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Chapter4Fundamentals of Cost Analysis for DecisionMakingSolutions to Review Questions4-1.Costs that are “fixed in the short run” are usually not fixed in the long run. In fact few, if any, costs are fixed over a very long time horizon.4-2.A sunk cost has taken place in the past and cannot be changed...

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Chapter 04 - Fundamentals of Cost Analysis for Decision Making

4 C h a p t e r Fundament al sofCostAnal ysi sf orDeci si on Maki ng

Sol ut i onst oRevi ew Quest i ons 41. Cos t st hatar e“ fi x edi nt hes hor tr un”ar eusual l ynotfix edi nt hel ongr un.I nf actf ew,i f any ,cos t sar efix edov erav er yl ongt i mehor i z on. 42. As unkcos thast ak enpl acei nt hepastandcannotbec hanged.Adi ffer ent i al costi s onet hatwi l l changewi t hagi v endeci si on. 43. St r i ct l yspeaki ng,s unkcos t scannev erbedi ffer ent i al cos t s.Howev er ,s unkcost scan det er mi net heamount sofcer t ai ndi ffer ent i al cost s .Forex ampl e,f eder al i ncomet ax es ar ebasedonhi st or i cal ( sunk )cost s .Thedi spos al ofafix edassetmayr es ul ti nat ax bas edont hedi ffer encebet weent hesal espr oceedsandt heundepr ec i at edsunkcos t . Manycont r act sar ebasedonsunkcost saswel l .Deci s i onsmayhav econt r act i mpl i cat i onst hatar i sewi t hchangesi npl ans. 44. Shor t r undeci si onsaffectoper at i onswi t hi noney ear( f orex ampl e,t hedeci si ont o acceptaspeci al or der ) .Longr undec i si onsaffectoper at i onsf orgr eat ert hanoney ear ( f orex ampl e,ex pansi onofpl antc apac i t y) . 45. Thef ul lcos tofapr oducti st hesum ofal l fix edandv ar i abl ecost sofmanuf act ur i ngand s el l i ngauni t .Ful l costi snotal waysappr opr i at ef ormaki ngdec i si ons —especi al l yshor t r undeci si ons .Fi x edcos t sar eof t eni r r el ev antf orshor t r undec i si ons( i . e. ,fix edcos t s of t enr emai nunc hangedf r om t hest at usquot ot heal t er nat i v e) . 46. Thepr oduc tl i f ec y cl ecov er st het i mef r om i ni t i al r esear chanddev el opmentt ot het i me atwhi chs uppor tt ot hecus t omeri swi t hdr awn.Manager sest i mat er ev enuesandcos t s t hr oughoutt hepr oduct ’ sl i f ecy c l et omak epr i c i ngdeci si ons .Li f ecy c l ecost si ncl udenot 4-1 © 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 04 - Fundamentals of Cost Analysis for Decision Making

onl yt hecos t sofdev el opmentandpr oduct i on,butal sot hecost sofmai nt enanc eand di spos al . 47. Cos t pl uspr i ci ngi smostl i k el yt obeus edf oruni quepr oduct swher enomar k etpr i ce i nf or mat i onexi s t s—ar easl i k econs t r uct i onj obs ,def ens econt r act s ,andcust om or der s . 48. Tar getcosti st het ar getpr i cemi nuss omedesi r edpr ofi tmar gi n.Tar getpr i cei sapr i ce s etbymanagementbas edoncus t omer s ’ per cei v edv al uef ort hepr oductandt hepr i c e compet i t or sc har ge.Ther ear ef ourst epst odev el opi ngt ar getpr i cesandt ar getcos t s : 1.Dev el opapr oductt hatsat i s fiest heneedsofpot ent i al c ust omer s . 2.Chooseat ar getpr i cebasedoncons umer s ’ per cei v edv al ueoft hepr oductand compet i t or ’ spr i ces . 3.Der i v eat ar getcos tbys ubt r act i ngt hedes i r edpr ofitmar gi nf r om t het ar getpr i ce. 4.Per f or mv al ueengi neer i ngt oachi ev et ar getcost s. 49. Pr edat or ypr i c i ngi st hepr act i ceofaset t i ngas el l i ngpr i ceatal owpr i cewi t ht hei nt ent ofdr i v i ngcompet i t or soutoft hemar k etorofcr eat i ngabar r i ert oent r yf ornew compet i t or s . Pr edat or ypr i c i ngi si l l egal i nmanyj ur i s di ct i onsbec ause,al t hought her emi ghtbea s hor t t er m benefi tt ocons umer s ,ascompet i t or sar edr i v enoutoft hemar k et ,t hefir m pr act i ci ngpr edat or ypr i ci ngi sabl et oactasamonopl ol y . 410. Dumpi ngi st hepr ac t i c eofexpor t i ngpr oduc t st ocons umer si nanot hercount r yatan expor tpr i cebel owt hedomest i cpr i ce.Acostaccount antwoul dhel pdet er mi net hecos t oft hepr oductandt hecost sofexpor t i ngv er susdi st r i but i ngt hepr oductdomest i cal l y . 411. Pr i cedi s cr i mi nat i oni st hepr act i ceofs el l i ngi dent i cal goodsors er vi cest odi ffer ent c ust omer satdi ffer entpr i ces.Acostaccount antwoul dhel pdet er mi net hecos t sof pr ovi di ngt hepr oductt odi ffer entcus t omer s .Ex ampl esofcost st hatmi ghtdi fferwoul d besuppor tcos t s( f orex ampl e,f ors of t war e)ordi st r i but i oncost s( f orex ampl e,f orur ban v er susr ur al cons umer s) .

