THE NATURE OF COSTS - 2-1 © 2014 by McGraw-Hill Education. This is p...

Chapter 02 - The Nature of Costs 2-1 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

CHAPTER 2

THE NATURE OF COSTS

P 2-1: Solution to Darien Industries (CMA adapted) (10 minutes)

[Relevant costs and benefits]

Current cafeteria income Sales $12,000 Variable costs (40% × 12,000) (4,800) Fixed costs (4,700) Operating income $2,500

Vending machine income Sales (12,000 × 1.4) $16,800 Darien's share of sales

(.16 × $16,800) 2,688

Increase in operating income $ 188

P 2-2: Negative Opportunity Costs (10 minutes)

[Opportunity cost]

Yes, when the most valuable alternative to a decision is a net cash outflow that would have occurred is now eliminated. The opportunity cost of that decision is negative (an opportunity benefit). For example, suppose you own a house with an in-ground swimming pool you no longer use or want. To dig up the pool and fill in the hole costs $3,000. You sell the house instead and the new owner wants the pool. By selling the house, you avoid removing the pool and you save $3,000. The decision to sell the house includes an opportunity benefit (a negative opportunity cost) of $3,000.

P 2-3: Solution to NPR (10 minutes)

[Opportunity cost of radio listeners]

The quoted passage ignores the opportunity cost of listeners’ having to forego normal programming for on-air pledges. While such fundraising campaigns may have a low out-of-pocket cost to NPR, if they were to consider the listeners’ opportunity cost, such campaigns may be quite costly.

Accounting for Decision Making and Control 8th Edition Zimmerman Solutions Manual Visit TestBankDeal.com to get complete for all chapters

Chapter 02 - The Nature of Costs 2-2 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

P 2–4: Solution to Silky Smooth Lotions (15 minutes)

[Break even with multiple products]

Given that current production and sales are: 2,000, 4,000, and 1,000 cases of 4, 8, and 12 ounce bottles, construct of lotion bundle to consist of 2 cases of 4 ounce bottles, 4 cases of 8 ounce bottles, and 1 case of 12 ounce bottles. The following table calculates the breakeven number of lotion bundles to break even and hence the number of cases of each of the three products required to break even.

Per Case 4 ounce 8 ounce 12 ounce Bundle Price $36.00 $66.00 $72.00 Variable cost $13.00 $24.50 $27.00 Contribution margin $23.00 $41.50 $45.00 Current production 2000 4000 1000

Cases per bundle 2 4 1

Contribution margin per bundle $46.00 $166.00 $45.00 $257.00

Fixed costs $771,000

Number of bundles to break even 3000

Number of cases to break even 6000 12000 3000

P 2–5: Solution to J. P. Max Department Stores (15 minutes)

[Opportunity cost of retail space]

Home Appliances Televisions Profits after fixed cost allocations $64,000 $82,000 Allocated fixed costs 7,000 8,400 Profits before fixed cost allocations 71,000 90,400 Lease Payments 72,000 86,400 Forgone Profits – $1,000 $ 4,000

We would rent out the Home Appliance department, as lease rental receipts are more than the profits in the Home Appliance Department. On the other hand, profits generated by the Television Department are more than the lease rentals if leased out, so we continue running the TV Department. However, neither is being charged inventory holding costs, which could easily change the decision.Also, one should examine externalities. What kind of merchandise is being sold in the leased store and will this increase or decrease overall traffic and hence sales in the other departments?

Chapter 02 - The Nature of Costs 2-3 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

P 2-6: Solution to Vintage Cellars (15 minutes)

[Average versus marginal cost]

• The following tabulates total, marginal and average cost.

Quantity Average Cost Total Cost Marginal Cost

1 $12,000 $12,000

2 10,000 20,000 $8,000

3 8,600 25,800 5,800

4 7,700 30,800 5,000

5 7,100 35,500 4,700

6 7,100 42,600 7,100

7 7,350 51,450 8,850

8 7,850 62,800 11,350

9 8,600 77,400 14,600

10 9,600 96,000 18,600

• Marginal cost intersects average cost at minimum average cost

(MC=AC=$7,100). Or, at between 5 and 6 units AC = MC = $7,100.

• At four units, the opportunity cost of producing and selling one more unit is

$4,700. At four units, total cost is $30,800. At five units, total cost rises to $35,500. The incremental cost (i.e., the opportunity cost) of producing the fifth unit is $4,700.

• Vintage Cellars maximizes profits ($) by producing and selling seven units.

Quantity Average Cost Total Cost Total Revenue Profit

1 $12,000 $12,000 $9,000 -$3,000

2 10,000 20,000 18,000 -2,000

3 8,600 25,800 27,000 1,200

4 7,700 30,800 36,000 5,200

5 7,100 35,500 45,000 9,500

6 7,100 42,600 54,000 11,400

7 7,350 51,450 63,000 11,550

8 7,850 62,800 72,000 9,200

9 8,600 77,400 81,000 3,600

10 9,600 96,000 90,000 -6,000

P2-7: Solution to ETB (15 minutes)

[Minimizing average cost does not maximize profits]

• The following table calculates that the average cost of the iPad bamboo case is

minimized by producing 4,500 cases per month.

Chapter 02 - The Nature of Costs 2-4 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Monthly Production and Sales Production (units) 3,000 3,500 4,500 5,000 Total cost $162,100 $163,000 $167,500 $195,000

Average cost $54.03 $46.57 $37.22 $39.00

• The following table calculates net income of the four production (sales) levels.

Monthly Production and Sales Production (units) 3,000 3,500 4,500 5,000

Revenue $195,000 $227,500 $292,500 $325,000 Total cost 162,100 163,000 167,500 195,000 Net income $32,900 $64,500 $125,000 $130,000

Based on the above analysis, the profit maximizing production (sales) level is to manufacture and sell 5,000 iPad cases a month. Selecting the output level that minimizes average cost (4,500 cases) does not maximize profits.

P 2-8: Solution to Taylor Chemicals (15 minutes)

[Relation between average, marginal, and total cost]

• Marginal cost is the cost of the next unit. So, producing two cases costs an

additional $400, whereas to go from producing two cases to producing three cases costs an additional $325, and so forth. So, to compute the total cost of producing say five cases you sum the marginal costs of 1, 2, …, 5 cases and add the fixed costs ($500 + $400 + $325 + $275 + $325 + $1000 = $2825). The following table computes average and total cost given fixed cost and marginal cost.