Week 10 Exercises

Question 1
Make sure you can answer these questions:

1. Three major influences on pricing decisions and how it influences the price.
2. 4 purposes of cost allocation
3. Describe two alternative approaches to long-run pricing decisions.
1. Market-based pricing,
2. Cost-based pricing
4. Find 2 examples of value-added cost & nonvalue-added cost
answer these questions:

Nelayan boat currently sells motor boats for $60,000. It has costs of $46,500. A competitor is
bringing a new motor boat to the market that will sell for $55,000. Management believes it must
lower the price to $55,000 to compete in the market for motor boats. The marketing department
believes that the new price will cause sales to increase by 12.5%, even with a new competitor in the
market. Nelayan boat's sales are currently 2,000 motor boats per year. 3
Required:
a. What is the target cost for the new target price if target operating income is 20% of sales?
b. What is the change in operating income if marketing department is correct and only the sales price is
changed?
c. What is the target cost if the company wants to maintain its same income level, and
marketing department is correct?
Question 2
The Magill Repair Shop repairs and services machine tools. A summary of its costs (by activity) for
2017 is as follows:
a. Materials and labor for servicing machine tools $1,100,000

b. Rework costs 90,000
c. Expediting costs caused by work delays 65,000
d. Materials-handling costs 80,000
e. Materials-procurement and inspection costs 45,000
f. Preventive maintenance of equipment 55,000
g. Breakdown maintenance of equipment 75,000
Required:
1. Classify each cost as value-added, non-value-added, or in the gray area between.
2. For any cost classified in the gray area, assume 60% is value-added and 40% is non-value-
added. How much of the total of all seven costs is value-added and how much is non-value-
added?
3. Magill is considering the following changes:
a) introducing quality-improvement programs whose net effect will be to reduce rework and
expediting costs by 40% and materials and labor costs for servicing machine tools by 5%;
b) working with suppliers to reduce materials-procurement and inspection costs by 20% and
materials-handling costs by 30%; and
c) increasing preventive-maintenance costs by 70% to reduce breakdown-maintenance costs by
50%. Calculate the effect of programs (a), (b), and (c) on value-added costs, non-value-
added costs, and total costs. Comment briefly.
Question 3
GLOBAL co. prepares architectural drawings to conform to local structural-safety codes. Its
income statement for 2017 is as follows:
Revenues $701,250
Salaries of professional staff (7,500 hours × $52 per hour) 390,000
Travel 15,000
Administrative and support costs 171,600
Total costs 576,600
Operating income $124,650
The percentage of time spent by professional staff on various activities follows:
Making calculations and preparing drawings for clients 77%

Checking calculations and drawings 3
Correcting errors found in drawings (not billed to clients) 8
Making changes in response to client requests (billed to clients) 5
Correcting own errors regarding building codes (not billed to clients) 7
Total 100%
Assume administrative and support costs vary with professional-labor costs. Consider each
requirement independently.
Required:
1. How much of the total costs in 2017 are value-added, non-value-added, or in the gray area
between? Explain your answers briefly. What actions can Global take to reduce its costs?
2. What are the consequences of misclassifying a non-value-added cost as a value-added cost?
When in doubt, would you classify a cost as a value-added or non-value-added cost? Explain
briefly.
3. Suppose Global could eliminate all errors so that it did not need to spend any time making
corrections and, as a result, could proportionately reduce professional-labor costs. Calculate
Global’s operating income for 2017.
4. Now suppose Global could take on as much business as it could complete, but it could not add
more professional staff. Assume Global could eliminate all errors so that it does not need to
spend any time correcting errors. Assume Global could use the time saved to increase revenues
proportionately. Assume travel costs will remain at $15,000. Calculate Global’s operating
income for 2017.

Week 10 Exercises

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Week 10 Exercises

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Question 1

Make sure you can answer these questions:

answer these questions:

a. Materials and labor for servicing machine tools $1,100,000

The percentage of time spent by professional staff on various activities follows:

Making calculations and preparing drawings for clients 77%

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