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Chapter 04 - Fundamentals of Cost Analysis for Decision Making

412. Uni tgr ossmar gi nsar et ypi cal l ycomput edwi t hanal l ocat i onoffix edcost s .Tot alfix ed cos t sgener al l ywi l l notchangewi t hac hangei nv ol umewi t hi nt her el ev antr ange. Uni t i z i ngt hefix edc ost sr es ul t si nt r eat i ngt hem ast hought heyar ev ar i abl ecos t swhen, i nf act ,t heyar enot .Mor eov er ,whenmul t i pl epr oduct sar emanuf act ur ed,t her el at i v e cont r i but i onbec omest hec r i t er i onf ors el ect i ngt heopt i mal pr oductmi x .Fi x edcost s al l ocat i onsc andi st or tt her el at i v econt r i but i onsandr es ul ti nas ubopt i maldec i si on. 413. Thecompanyshoul dcomput et hecont r i but i onmar gi nofeac hpr oductperuni toft he const r ai ni ngr esour ce.I tshoul dr ankt hepr oduct sf r om hi ghes tt ol owes tcont r i but i on mar gi nperuni tofconst r ai ni ngr es our ce,t henpr oducet hepr oduct si nor deroft hi s v al ue. 414. Pr oduc t i oncons t r ai nt smeant hatmanager shav et ocons i dert heoppor t uni t ycostof us i ngpr oduct i onr esour ces .Pr oduci ngoneuni tofPr oductAmeanst hatl es sofPr oduct Bc anbepr oduced.Thel os tcont r i but i onf r om sel l i ngPr oductBi sanoppor t uni t ycostof pr oduc i ngPr oductA.Theopt i mal pr oductmi xi st heonet hatmax i mi z est het ot al cont r i but i onmar gi nf r om al l pr oduct ss ubj ectt ot heconst r ai nt s. 415. Commonnonfinanc i al cons i der at i onst hatar ei mpor t anti ndec i di ngt odr opapr oduct l i nei ncl udet heeffectonempl oy eest hatwor kont hatl i ne,t hei mpactonsal esofot her pr oduct si fi ti si mpor t antt obeknownasacompanyt hatcanpr oducet hepr oduct dr opped,t heeffec tont hecommuni t yf r om poss i bl epl antc l osi ngs,andsoon. 416. Thet heor yofcons t r ai nt sf oc usesont hes et hr eef act or s: 1.Thr oughputcont r i but i on:Sal esdol l ar smi nusdi r ectmat er i al sandot herv ar i abl e cos t s. 2.I nv est ment s:I nv ent or i es ,equi pment ,bui l di ngs ,andot herass et sus edt ogener at e t hr oughputcont r i but i on. 3.Oper at i ngcost s :Al l oper at i ngcost sot hert handi r ectmat er i al sandot herv ar i abl e cos t s.

