CHAPTER 6

RELEVANT INFORMATION AND DECISION MAKING: PRODUCTION DECISIONS TRUE / FALSE:

1. Opportunity costs need to be considered when deciding on the use of limited resources. T Opportunity cost depends on alternatives available at a point in time. T Opportunity costs and outlay costs are widely used synonyms. F Opportunity costs apply to resources that will be owned. F Outsourcing is a make-or-buy decision for services. T Qualitative factors do not affect a make-or-buy decision. F In a make-or-buy decision, if facilities are and will remain idle when the decision is made to not make a part internally, then the opportunity cost is zero. T The key reasons that companies outsource are to improve the companys focus and reduce operating costs. T Past costs can be good predictors of future costs. T The cost of inventory is relevant when deciding whether to dispose of the inventory in cases of obsolescence. F The disposal value of old equipment is relevant. T Sunk cost is another term for historical cost or past cost. T When making a decision to replace some old equipment with new, the depreciation taken on both the old or new equipment is irrelevant information.
1

2. 3. 4. 6. 7. 8.

9.

18. 19.

20. 21. 22.

F 24. 25. 26. 34. Future costs are relevant if they are the same under all feasible alternatives. F Equipments book value is the original cost plus depreciation. F Past costs may affect future payments for income taxes. T The contribution margin is computed using variable manufacturing costs and variable selling and administrative costs. T

MULTIPLE CHOICE:
35.

Joe Smith has paid off the mortgage on his house and continues to live in the house. The interest income forgone by not selling the house and investing the proceeds is an example of a(n): a. b. c. d. sunk cost detrimental cost opportunity cost outlay cost

c. 38.

opportunity cost Wholesome Company paid $130,000 for a machine used to mill oats. The annual contribution margin from oat sales is $60,000. The machine could be sold for $90,000. The opportunity cost of producing wheat flour is: a. b. c. d. $130,000 $90,000 $60,000 $30,000

b. $90,000 39. The salary forgone by a person who quits a job to start a business is an example of a (n): a. b. c. d. sunk cost opportunity cost depreciable cost outlay cost

b. opportunity cost

40.

Janice is considering leaving her current position to open a coffee shop. Janices current salary is $56,000. Annual coffee shop revenue and costs are estimated at $250,000 and $210,000, respectively. ___________ is the outlay cost associated with the decision to open the coffee shop. a. b. c. d. $56,000 $210,000 $460,000 $40,000

b. $210,000 41. Sharon is considering leaving her current position to open a coffee shop. Sharons current salary is $83,000. Annual coffee shop revenue and costs are estimated at $250,000 and $210,000, respectively. ____________ is the opportunity cost of opening the coffee shop. a. b. c. d. $83,000 $210,000 $333,000 $40,000

a. $83,000 42. Lynnette is considering leaving her current position to open an ice cream shop. Lynnettes current salary is $77,000. Annual ice cream shop revenue and costs are estimated at $250,000 and $210,000, respectively. ________ is the opportunity cost of remaining employed. a. b. c. d. $77,000 $210,000 $287,000 $40,000

d. $40,000 $250,000 - $210,000 = $40,000 43. Beyonce is considering leaving her current position to open a music store. Beyonces current salary is $45,000. Annual music store revenue and costs are estimated at $250,000 and $210,000, respectively. If Beyonce decides to open the music store, the change in her annual income would be: a. b. c. d. $85,000 ($5,000) $250,000 $40,000

b. ($5,000) ($250,000 - $210,000) - $45,000 = ($5,000)

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LEARNING OBJECTIVE 2 44. Finch Company manufactures a part for its production cycle. The costs per unit for 5,000 units of this part are as follows: Direct materials Direct labor Variable factory overhead Fixed factory overhead Total costs $3 5 4 2 $14

The fixed factory overhead costs are unavoidable. Scalding Corporation has offered to sell 5,000 units of the same part to Finch Company for $15 a unit. Assuming no other use for the facilities, Finch Company should: a. b. c. d. buy from Scalding Corporation to save $1 per unit make the part to save $1 per unit buy from Scalding Corporation to save $3 per unit make the part to save $3 per unit

d. make the part to save $3 per unit $15 - ($3 + $5 + $4) = $3 Savings 45. Mad Cow Company manufactures a part for its production cycle. The costs per unit for 38,000 units of this part are as follows: Direct materials Direct labor Variable factory overhead Fixed factory overhead Total costs $3 5 4 3 $15

The fixed factory overhead costs are unavoidable. Assuming no other use of their facilities, the highest price that Mad Cow Company should be willing to pay for the part is: a. b. c. d. $12 $15 $8 $11

a. $12 $3 + $5 + $4 = $12

46.

