b. Cash fixed costs = total fixed costs - depreciation = $148,960 - ($16,000 + $8,000) = $124,960, However, the depreciation tax shield ($24,000 x 30%) offsets $7,200 of these fixed costs, leavin: $117,760 net cash fixed costs. Break-even volume, on a cash basis, then, is $117,760 + $5, 19.192 pizzas. © Cash generated by operations equals net income plus noneash expenses (here, only depreciation) $46,648 + $24,000 = $70,648, leaving $56,248 if Calderone withdraws $14,400 for his personal use. 4. The easiest way to approach this question is to treat the target pretax income as a fixed cost. Since the target income is $60,000, the target pretax income is $60,000 + 70% = $85,713. Adding this to the $148,960 fixed costs gives a total of $234,673. So the required volume = $234,673 / $5.95 = 39,441 & ©. Most of the expenses are fixed. Therefore a large volume of sales is required before any profit is made, Once this point is reached (break-even), each sale contributes $5.95 to profits, a larger change in profits since profits begin at 2ero at this point while the $8.50 change in sales is a smaller Proportion of sales because of the large amount of sales required to reach the break-even point. f The cash flow from operations will exceed his profits because $24,000 of the expense (depreciation) is not a current cash-consuming cost. Cases Note: This case is unchanged from the Eleventh Edition, If not used at this point, the case can be used with Chapter 26, Approach ‘The Hospital Supply case is placed in this chapter for those instructors who wish to expose students to alternative choice decisions and the related differential costing prior fo getting into the details of full costing, Because in many programs the marketing and management accounting courses begin at the same fime, this case also enables the accounting instructor to assist his or her colleagues in marketing by introducing break-even analysis atthe start of the term; questions | and 4 can be used for this purpose The case is also useful for giving stuclents a good understanding of the fixed/variable cost dichotomy. In Particular, | think it worthwhile to emphasize to students that fixed costs may be "unitized" (ice, allocated {o individual units of product) for certain purposes, and that this allocation procedure may make such costs appear to be variable, Indeed, many students treat the $660 per unit fixed manufacturing overhead and $770 per unit fixed marketing costs as though they were variable costs, despite the fact that they are clearly labeled "fixed." Finally, | use the case fo introduce the concept of opportunity cost. Question 3 can be used in this way, as can question 5 if you postulate a serap value for the obsolete hoists This teaching note was prepared by Professor James S. Reece hased on solutions prepared by Professor Michael Maher. Copyright © by, James S. Reece, 298 WhComments on Questions Question 1 Total fixed costs (TFC) = fixed costs per unit times normal volume =($660 + $770)*3,000 = $4,290,000, Contribution margin per unit = unit price minus unit variable costs = $4,350 - $2,070 $4,290,000 882 units Break ~ even volume = 52,280 Break —even sales = $4,290,000/| $8,185,461 $4,350 (actually, 1,882 *$4,350 = $8,186,700) $4,350- 207) Question 2 Recommendation: Lowering prices reduces income. Other factors, such as the reduction of available capacity and the capacity and the impact on market share, could also affect the decision: Before Price After Price Impact: Reduction Reduction Difference Price. $4350 $3,850 3 (500) Quantity. 3,000 3,500 500 Revenue.. = $13,050,000 $13,475,000 $ 425,000 Variable mfg costs... ( 5,385,000) (6,282,500) (897,500) Variable mktg. costs. (825,000) (962,500. (137,500) Contribution margin 6,840,000 6,230,000 (610,000) Fixed mfg, costs... (1,980,000) 1,980,000) ~ (2,310,000) 2,310,000) $.2.550,000 $1,940,000 $(610.000) Fixed mktg, cost Income Note that the differential contribution margin and differential income are the same. Question 3 Recommendation: Don't accept contract, Without With Governmem Contract Govt Impact: Coniract Regular Goverment Total Difference Revenue, omnmunne $17,400,000 $15,225,000 $1,420,000 $16,645,000 §(753,000) Variable mfg. (7,180,000) (6,282,500) (897,500) (7,180,000) . 