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Chapter 04 - Fundamentals of Cost Analysis for Decision Making

Sol ut i onst oCr i t i calAnal ysi sandDi scussi onQuest i ons 417. Themai ndi ffer ent i alc ost sar et her entandt headdi t i onal commi ssi on.St affsal ar i es andt heot herc ost sofpr ov i di ngmor t gageswoul dnotbedi ffer ent i al . 418. Ther emai ni ngl easecost sar esunk( as sumi ngt hecompanycannots ubl ett hespace) , s ot heyar enotr el ev antt ot hedec i si on. 419. Al t hought hev ar i abl ecos tofapass engeri sv er yl ow,ai r l i nesdonotus ual l ypr i ce l i t er al l yatv ar i abl ecost ,ev enatt hel astmi nut e.Oner easoni st hatt hi swoul dl eadal l pas senger st ot r yt hi sappr oac h.Theacc ount i ngs y st em doesnotr ecor dt hi st ypeof cos t . 420. Becaus et het el ephonesar eobs ol et e,t henewpr i cemi ghtr efl ectt hev al ueconsumer s pl aceont hem.I ti sunl i k el yt hatt hel owpr i ceonobsol et eequi pmentwi l ldr i v e compet i t or sf r om t hemar k et .Thi si snotpr edat or ypr i c i ng. 421. Thi si spr i cedi s cr i mi nat i on.Theai r l i nesar eabl et osegmentcus t omer swhoar emor e s ensi t i v et ot hes chedul eort oknowi ngt r av el pl ansi nadv ance. 422. Fr om t hear t i c l ei ti snotcl earwhatgo! ’ scost sact ual l yar e,soi ti snotposs i bl et osay whet herornott hi swaspr edat or ypr i ci ng.I ti sal s onotcl earwhatt hei nt entoft he pr i ci ngpl ani s . 423. Var i abl ecost sar eus ual l yr el ev antwhent al ki ngaboutchangesi npr oduct i onv ol umes. Howev er ,i ft hec hangei npr oduct i onv ol umeex t endsbey ondt he“ r el ev antr ange, ”some fi x edcos t smayal sobedi ffer ent i al .I naddi t i on,t her ear eoppor t uni t ycost st hatmaybe di ffer ent i al f oracer t ai ndec i si on.I nsomecasest her emaybenochangei nv ar i abl e cos t s.Forex ampl e,i facompanywer et oaddasecondcopi eri nt heofficewor kr oom t o expedi t ecopyi ng,t henumberofcopi espr oducedwoul dbeunchanged,butt hefix ed cos t soft heequi pmentwoul dappr oxi mat el ydoubl e.

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Chapter 04 - Fundamentals of Cost Analysis for Decision Making

424. I nt heshor tr un,sal esr ev enuesneedonl ycov ert hedi ffer ent i al cost sofpr oduct i onand s al e.So,f r om ashor t r unper s pect i v e,s ol ongast hes al edoesnotaffectot herout put pr i cesornor mal sal esv ol ume,a“ bel owcost ”sal emayr esul ti naneti nc r easei n i nc omesol ongast her ev enuescov ert hedi ffer ent i alcos t s .Howev er ,i nt hel ongr unal l cos t smustbecov er edormanagementwoul dnotr ei nv esti nt hes amet ypeofasset s.I f t hecompanymustcont i nual l ysel lbel owt hef ul l costofpr oduct i ont heni twi l l mostl i k el y getoutoft hatpar t i cul arbusi nes swheni tcomest i met or epl acet hosef aci l i t i es . 425. Thi si sadi ffic ul tandcompl exi ss ue,sot hepur pos eoft hi squest i oni st ost i mul at e di scus si onandhav es t udent st hi nkaboutt hecompl exi t i esofusi ngi ncr ement al cost sas abas i sf ordec i si onmak i ng. Ass umi ngt hepas sengerwhoi supgr adedi snotr epl ac edbyanot hereconomy pas senger ,t hedi ffer ent i al cost sar et hecos t sofanyi ncr ement alf oodandbev er age s er v edi nfir stcl ass .I ft hepas sengeri sr epl aced,t hedi ffer ent i alcos t swoul dbet he cos t soft hebev er agesandmeal si nfir stcl ass ,pl ust headdi t i onal f uel r equi r edf ort he addi t i onal pas sengerandass oci at edbaggage. Theoppor t uni t ycos ti nc l udesanyr ev enuel ostf r om al ast mi nut ecus t omerwi l l i ngt o payf orfir stcl ass ,i ft heupgr adedseati st hel astonet ak en.Theoppor t uni t ycos t sofnot upgr adi ngt hepas sengeri st heposs i bl el os tr ev enue( pr ofi t )t ot heai r l i ne,i ft heel i t e pas sengerbecomesunhappyandshi f tbusi nes st oanot herai r l i ne. 426. Thedi ffer ent i al cost si nc l ude: 

Fuel



Wearandt earr el at edt omi l esdr i v ens uchast i r es ,mi l eager el at ed mai nt enance,l ubeandoi l