Tender Company manufactures a part for its production cycle. The costs per unit for 5,000 units of this part are as follows: Direct materials Direct labor Variable factory overhead Fixed factory overhead Total costs $3 5 4 2 $14

The fixed factory overhead costs are unavoidable. Assume that Tender Company has been offered 5,000 units of the part from another producer for $15 each. The facilities currently used to make the part could be rented out to another manufacturer for $20,000 a year. Tender Company should: a. b. c. d. make the part to save $1 per unit buy the part to save $3 per unit buy the part to save $1 per unit make the part to save $3 per unit

c. buy the part to save $1 per unit Buy: (5,000 x $15) - $20,000 = $55,000 Make: (5,000 x $12) = $60,000; and ($60,000 - $55,000) / 5,000 units = $1 per unit 47. Bull Company manufactures a part for its production cycle. The costs per unit for 5,000 units of this part are as follows: Direct materials Direct labor Variable factory overhead Fixed factory overhead Total costs $3 5 4 2 $14

The fixed factory overhead costs are unavoidable. Assume that Bull Company has been offered 5,000 units of the part from another producer for $14 each. The facilities currently used could be used to make 5,000 units of a product that would contribute $5 a unit to fixed expenses. No additional fixed costs would be incurred. Bull Company should: a. make the new product and buy the part to earn an extra $3 per unit contribution to profit b. make the new product and buy the part to earn an extra $1 per unit contribution to profit c. continue to make the part to earn an extra $1 per unit contribution to profit d. continue to make the part to earn an extra $3 per unit contribution to profit a. make the new product and buy the part to earn an extra $3 per unit contribution to profit ($14 - $5) - $12 = $(3)
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48.

Hoover Company manufactures a part for its production cycle. The costs per unit for 10,000 units of this part are as follows: Direct materials Direct labor Variable factory overhead Fixed factory overhead Total costs $20 15 16 10 $61

The fixed factory overhead costs are unavoidable. Madison Company has offered to sell 10,000 units of the same part to Hoover Company for $55 a unit. Assuming no other use for the facilities, Hoover Company should: a. make the part to save $4 per unit b. buy from Madison to save $6 per unit c. make the part to save $6 per unit d. buy from Madison to save $4 per unit a. make the part to save $4 per unit $55 - ($20 + $15 + $16) = $4 Savings 50. Kennedy Company manufactures a part for its production cycle. The costs per unit for 10,000 units of this part are as follows: Direct materials Direct labor Variable factory overhead Fixed factory overhead Total costs $20 15 16 10 $61

The fixed factory overhead costs are unavoidable. Assume that Kennedy Company can buy 10,000 units of the part from another producer for $60 each. The facilities currently used to make the part could be rented out to another manufacturer for $100,000 a year. Kennedy Company should: a. b. c. d. buy the part to save $2.50 per unit buy the part to save $1 per unit make the part to save $2.50 per unit make the part to save $1 per unit

b. buy the part to save $1 per unit Buy: (10,000 x $60) - $100,000 = $500,000; Make: (10,000 x $51) = $510,000; and ($510,000 - $500,000) / 10,000 = $1

52.

Super Cooper Company currently produces a key part at a total cost of $210,000. Variable costs are $170,000. Of the fixed cost, $10,000 relate specifically to this part. The remaining fixed costs are unavoidable. Another manufacturer has offered to supply the part for $190,000. The facilities currently used to manufacture the part could be used to manufacture a new product with an expected contribution margin of $30,000. Alternately, the facilities could be rented out at $60,000. Given all of these alternatives, ________________ is Super Coopers lowest net cost for the part. a. b. c. d. $170,000 $180,000 $190,000 $130,000

d. $130,000 $190,000 - $60,000 = $130,000 vs. $210,000 - ($210,000 - $170,000 - $10,000) = $180,000 56. Hoopster Company produces a part that is used in the manufacture of one of its products. The costs associated with the production of 5,000 units of this part are as follows: Direct materials Direct labor Variable factory overhead Fixed factory overhead Total costs $108,000 156,000 72,000 168,000 $504,000

Of the fixed factory overhead costs, $72,000 are avoidable. Knight Company has offered to sell 5,000 units of the same part to Hoopster for $86.40 per unit. Assuming there is no other use for the facilities, Hoopster Company should: a. b. c. d. make the part to save $14.40 per unit buy the part to save $14.40 per unit buy the part to save the company $72,000 make the part to save $4.80 per unit

d. make the part to save $4.80 per unit $108,000 + $156,000 + $72,000 + $72,000 = $408,000 $86.40 - ($408,000 / 5,000) = $4.80

57.

