Chapter 11-33 Week 3

Solution to Chapter 11 Problems
11-33 Special Order (15 min)
1. Current Special Order
Revenue per unit $ 45 $ 35
Variable costs per unit: Direct materials $ 9 $ 9 Direct labor $ 8 $ 8 Variable factory overhead $ 4 $ 4 Variable nonmanufacturing costs $ 8 29 $ 4 25 Contribution margin per unit $ 16 $ 10

Contribution margin for 5,000 units $ 80,000 $ 50,000

The difference in favor of continuing with current production and turning down the special order is $30,000 ($80,000 - $50,000).

Note that because Alton, Inc. is at full capacity, the decision whether or not to produce the special order is based
on the comparison of current and special order production. If there were additional capacity, the proper decision would be to accept the special order since it has a positive contribution of $50,000.

The minimum price for the order would be the relevant total variable costs of $25.

2. The minimum price would be $28.20.
At 16,000 units of current output and 20,000 units of capacity, Alton does not have enough capacity to produce the entire order for SHC. Further, the contribution on regular sales ($16) exceeds the contribution on sales to SHC ($10), so Alton should try to reduce or delay 1,000 units of the SHC order to get an order for 4,000 units. Then the special order could be accepted without a loss of regular sales. If SHC insists on the full order of 5,000 units, then Alton must figure the costs of lost sales ($16 x 1,000 = $16,000). This loss is less than the contribution of the special order ($30,000), so the special order would still be accepted at the $35 price. The minimum price would be the total variable cost per unit ($25) plus the per unit cost of lost sales ($3.20 = $16,000/5,000): $25 + $3.20 = $28.20. 11-37 Relevant Cost Problems (5-10 min, each part)

a. Make or Buy
The total costs for producing the product are as follows:

Costs Per Unit: Direct Materials $ 28 Direct Labor 18 Var.
Overhead 16 Total $ 62

($62 x 2,000) = $124,000.
The total cost to purchase the units is $120,000. Saving to purchase $124,000 - $120,000 = $4,000

Since the purchase price is less than the production cost, Terry Inc. should purchase the units. Since there is some urgency to the order Mr. Walters may opt for the alternative which will allow him to deliver the product as quickly as possible. Quality, reliability, and capacity utilization are other considerations.

d. Profit from Processing Further
The main point of this exercise is that joint costs should be ignored (see also coverage of this point in chapter 7). A B C
Addt’l costs of further process $28,000 20,000 12,000
Increase in sales value * 40,000 20,000 10,000
Differential benefit (loss) $12,000 $0 ($2,000)

* $40,000= $280,000-$240,000; $20,000=$120,000-$100,000;
$10,000=$70,000-$60,000

Deaton Corp. Is indifferent about the further processing for B since the net benefit is zero. There would be a positive benefit for further processing of A ($12,000) and a loss from further processing of C ($2,000).

f.
Selection of most Profitable Product Flash Clash
Selling price per unit $250.00 $140.00
Variable cost per unit* 200.00 100.00
Contribution margin per unit $ 50.00 $ 40.00
Relative use of labor hours  2  1 (Clash requires ½ as many as Flash)
Contribution margin per labor hr. $ 25.00 $ 40.00
*$200 = $50+$100+$50; $100 =$25+$50+$25

Since Clash requires ½ the labor time, and since labor capacity is a constraint, and since Clash’s relative contribution per labor hour is greater, as much production as possible should be devoted to Clash. Note that the products have the same per unit profit, but Flash has the higher contribution, and Clash has the higher contribution per labor hour. Thus, Flash would be the most profitable product without a labor constraint, while Clash is the most profitable product with the labor constraint. The measure, operating profit, is not used because it includes the sunk fixed costs.

11-50 Profitability Analysis, Scarce Resources (25 min)

1. When there is no limit on production capacity, the super model should be manufactured since it has the highest contribution margin per
unit.

No Frills Standard Super Model Model Model
Selling Price $30.00 $35.00 $50.00

Direct Materials 9.00 11.00 11.00
Direct Labor ($10/hour) 5.00 10.00 15.00
Variable overhead 3.00 6.00 9.00
Total Variable Cost $17.00 $27.00 $35.00

Contribution Margin $13.00 $8.00 $15.00

2. When labor is in short supply, the No Frills Model should be manufactured since it has the highest contribution margin per direct labor hour. See below. No Frills Standard Super Model Model Model
Contribution Margin $ 13 $8 $15
Labor Hours Required* .5 1 1.5
Contribution Margin/hr. $26.00 $8.00 $10 *Labor cost is $10 per hour, and unit labor costs for the three products are $5, $10 and $15, respectively.
11-50 (continued -1)

Note: As an additional in-class assignment, the class can be asked to determine the best product mix when machine time rather than labor is the limited resource. Since fixed overhead is applied on the basis of machine hours, and fixed overhead per unit is given, it is possible to determine the relative proportion of machine time in each product. Since the fixed overhead in No Frills is $3 and in the Standard model is $6, we can infer that there is twice the amount of machine time in Standard as in No Frills. Similarly, there is twice the amount of machine time in the Super model relative to No Frills. The contribution per (relative) machine hour is again greatest for the No Frills model, as follows:

Contribution Relative Machine Hours Contribution/ Rel. Hour
No Frills $13.00 1 $13.00
Standard 8.00 2 4.00
Super 15.00 2 7.50