MADM Session 2

PROBLEM 14-43 (25 MINUTES)
1.
Yes, the order should be accepted because it generates a profit of $34,050 for the firm. Note:
The fixed administrative cost is irrelevant to the decision, because this cost will be incurred
regardless of whether Jupiter accepts or rejects the order.
Selling price
Less: Direct material ($8.20 - $2.10).
Direct labor..
Variable manufacturing overhead
(.5 hours x $7.50*)..
Unit contribution margin.
Total contribution margin (11,000 units x $3.65)..
Less: Additional setup costs
Special device.
Net contribution to profit.
$15.75
$6.10
2.25
3.75
12.10
$ 3.65
$40,150
$3,700
2,400
6,100
$34,050
* Fixed manufacturing overhead: $750,000 60,000

machine hours = $12.50 per hour
Variable manufacturing overhead: $20.00 - $12.50 = $7.50
2.
3.
No, Jupiter lacks adequate machine capacity to manufacture the entire order.
Planned machine hours (5,000 hours x 3 months)
Current usage (15,000 hours x 70%)..
Available hours
15,000
10,500
4,500
Required machine hours (11,000 units x .5 hours)
5,500
Options include the following:

Sacrificing some current business in the hope that a long-term relationship with Venus can
be established and proves to be profitable
Acquiring more machine capacity
Outsourcing some units
Working overtime
PROBLEM 14-44 (25 MINUTES)

1.
Per-unit contribution margins:

Basic
Selling price...
Less: Variable costs:
Direct material.
Direct labor..
Variable manufacturing overhead
Sales commission
$250 x 10%; $330 x 10%.
Total unit variable cost
Unit contribution margin
Enhanced
$250
$330
$28
15
24
$45
20
32
25
33
92
$158
130
$200
2.
The following costs are not relevant to the decision:

Development costssunk
Fixed manufacturing overheadwill be incurred regardless of which product is selected
Sales salariesidentical for both products
Market studysunk
3.
Johnson and Gomez, Inc. expects to sell 10,000 Basic units (40,000 units x 25%) or 8,000
Enhanced units (40,000 units x 20%). On the basis of this sales forecast, the company would be
advised to select the Basic model.
Total contribution margin:

10,000 units x $158; 8,000 units x $200.
Less: Marketing and advertising
Income...
4.
Basic
Enhanced
$1,580,000
130,000
$1,450,000
$1,600,000
200,000
$1,400,000
The quantitative difference between the profitability of Basic and Enhanced is relatively small,
which may prompt the firm to look at other factors before a final decision is made. These
factors include:
Competitive products in the marketplace
Data validity
Growth potential of the Basic and Enhanced models
Production feasibility
Effects, if any, on existing product sales
Break-even points
Problem 14-47 (20 minutes)

The analysis prepared by the engineering, manufacturing, and accounting departments of CTR was not
correct. However, their recommendation was correct, provided that potential labor-cost improvements
are ignored. An incremental cost analysis similar to the following table should have been prepared to
determine whether the pump should be purchased or manufactured. In the following analysis, fixed
factory overhead costs and general and administrative overhead costs have not been included because
they are not relevant; these costs would not increase, because no additional equipment, space, or
supervision would be required if the pumps were manufactured. Therefore, if potential labor cost
improvements are ignored, CTR should purchase the pumps because the purchase price of $68.00 is less
than the $72.00 relevant cost to manufacture.
Incremental cost analysis:
Purchased components ..................................................................

Assembly labor ................................................................................
Variable manufacturing overhead ..................................................
Total relevant cost.........................................................................
Cost of
10,000 Unit
Assembly Run Per Unit
$120,000
$12.00
300,000
30.00
300,000
30.00
$720,000
$72.00

1.
The incremental cost of producing one unit of component B81 is computed as

follows:
Direct material ..............................................................................................
Direct labor ...................................................................................................
Variable overhead ........................................................................................
Total variable cost per unit .........................................................................
$ 3.75
4.50
2.25
$10.50
Purchase price quoted for component B81 ...............................................

Incremental cost of production per unit ....................................................
Net loss per unit if purchased .....................................................................
$13.50
10.50
$ 3.00
Net loss per machine hour if component B81 is purchased = $3.00/3 machine hours =
$1.00 per machine hour.
2.
T79
B81
Purchase price quoted ................................................................................

$11.25
$13.50
Direct material ..............................................................................................

$ 2.25
Direct labor ...................................................................................................
4.00
$ 3.75
4.50
Variable overhead ........................................................................................

2.00
Total variable cost .......................................................................................
$ 8.25
2.25
$10.50
Net benefit per unit of making component ................................................

