a specific form of specialized labor that is in limited supply. If the company is limited to 12,000 hours of this specialized labor, how many clients of each type should it accept in order to maximize operating income?

Client Type	A	B	C
Revenue per client	$1,700	$3,800	$5,300
Variable costs per client	$800	$1,400	$2,700
Specialized labor hours required per client	6	15	20
Maximum clients available	800	600	200

ACT 5140 - Accounting for Decision Makers HW #6 - Chapter 4 Directions: Answer all 4 questions. Please submit your work in Word or PDF formats only. You can submit an Excel file to support calculations, but please \"cut and paste\" your solutions into the Word or PDF file. Be sure to show how you did your calculations. Also, please be sure to include your name at the top of the first page of your file. The assignment is due by 11:59 PM on October 7, 2016. Please run spell check and proofread your answers. Question #1 Consider the following information, prepared based on a monthly capacity of 500,000 units: Category Variable manufacturing costs Fixed manufacturing costs Variable selling costs Fixed selling costs Cost per Unit $21 $4 $5 $3 Capacity cannot be added in the short run and the firm currently sells the product for $43 per unit. a) The company is currently producing 440,000 units per month. A potential customer has contacted the firm and offered to purchase 50,000 units this month only. The customer is willing to pay $36 per unit. Since the potential customer approached the firm, there will be no variable selling costs incurred. Should the company accept the special order? Why or why not? Be specific. b) Assume the same facts as in part a, except that the company is producing 500,000 units per month. Should the company accept the special order? Why or why not? Be specific. c) List and describe other factors (not those addressed in parts a and b) that should be taken into consideration when deciding whether to accept a special order? Be specific in your responses. Question #2 Consider the following information, prepared based on monthly production and sales of 100,000 units: Category Variable manufacturing costs Variable marketing costs Cost per Unit $45.00 $12.00 The firm has total fixed costs of $3,000,000 and currently sells the product for $120 per unit. a) Assume the company is producing and selling 100,000 units per month. It is considering an arrangement where an outside manufacturer would produce and ship the product directly to customers. Under this arrangement, variable marketing costs would decrease 70% per unit and $2,100,000 in fixed costs would be avoided. What is the maximum amount per unit the company would be willing to pay to the outside manufacturer? b) List and describe other factors that should be taken into consideration when deciding whether to accept this offer. Be specific in your responses. Question #3 A consulting company performs a \"basic\" market analysis for a client. It incurs costs of $100,000 in performing the analysis and plans to sell the report to the client for $250,000. After reviewing the initial report, the client asks the firm if it is willing to do a more extensive report. The client offers to pay $450,000 for a more extensive report. If the more extensive report is done, the client will NOT pay the $250,000. If the consulting firm estimates it will require $210,000 in additional expenses to complete the more extensive report, should it agree to do the more extensive report? Why or Why not? Be specific in your response. Question #4 Assume an engineering company provides services for three types of clients. Each service requires a different amount of a specific form of specialized labor that is in limited supply. If the company is limited to 12,000 hours of this specialized labor, how many clients of each type should it accept in order to maximize operating income? Client Type Revenue per client Variable costs per client Specialized labor hours required per client Maximum clients available A B C $1,700 $3,800 $5,300 $800 $1,400 $2,700 6 15 20 800 600 200 ACT 5140 - Accounting for Decision Makers HW #6 (Chapter 4) KEY Question #1 Consider the following information, prepared based on a monthly capacity of 80,000 units: Category Variable manufacturing costs Fixed manufacturing costs Variable selling costs Fixed selling costs Cost per Unit $24 $5 $4 $1 Capacity cannot be added in the month and the firm currently sells the product for $40 per unit. Consider each of these scenarios independent of each other. a) The company is currently producing 72,000 units per month. A potential customer has contacted the firm and offered to purchase 8,000 units this month only. The customer is willing to pay $33 per unit. Since the potential customer approached the firm, there will be no variable selling costs incurred. Should the company accept the special order? Why or why not? Be specific. The order should be accepted. Only the variable manufacturing costs are relevant, so relevant costs are $24 per unit. Relevant revenue is $33 per unit. As a result, the order will increase operating income by $9 per unit, or $72,000. Units sold Revenue Variable manufacturing Variable selling Contribution margin Fixed manufacturing Fixed selling Operating Income Without Order 72,000 $2,880,000 $1,728,000 $288,000 $864,000 $400,000 $80,000 $384,000 With Order 80,000 $3,144,000 $1,920,000 $288,000 $936,000 $400,000 $80,000 $456,000 Incremental 8,000 $264,000 $192,000 $0 $72,000 $0 $0 $72,000 b) Assume the same facts as in part a, except that the company is producing 80,000 units per month. Should the company accept the special order? Why or why not? Be specific. The order should not be accepted. Because the company is producing at full capacity, the only way to accept the order is to give up some existing sales. This results in an opportunity cost of $7 per unit (lost revenue from selling at $33 instead of $40). Although there is a cost savings of $4 per unit on the special order, the net result is a reduction in income of $3 per unit, or $24,000. Units sold Revenue Variable manufacturing Variable selling Contribution margin Fixed manufacturing Fixed selling Operating Income Without Order 80,000 $3,200,000 $1,920,000 $320,000 $960,000 $400,000 $80,000 $480,000 With Order 80,000 $3,144,000 $1,920,000 $288,000 $936,000 $400,000 $80,000 $456,000 Incremental 0 -$56,000 $0 -$32,000 -$24,000 $0 $0 -$24,000 c) List and describe other factors (not those addressed in parts a and b) that should be taken into consideration when deciding whether to accept a special order? Be specific in your responses. Is there a possibility of future sales from the customer? Will current customers object to being charged a higher price? Will current customers object to being denied sales so that special order can be filled (part b) Question #2 Consider the following information, prepared based on monthly production and sales of 50,000 units: Category Variable manufacturing costs Variable marketing costs Cost per Unit $8.00 $3.00 The firm has total fixed costs of $250,000 and currently sells the product for $15 per unit. a) Assume the company is producing and selling 50,000 units per month. It is considering an arrangement where an outside manufacturer would produce and ship the product directly to customers. Under this arrangement, variable marketing costs would decrease 40% per unit and $80,000 in fixed costs would be avoided. What is the maximum amount per unit the company would be willing to pay to the outside manufacturer? The maximum price is $10.80, as this is the amount \"avoided\" by out-sourcing the product. Costs avoided if outsource Variable manufacturing costs Variable marketing costs Avoidable fixed costs (per unit) Total savings per unit $8.00 $1.20 $1.60 $10.80 PROOF Variable manufacturing costs Variable marketing costs Total fixed costs Purchase price ($10.80 per unit) Total Costs Make $400,000 $150,000 $250,000 $0 $800,000 Outsource $0 $90,000 $170,000 $540,000 $800,000 b) List and describe other factors that should be taken into consideration when deciding whether to accept this offer. Be specific in your responses. Quality requirements - Can the vendor provide the quality level we need? Loss of control - We are giving the vendor control over the product & service delivered Morale - If we lay people off, how will remaining employees feel about the firm? Ethics - Is it ethical to lay people off? Competitive issues - Will we need to share proprietary information with the vendor? Stability of the price - How long will the vendor keep the price at the current level? Stability of the vendor - Will the vendor still be in business in two years? Question #3 A consulting company performs a \"basic\" market analysis for a client. It incurs costs of $15,000 in performing the analysis and plans to sell the report to the client for $33,000. After reviewing the initial report, the client asks the firm if it is willing to do a more extensive report. The client offers to pay $65,000 for a more extensive report. If the more extensive report is done, the client will NOT pay the $33,000. If the consulting firm estimates it will require $22,000 in additional expenses to complete the more extensive report, should it agree to do the more extensive report? Why or Why not? Be specific in your response. Yes. The incremental revenue from doing the more extensive report is $32,000 while the incremental costs are only $22,000. This increases income by $10,000. The $15,000 is not relevant as it cannot be changed based on the decision made (it is a sunk cost). See below for a proof of this. Revenue Initial cost Additional cost Income Basic Report $33,000 $15,000 $0 $18,000 Extensive Report $65,000 $15,000 $22,000 $28,000 Incremental $32,000 $0 $22,000 $10,000 Question #4 Assume an engineering company provides services for three types of clients. Each service requires a different amount of a specific form of specialized labor that is in limited supply. If the company is limited to 14,000 hours of this specialized labor, how many clients of each type should it accept in order to maximize operating income? Client Type Revenue per client Variable costs per client A B C $1,600 $4,500 $2,400 $600 $1,800 $1,000 8 25 10 700 400 500 Specialized labor hours required per client Maximum clients available Client Type Revenue per client Variable costs per client Specialized labor hours required per client Maximum clients available A $1,600 $600 8 700 B $4,500 $1,800 25 400 C $2,400 $1,000 10 500 CM per client CM per specialized hour of labor Order of emphasis $1,000 $125.00 2nd $2,700 $108.00 3rd $1,400 $140.00 1st Labor hours used on C Labor hours used on A Labor hours used on B 5,000 5,600 3,400 Maximum hours available 14,000 (500 clients) (700 clients) (136 clients)