Par ki ngandt ol l s ,i fany



Carwas hi fneededduet ot het r i p



Ri s kofcas ual t i est hatv ar ywi t hmi l eage



Ot hercost st hatv ar ywi t hmi l eage

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Chapter 04 - Fundamentals of Cost Analysis for Decision Making

427. Thedi ffer ent i al cost si nc l ude: 

Cos toft hecar



For gonei nt er esti ncomeonf undspai df ort hecar



I nt er estondebtont hecar



I ns ur ance



Mai nt enancet hati st i mer el at ed



Li censeandt ax es

Thesecos t sar edi ffer entt hant hecost si n426.Thecos t si n426ar et hoser equi r edt o oper at et hecarf oranaddi t i onal f ewmi l es .Thecos t st hatv ar ywi t ht henumberofcar s donotv ar ywi t hmi l eage.Thecos t si n427v ar ywi t ht henumberofcar sandnotwi t h t hemi l es dr i v en. Ofcour se,t her ei st hepos si bi l i t yt hati fy oubuyanewcary ouwi l lbeask edt odr i v e y ourf r i endsar oundmor eof t ent hanot her wi s e. 428. Thi sappr oachwi l l maxi mi z epr ofit sonl yi ft her ear enocons t r ai nt sonpr oduct i onor s al es ,ori fbot hpr oduct sus eal lscar cer esour cesatanequalr at e.Ot her wi se managementwoul dwantt omax i mi z et hecont r i but i onperuni tofscar cer es our ce. 429. Fi x edcos t sar er el ev antanyt i met heyc hangewi t ht hepr oduct mi xdec i si on.For ex ampl e,i ft her ear efix edcos t st hatcanbeel i mi nat edwi t ht heel i mi nat i onofoneor mor eoft hei ndi vi dualpr oduct s ,t hent hos efix edcos t smi ghtber el ev anti namul t i pr oductset t i ng.Theywoul dber el ev anti ft hecont r i but i onf r om pr oduct i onofanyone pr oductwasi ns uffic i entt oc ov ert hefi x edcos t st hatcoul dbeel i mi nat ed. 430. Per f or manc ecanbei mpr ov edatt hebot t l eneckbyi nc r easi ngcapac i t yorshi f t i ng r es our cesf r om nonbot t l enec kar east ot hebot t l enec k. 431. Pr ofi t scanbei nc r easedbydec r eas i ngi nv est ment s ,i nc r eas i ngt hr oughput ,and dec r eas i ngoper at i ngexpens es .Mos twhosubs cr i bet ot het heor yofcons t r ai nt sf oc us oni ncr eas i ngt hr oughputcont r i but i on.

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Chapter 04 - Fundamentals of Cost Analysis for Decision Making

Sol ut i onst oExer ci ses 432. ( 25mi n.  S ) peci alOr der s:Mar i a’ sFoodSer vi ce. a. St at usQuo Al t er nat i v e 3, 000Uni t s 3, 300Uni t s Sal esr ev enue. . . . . . . . $18, 000 $19, 050 Var i abl ecost s :  Meal sa. . . . . . . . . . . . . . . . 9, 000 9, 900  Admi ni st r at i v eb. . . 1, 500 1, 500 Cont r i but i onmar gi n $ 7, 500 $7, 650 Fi x edcos t s . . . . . . . . . . . . . 5, 100 5, 100 Oper at i ngpr ofi t . . . . . . $ 2, 400 $ 2, 550

Di ffer enc e $1, 050 ( hi gher ) 900 ( hi gher ) 0 $150 ( hi gher ) 0 $150 ( hi gher )

aVa r i abl ecost spermeal =( $13, 500– $4, 500)÷3, 000uni t s

=$3. 00peruni t . Al t er nat i v el y ,v ar i abl ecos t spermeal : $4. 50 [ ( $13, 500–$4, 500)÷$13, 500]=$3. 00peruni t . $3. 00peruni tx300=$900addi t i onal cos t . bNoa ddi t i onal admi ni s t r at i v ecost saccor di ngt ot heex er ci s e.

Al t er nat i v epr es ent at i on. PerUni t 300Meal s Sal esr ev enue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3. 50 $1, 050 Var i abl ecost s : Meal cost s : $4. 50 [ ( $13, 500–$4, 500)÷$13, 500]= 3. 00 900 Cont r i but i ont ooper at i ngpr ofit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $0. 50 $150

Accept i ngt hi sor derwoul di nc r eas eoper at i ngpr ofi t sby$150. b.Thedi ffer enc ei sr el at i vel ysmal l ,soMar i ami ghtwantt ocons i derhowconfi dentshe i si nt heest i mat es .I naddi t i on,s heshoul dconsi derwhet heraccept i ngt hi sor derwi l l l eadt or egul arcus t omer sas ki ngf orspec i al pr i ces.