$ 3.00
$ 3.00
Machine hours required per unit .............................................................

2.5
Net benefit per machine hour of making component ...............................
$ 1.20
3
$ 1.00
Machine hours available .....................................................................

Best use of machine time: produce 8,000 units of component T79
(8,000 2.5 hrs. per unit) ..................................................................
Machine hours remaining for production of component B81 ..........
41,000 hours
Machine hours required per unit of component B81 .....................

Feasible production of component B81: (21,000/3) .........................
3 hrs. per unit

7,000 units
Required quantity of component B81 ................................................

Feasible production of component B81 .............................................
Quantity of component B81 to be purchased ....................................
11,000 units
7,000 units
4,000 units
20,000 hours
21,000 hours
Conclusion: purchase 4,000 units of component B81 and manufacture the remaining
bearings. Answer to requirement (2): d
3.
Variable cost per unit of component B81 ..................................................

Traceable, avoidable, fixed cost per unit of
component B81 ($44,000/11,000 units) ....................................................
Maximum price Upstate Mechanical should pay for component B81 ......
$10.50
4.00
$14.50

1.
Sell to
Kaytell
Convert
as
to
Special
Standard
Order
Model
Sales price ........................................................................
$68,400
$62,500
Less cash discount .........................................................
-
1,250
Net price ...........................................................................
$68,400
$61,250
Additional manufacturing costs
Direct material ..............................................................
$ 6,200
$ 2,850
Direct labor ...................................................................
4,200
3,300
Sell as
Special
Order
as Is
$52,000
$52,000
$
Variable manufacturing overhead ...............................

2,100
1,650
Total additional manufacturing costs ............................
$12,500
$ 7,800
Commissions ...................................................................
2,052
1,250
Total costs and expenses ...............................................
$14,552
9,050
Net contribution ..................................................................
$53,848
$52,200
$
1,560
1,560
$50,440
2.
Contribution from sale to Kaytell .......................................
Contribution from next best alternative:
sell as standard model ......................................................
Difference in contribution ...................................................
Percentage of sales price received net of
commission on special order: 100% 3% ......................
Acceptable reduction in sales price from Kaytell =
$53,848
52,200
$ 1,648
97%
$1,648
= $1,699 (rounded)
.97
Original price quote to Kaytell ...........................................

Acceptable reduction ..........................................................
Minimum acceptable price from Kaytell ............................
Proof: Suppose Kaytell pays a price of $66,701:
Sales price ........................................................................
Less: Sales commission (3%) .........................................
Less: Additional manufacturing costs ...........................
Contribution with reduced price to Kaytell ....................
$68,400
1,699
$66,701
$66,701
2,001 (rounded)
$64,700
12,500
$52,200
Therefore, at a price of $66,701 to Kaytell, Miami Industries management would be

indifferent between selling the machine to Kaytell and converting it to a standard
model. At any price quote from Kaytell below $66,701, Miami Industries management
would prefer to convert the machine to a standard model.
3.
Fixed manufacturing overhead should have no influence on the sales price quoted
by Miami Industries for special orders. Management should accept special orders
whenever the firm is operating substantially below capacity, including below the
breakeven point, whenever the marginal revenue from the order exceeds the
marginal cost. Normally, this would mean that the order should be accepted as long
as the sales price of the order exceeds the variable production costs. The special
order will result in a positive contribution toward fixed costs. The fixed
manufacturing overhead is not considered in pricing because it will be incurred
whether the order is accepted or not.

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PROBLEM 14-43 (25 MINUTES)

* Fixed manufacturing overhead: $750,000 60,000

Required machine hours (11,000 units x .5 hours)

Options include the following:

PROBLEM 14-44 (25 MINUTES)

Per-unit contribution margins:

The following costs are not relevant to the decision:

Total contribution margin:

Problem 14-47 (20 minutes)

Purchased components ..................................................................

Problem 14-51 (40 minutes)

The incremental cost of producing one unit of component B81 is computed as

Purchase price quoted for component B81 ...............................................

Purchase price quoted ................................................................................

Direct material ..............................................................................................

Variable overhead ........................................................................................

Net benefit per unit of making component ................................................

Machine hours required per unit .............................................................

Machine hours available .....................................................................

Machine hours required per unit of component B81 .....................

3 hrs. per unit

Required quantity of component B81 ................................................

Variable cost per unit of component B81 ..................................................

Problem 14-53 (45 minutes)

Variable manufacturing overhead ...............................

Original price quote to Kaytell ...........................................

Therefore, at a price of $66,701 to Kaytell, Miami Industries management would be

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