Crenshaw Company produces a part that is used in the manufacture of one of its products. The costs associated with the production of 5,000 units of this part are as follows: Direct materials Direct labor Variable factory overhead Fixed factory overhead Total costs $108,000 156,000 72,000 168,000 $504,000

Of the fixed factory overhead costs, $72,000 is avoidable. Assuming no other use of their facilities, the highest price that Crenshaw Company should be willing to pay for 5,000 units of the part is: a. b. c. d. $504,000 $336,000 $432,000 $288,000

c. $432,000 $108,000 + $156,000 + $72,000 + ($168,000 - $72,000) = $432,000 59. Miller Company produces a part that is used in the manufacture of one of its products. The costs associated with the production of 5,000 units of this part are as follows: Direct materials Direct labor Variable factory overhead Fixed factory overhead Total costs $108,000 156,000 72,000 168,000 $504,000

Of the fixed factory overhead costs, $72,000 is avoidable. Assume that Miller Company can buy 5,000 units of the part from another producer for $100.80 each. The current facilities could be used to make 5,000 units of a product that has a contribution margin of $24 per unit. Fixed factory overhead costs to produce this new product would be exactly the same as for the currently produced part. Miller Company should: a. continue to make the part and earn an extra $48,000 in profit b. buy the part and produce the new product and earn an extra $4.80 per unit contribution to profit c. continue to make the part and earn an extra $4.80 per unit contribution to profit d. buy the part and produce the new product and earn an extra $24 per unit contribution to profit d. buy the part and produce the new product and earn an extra $24 per unit contribution to profit Buy: $100.80 - $24.00 = $76.80 Make: $504,000 / 5,000 = $100.80

60.

A key factor in a make-or-buy decision is: a. b. c. d. whether or not there are idle facilities the amount of the sunk costs gain or loss on the disposal of equipment the total joint costs a. whether or not there are idle facilities

61.

_____________________are a qualitative factor of a make-or-buy decision. a. Variable manufacturing costs b. Avoidable costs c. Long term relationship with suppliers d. Opportunity costs c. Long term relationship with suppliers

62.

Future costs are relevant in decision making when: a. they exceed future revenues b. they are not based on estimates c. they differ between alternatives d. they are the same between alternatives c. they differ between alternatives

63.

_________________ would be a consideration in a make-or-buy decision. a. b. c. d. Excess capacity Variable factory overhead Rental income from unused facilities All of these answers are correct.

d.All of these answers are correct. 82. _____________________ is not likely to be relevant in a decision concerning the disposal of obsolete inventory. a. b. c. d. Inventory cost Expected future revenues Scrap value of inventory Expected future costs

a. Inventory cost

83.

____________________ is relevant in a decision to replace equipment.

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a. b. c. d.

Cost of old equipment Book value of old equipment Depreciation accrued on old equipment Future maintenance costs of old equipment

d. Future maintenance costs of old equipment 84. Depreciation is: a. the periodic cost of equipment spread over the future periods in which the equipment is expected to be used b. the decline in equipment value due to obsolescence c. the difference between the original cost and current market value d. All of these answers are correct. a. the periodic cost of equipment spread over the future periods in which the equipment is expected to be used 85. Book value is defined as: a. b. c. d. disposal value disposal value less accumulated depreciation cost less accumulated depreciation disposal value less original cost

c. cost less accumulated depreciation 87. Derwood Company is considering replacing a machine that is presently used in the production of its product. The following data are available: Old Machine Original cost Useful life in years Current age in years Book value Disposal value now Disposal value in 5 years Annual cash operating costs $99,000 9 3 $33,000 $28,000 0 $17,000 Replacement Machine $88,000 6 0 0 $14,000

___________________________________ is a sunk cost. a. b. c. d. 88. The annual cash operating costs of the old machine The annual cash operating costs of the replacement machine The disposal value of the old machine The original cost of the old machine

d. The original cost of the old machine Tabitha Company is considering replacing a machine that is presently used in the
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production of its product. The following data are available: Old Machine Original cost Useful life in years Current age in years Book value Disposal value now Disposal value in 5 years Annual cash operating costs $60,000 10 5 $25,000 $8,000 0 $10,000 Replacement Machine $35,000 5 0 0 $4,000

The total relevant costs to consider if the old machine is kept are: a. b. c. d. $60,000 $50,000 $52,000 $30,000

b. $50,000 $10,000 x (10 years 5 years) = $50,000 89. Major Nelson Company is considering replacing a machine that is presently used in the production of its product. The following data are available: Old Machine Original cost Useful life in years Current age in years Book value Disposal value now Disposal value in 5 years Annual cash operating costs $57,000 17 12 $39,000 $8,000 0 $7,000 Replacement Machine $35,000 5 0 0 $4,000

The difference in cost between keeping the old machine and replacing the old machine, ignoring income taxes, is: a. b. c. d. $22,000 in favor of keeping the old machine $12,000 in favor of keeping the old machine $37,000 in favor of replacing the old machine $22,000 in favor of replacing the old machine

b. $12,000 in favor of keeping the old machine [($7,000 - $4,000) x 5] - $35,000 + $8,000 = $($12,000)

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90.

