10.2 Decision Making - Applying Marginal Analysis Flashcards
In order to avoid pitfalls in relevant-cost analysis, management should focus on
A. Variable cost item that differ for each alternative.
B. Long-run fixed costs of each alternative.
C. Anticipated fixed costs and variable costs of all alternative.
D. Anticipated revenues and costs that differ for each alternative.
D. Anticipated revenues and costs that differ for each alternative.
Gleason Co. has two products, a frozen dessert and ready-to-bake breakfast rolls, ready for introduction. However, plant capacity is limited, and only one product can be introduced at present. Therefore, Gleason has conducted a market study at a cost of $26,000, to determine which product will be more profitable.
The cost incurred by Gleason for the market study is a(n)
A. Incremental cost.
B. Prime cost.
C. Opportunity cost.
D. Sunk cost.
D. Sunk cost.
A sunk cost is a previously incurred cost that is the result of a past irrevocable management decision. Nothing can be done in the future about sunk costs. The market study cost is an example.
Gleason Co. has two products, a frozen dessert and ready-to-bake breakfast rolls, ready for introduction. However, plant capacity is limited, and only one product can be introduced at present. Therefore, Gleason has conducted a market study at a cost of $26,000, to determine which product will be more profitable.
Assuming that Gleason elects to produce the frozen dessert, the profit that would have been earned on the breakfast rolls is a(n)
A. Deferrable cost.
B. Sunk cost.
C. Avoidable cost.
D. Opportunity cost.
D. Opportunity cost.
An opportunity cost is the maximum return that could have been earned on the next best alternative use of a resource. In this case, the lost profit on the rolls is an opportunity cost.
Two months ago, a corporation purchased 4,500 pounds of Kaylene at a cost of $15,300. The market for this product has become very strong, with the price jumping to $4.05 per pound. Because of the demand, the corporation can buy or sell Kaylene at this price. The corporation recently received a special order inquiry that would require the use of 4,200 pounds of Kaylene. In deciding whether to accept the order, management must evaluate a number of decision factors. Without regard to income taxes, which one of the following factors is a relevant decision factor?
A. Purchase price of $3.40 per pound.
B. 4,500 pounds of Kaylene purchased.
C. Remaining 300 pounds of Kaylene.
D. Market price of $4.05 per pound.
D. Market price of $4.05 per pound.
The market price that the corporation must pay for Kaylene (or can sell its current stock for) is a relevant factor.
Jennilyn Jasper, whose annual salary as a flight instructor is $40,000, has just inherited $100,000 after taxes. She is considering quitting her job and opening a day-care center. Certificates of deposit at the local bank are currently paying 6%. Jennilyn estimates that she will have to pay $120,000 in salaries to employees per year, $20,000 to rent a building, $9,000 each for furniture and supplies, $80,000 for insurance, and $7,000 for utilities.
If Jennilyn’s projections are accurate and she earns $250,000 in revenue from the business, she will have incurred
A. Both an accounting profit and an economic profit.
B. An accounting profit but not an economic profit.
C. Neither an accounting nor economic profit.
D. An economic profit but not an accounting profit.
B. An accounting profit but not an economic profit.
An accounting profit is the excess of revenues over explicit costs, in this case ($250,000 revenue) - ($120,000 salaries + $20,000 rent + $9,000 furniture + $9,000 supplies + $80,000 insurance + $7,000 utilities) = $5,000. An economic profit is a significantly higher hurdle. It is not earned until the organization’s income exceeds not only costs as recorded in the accounting records, but the firm’s implicit costs as well. In this case, the most important implicit costs are Jennilyn’s forgone salary ($40,000) and the interest should could have earned by simply investing the inherence instead of plowing it into the business ($100,000 x 6%). Since the combined implicit costs of $46,000 exceed the accounting profit of $5,000, Jennilyn would incur an accounting profit but an economic loss.
Hermo Company has just completed a hydro-electric plant at a cost of $21,000,000. The plant will provide the company’s power needs for the next 20 years. Hermo will use only 60% of the power output annually. At this level of capacity, Hermo’s annual operating costs will amount to $1,800,000, of which 80% are fixed. Quigley Company currently purchases its power from MP Electric at an annual cost of $1,200,000. Hermo could supply this power, thus increasing output of the plant to 90% of capacity. This would reduce the estimated life of the plant to 14 years.
If Hermo decides to supply power to Quigley, it wants to be compensated for the decrease in the life of the plant and the appropriate variable costs. Hermo has decided that the charge for the decreased life should be based on the original cost of the plant calculated on a straight-line basis. The minimum annual amount that Hermo would charge Quigley would be
A. $990,000
B. $630,000
C. $450,000
D. Some amount other than those given.
B. $630,000
The minimum charge would include any variable costs incurred plus depreciation on a straight-line basis. Currently, variable costs are $360,000 at 60% of capacity ($1,800,000 x 20%). If Quigley purchases energy equal to an additional 30% of capacity, it can be assumed that the increase in total variable costs will be half of the variable costs for 60% of capacity, or $180,000. Also, allocating $21,000,000 over 14 years results in an annual depreciation of $1,500,000. Of this amount, 30% will relate to the capacity sold. Thus, the depreciation charge to Quigley is $450,000 ($1,500,000 x 30%). The total charge is $630,000 ($450,000 depreciation + $180,000 VC).
A corporation is considering the purchase of a new machine for $800,000. The machine is capable of producing 1.6 million units of product over its useful life. The manufacturer’s engineering specifications state that the machine-related cost of producing each unit of product should be $.50. The corporation’s total anticipated demand over the asset’s useful life is 1.2 million units. The average cost of materials and labor for each unit is $.40. In considering whether to buy the new machine, would you recommend that the corporation use the manufacturer’s engineering specification of machine-related unit production cost?
A. No, the machine-related cost of producing each unit is $.90.
B. No, the machine-related cost of producing each unit is $2.00.
C. No, the machine-related cost of producing each unit is $.67.
D. Yes, the machine-related cost of producing each unit is $.50.
C. No, the machine-related cost of producing each unit is $.67.
Dividing the cost of the machine ($800,000) by the anticipated lifetime production (1,200,000 units) results in a machine-related per-unit cost of $.67.
Hermo Company has just completed a hydro-electric plant at a cost of $21,000,000. The plant will provide the company’s power needs for the next 20 years. Hermo will use only 60% of the power output annually. At this level of capacity, Hermo’s annual operating costs will amount to $1,800,000 of which 80% are fixed. Quigley company currently purchases its power from MP Electric at an annual cost of $1,200,000. Hermo could supply this power, thus increasing output of the plant to 90% of capacity. This would reduce the estimated life of the plant to 14 years.
The maximum amount Quigley would be willing to pay Hermo annually for the power is
A. Some amount other than those given.
B. $600,000
C. $1,050,000
D. $1,200,000
D. $1,200,000
Since Quigley is currently paying $1,200,000, it would not want to pay any more for the same service.