962.500) 0 8.502.500 (617,300) 1,980,000) - Variable mktg, costs... Contribution margin Fixed mfg. costs, vw. {1,100.000) __ (962.500) _ - 9,120,000 7,980,000 522,500 (1,980,000) Fixed mktg, c05t8,...0 -(2.310,000 _2310,000) Tneome nana $4,830,000 $.4212,500 $(617,500) 20,000, assuming the governments "share" of i revenue = (500 * $1,795) +125 ($1,980,000) + $275,000: March fixed manufacturing costs is 125 (S06/4,000). 299A shorter approach to question 3 (but harder for some students to understand) is this Forgone contribution (equals forgone income, as was illustrated by question 2) on regular sales if government contract is accepted = 500 * $2,280 Income from government contact Fixed fee = = Shave of fixed még, costs (1/8 * $1,980,000) Differential income if contract accepted Question 4 Minimum price = variable mfg costs + shipping costs + order costs = $1,795 + $410 + $22,000/1,000 = $2,227 At this price per unit, the $2,227,000 of differential costs caused by the 1,000-unit order will just be uncovered, Some students solve for this price using the break-even formula (UR = unit revenue): uw UR-UVC=Q 22,000 UR = 2,205 =1,000 units $22,000 = 1,000UR - $2,205,000 $2,227,000 = 1,000UR, 92.227 UR Question 5 ‘The manufacturing costs are sunk; therefore, any price in excess of the differential costs of selling the hoists will add to income. In this case, those differential costs are apparently the $275 per unit variable marketing costs, since the hoists are to be sold through regular channels; thus the minimum price is $275. (if the instructor wishes to reinforce the concept of opportunity cost, the most general answer to this question is that the price should exceed the sum of (1) the differential marketing costs and (2) the Potential scrap proceeds, which are an opportunity cost of selling the hoists rather than scrapping them.) This assumes, however, that sale of these "obsolete" hoists will not cut into sales of the current model. If this assumption is not valid, then the contribution margin on any "cannibalized" sales must be taken into account. 74,Question 6 What price is equivalent to in-house cost of production? Alll Production 1,000 Units In-house Contracted Total revenue $13,050,000 $13,050,000 Total variable manufacturing costs. (5,385,000) __,590,000) Total variable marketing costs. (825,000) __(770,000) Total contribution margin 6,840,000 8,690,000 Total fixed manufacturing costs (1,980,000) (1,386,000) Total fixed marketing costs... 2,310,000 (2,310,000) Payment to contractor... . x Income $2550.000 "¥Z994,000- x $4,994,000 - X= $2,550,000 $244,000 oF $2,444 per unit maximum purchase price ‘Therefore, a $2,475 purchase price is not acceptable; it would decrease income by $31,000 [($2,475 - $2,444) * 1,000]. A shorter (but more difficult) approach uses the concept of opportunity costs: Variable manufacturing cost $1,795 Variable marketing opportunity cost ($273 ~ S20, 35 Fixed manufacturing opportunity cost. _s94e Equivalent in-house cost.. 2.444 (51,980,000 -$1,386,000)/1,000 unis Question 7 Contract 1,000 Regular Hoists and Produce 800 Modified Hoists 3,000 Regular Hoists Produced Regular In-house Regular (In) (Out) Modified Total Revenui . $13,050,000 $8,700,000 $4,350,000 $3,960,000 $17,010,000 Variable mfg, costs... (5,385,000) (3,590,000) = (2,420,000) (6,010,000) Variable mktg. costs (825,000) __(550,000) __(220,000) _(440,000) _(1.210.000) Contribution margin 6,840,000 4,560,000 ~ 4,130,000 1,100,000 ~ 9,790,000 Fixed mf, costs 1,980,000) 1,980,000) Fixed mkt, cost - (2,310,000) (2,310,000) Payment t0 contractor o oO | ies Income : $ 2,550,000 35,500,000 - imum payment = $2,950,000. Now proposal should be accepted as a pr ice of $2,475, HN.