Tony Company is considering replacing a machine that is presently used in the production of its product. The following data are available: Old Machine Original cost Useful life in years Current age in years Book value Disposal value now Disposal value in 5 years Annual cash operating costs ____________________________ is irrelevant. a. b. c. d. The original cost of the replacement machine The disposal value of the old machine The book value of the old machine The annual operating cost of the old machine $295,000 11 6 $130,000 $52,000 0 $39,000 Replacement Machine $188,000 5 0 0 $24,000

c. The book value of the old machine 91. Jeannie Company is considering replacing a machine that is presently used in the production of its product. The following data are available: Old Machine Original cost Useful life in years Current age in years Book value Disposal value now Disposal value in 5 years Annual cash operating costs __________________________ is a sunk cost. a. b. c. d. The disposal value of the old machine The original cost of the old machine The annual cash operating costs of the old machine The annual cash operating costs of the replacement machine $333,000 6 1 $198,000 $132,000 0 $45,000 Replacement Machine $222,000 5 0 0 $34,000

b. The original cost of the old machine

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92. Cocoa Beach Company is considering replacing a machine that is presently used in the production of its product. The following data are available: Old Machine Original cost Useful life in years Current age in years Book value Disposal value now Disposal value in 5 years Annual cash operating costs $200,000 10 5 $100,000 $32,000 0 $20,000 Replacement Machine $160,000 5 0 0 $14,000

Ignoring income taxes, the difference in cost between the old and new machine is: a. b. c. d. $98,000 in favor of the old machine $98,000 in favor of the new machine $40,000 in favor of the new machine $12,000 in favor of the new machine

a. $98,000 in favor of the old machine [($20,000 - $14,000) x 5] - $160,000 + $32,000 = $(98,000) 93. The gain or loss on the disposal of equipment is determined by: a. b. c. d. adding the book value of the old equipment to the cost of the new equipment adding the disposal value and the book value of the old equipment subtracting the book value from the cash received for the old equipment subtracting the book value of the old equipment from the cost of the new equipment

c. subtracting the book value from the cash received for the old equipment 94. In a decision to keep or replace existing equipment, ____________ is a false statement. a. b. c. d. the disposal value of the old equipment is irrelevant the book value of the old equipment is irrelevant the cost of the new equipment is relevant depreciation on the new equipment is relevant

a. the disposal value of the old equipment is irrelevant

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95. Geren Company produces and sells a product that has variable costs of $9 per unit and fixed costs of $200,000 per year.

If production decreases from 50,000 to 40,000 units, the cost per unit will: a. b. c. d. increase by $1 decrease by $1 increase to $13 decrease to $14

a. increase by $1 ($200,000 / 50,000) ($200,000 / 40,000) = $1 96. Melissa Company produces and sells a product that has variable costs of $7 per unit and fixed costs of $240,000 per year. ___________ is the cost per unit if 20,000 units per year are produced and sold. a. b. c. a. $7 $19 $5 $12

b. $19 $7 + ($240,000 / 20,000) = $19 98. Joshua Company produces and sells a product that has variable costs of $7 per unit and fixed costs of $200,000 per year. If production increases from 20,000 units to 25,000 units, the unit cost will: a. b. c. d. increase by $35,000 decrease by $8 per unit decrease by $2 per unit not change

c. decrease by $2 per unit ($200,000 / 20,000) - ($200,000 / 25,000) = $2 99. Past costs that are unavoidable and unchangeable are known as: a. b. c. d. fixed overhead costs operating costs product production costs sunk costs

d. sunk costs

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138.

The Cyclone Corporation is contemplating the replacement of some old equipment. The pertinent information is as follows: Old Replacement Equipment Equipment Original cost Useful life in years Current age in years Book value Disposal value now Disposal value in 6 years Annual cash operating costs Required: Prepare a cost comparison of all relevant items for the next six years together. Ignore income taxes. Comment on the best alternative for Cyclone Corporation. Answer: Keep Cash operating costs Disposal value of old equipment New equipment, acquisition cost Total relevant costs $90,000 -__ $90,000 Replace $66,000 (45,000) 60,000 $81,000 Difference $24,000 45,000 (60,000) $9,000 $93,000 13 7 $57,000 $45,000 0 $15,000 $60,000 6 0 0 $11,000

The $9,000 cumulative effect over the six years favors replacing the old equipment.

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