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Chapter 04 - Fundamentals of Cost Analysis for Decision Making

433.( 25mi n. ) Speci alOr der s:Car l sbadEnt er pr i ses. Car l sbadshoul dacceptt heoffer ;pr ofiti shi gherby$160, 000. a. ( Al l cost si n$000) St at usQuo Al t er nat i v e 320, 000Uni t s 340, 000Uni t s Sal esr ev enue. . . . . . . . . . . . . . . . . . . . . . . . $25, 600 $26, 600 Var i abl ecost s :  Manuf act ur i ng. . . . . . . . . . . . . . . . . . . . . 10, 240 10, 880  Sel l i ngandadmi ni st r at i ve. . 5, 120 5, 320 Cont r i but i onmar gi n. . . . . . . . . . . . . . . . $10, 240 $10, 400 Fi x edcos t sa. . . . . . . . . . . . . . . . . . . . . . . . . . . 3, 840 3, 840 Oper at i ngpr ofi t . . . . . . . . . . . . . . . . . . . . .

$ 6, 400

Di ffer enc e $1, 000 ( hi gher )

640 ( hi gher ) 200 ( hi gher ) $ 160 ( hi gher ) 0 $ 6, 560 $ 160 ( hi gher )

a$ 3, 840, 000=320, 000uni t sx( $8fix edmanuf act ur i ng+$4fix edsel l i ng) .

Al t er nat i v epr es ent at i on. PerUni t 20, 000Uni t s ( $000) Sal esr ev enue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $50 $1, 000 Var i abl ecost s Manuf act ur i ngcos t s. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 640 Sel l i ngandadmi ni st r at i v ecost s. . . . . . . . . . . . . . . . . . . . . . . . 10 200 Cont r i but i ont ooper at i ngpr ofit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8 $160 b.Basedoni nc r ement al pr ofit s ,t hecompanys houl dacc eptt heoffer .Howev er ,i tshoul d cons i dert hei mpactofaccept i ngt heor deroni t sr egul arc ust omer sandt hepos si bi l i t y t hatt hecus t omerwi t ht hespec i al or derwi l l expectspec i al pr i ci ngonf ut ur eor der s .

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Chapter 04 - Fundamentals of Cost Analysis for Decision Making

434. ( 30mi n. ) Pr i ci ngDeci si ons:Col dRock. a.

St at usQuo Al t er nat i v e 20, 000gal l ons 20, 400gal l ons

Sal esr ev enue. . . . . . . . . . . . . . . . $96, 000a Les sv ar i abl ecos t s:  Mat er i al s. . . . . . . . . . . . . . . . . . . . . 36, 000  Labor . . . . . . . . . . . . . . . . . . . . . . . . . . 12, 000  Var i abl eov er head. . . . . . 6, 000   Tot al v ar i abl ecos t . . . $54, 000 Cont r i but i onmar gi n. . . . . . . $42, 000 Les sfi x edcos t s . . . . . . . . . . . . . 24, 000 Oper at i ngpr ofi t . . . . . . . . . . . . . . $18, 000

$97, 440b

Di ffer enc e $1, 440 ( hi gher )

36, 720 720 ( hi gher ) 12, 240 240 ( hi gher ) 6, 120 120 ( hi gher ) $55, 080 $ 1, 080 ( hi gher ) $42, 360 $ 360 ( hi gher ) 24, 000 0 ( hi gher ) $18, 360 $ 360 ( hi gher )

Oper at i ngpr ofi t swoul dbehi gherwi t ht headdi t i onal or derby$360. a.$ 96, 000=20, 000gal l onsx$4. 80pergal l on. b.$ 97, 440=( 20, 000gal l onsx$4. 80pergal l on)+( 400gal l onsx$3. 60pergal l on) . b.Thel owestpr i cet hei cecr eam coul dbesol dwi t houtr educi ngpr ofit si s$2. 70per gal l on,whi chwoul dj ustcov ert hev ar i abl ecost soft hei cecr eam. c .Ani mpor t antf act ort ocons i derwoul dbet heeffectont her egul arbus i nessonce ot hercust omer sl ear noft hes peci al pr i ce.I ti sal soi mpor t antf ort hemanagert o under st andt hatt hi scus t omerwi l lexpectt hi spr i ceconcessi oni nt hef ut ur eandat t hatt i met hecompanymaybeoper at i ngatcapac i t y .

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