Relevant Decision Factors

1. The following costs relate to a variety of decision settings:

Cost Decision
1. Allocated corporate overhead Closing a money-losing department
2. Cost of an old car Vehicle replacement
3. Direct materials Make or buy a product
4. Salary of marketing manager Project discontinuance; manager to be transferred
elsewhere in the firm
5. Home theater installation Purchase of a new home
6. Unavoidable fixed overhead Plant closure
7. Research expenditures incurred last Product introduction to marketplace
year, related to new product
8. $4 million advertising program Whether to promote product A or B with the $4
million program
9. Manufactured cost of existing Whether to discard the goods or sell them to a
inventory third-world country

Required:
Consider each of the nine costs listed and determine whether it is relevant or irrelevant to the decision
cited. If the cost is irrelevant, briefly explain why.

Relevant Decision Factors

2. Clancy Van Lines is considering the acquisition of two new trucks. Because of improved mileage, these
vehicles are expected to have a lower operating cost per mile than the trucks the company plans to replace.
Management is studying whether the firm would be better-off keeping the older vehicles or going ahead with
the replacement, and has identified the following decision factors to evaluate:
1. Cost and book value of the old trucks
2. Moving revenues, which are not expected to change with the acquisition
3. Operating costs of the new and old vehicles
4. New truck purchase price and related depreciation charges
5. Proceeds from sale of the old vehicles
6. The 8% return on alternative investments that Clancy will forego by tying up cash in the new
trucks
7. Drivers' wages and fringe benefits
Required:
Classify the seven decision factors listed into the following categories (note: factors may be used more
than once):
A. Relevant costs.
B. Opportunity costs.
C. Sunk costs.
D. Factors to be considered in the decision.
Relevant Costs
2. Attleboro Company recently discontinued the manufacture of product J15. The standard costs for this
product were:
Direct material $ 50
Direct labor 20
Variable overhead 14
Fixed overhead 35
Total $119
There are 800 units of this product in finished-goods inventory. The units are technologically obsolete, and
the following alternatives are being considered:
1. Dispose of as scrap. The proceeds from the sale will equal the cost of transportation to the disposal
site.
2. Sell to an exporter for sale in a developing country. The sales price to the exporter would be $12
per unit.
3. Remanufacture the products to convert them into model J16, a model that normally sells for $200.
The additional cost to convert the J15 units would be $45; the standard cost to manufacture J16 is
$125. Presently, there is sufficient capacity to manufacture product J16 directly or to do the
necessary conversion work on J15.
Required:
A. Determine the current carrying value of the J15 inventory.
B. Evaluate each alternative and determine the financial benefit to Attleboro if the alternative is
pursued.
Relevant Costs
4. Mystic, Inc., produces a variety of products that carry the logos of teams in Southern Football League (SFL).
The company recently paid the league $85,000 for the rights to market a popular player jersey and
immediately began production. The following information is available:
Number of jerseys manufactured: 25,000
Cost of jerseys manufactured: $625,000
Amount of manufacturing costs paid to-date: $410,000
Number of jerseys sold to-date: 0
Estimated future marketing costs: $330,000
Anticipated selling price per jersey: $42

The SFL is about to file a lawsuit to stop jersey sales and is demanding another $50,000 from Mystic for the
manufacturing rights. Conversations with Mystic's attorneys indicate that the league has a strong case and is
likely to win the suit. If this situation arises, Mystic will be unable to recover any amounts paid to the SFL.

Required:
Mystic's sales department anticipates very strong demand and a sellout of all jerseys manufactured.
1. Determine the overall profitability of the jersey product line if Mystic settles the disagreement
with the SFL and the anticipated sellout occurs.
2. Should the company pay the additional $50,000 demanded by the league, how much benefit (loss)
will the company have?
3. Compute the total sunk cost in the problem.

Special (Custom) Order

4. Howard Robinson builds custom homes in Cincinnati. Robinson was approached not too long ago by a
client about a potential project, and he submitted a bid of $483,800, derived as follows:
Land $ 80,000
Construction materials 100,000
Subcontractor labor costs 120,000
$300,000
Construction overhead: 25% of direct costs 75,000
Allocated corporate overhead 35,000
Total cost $410,000

Robinson adds an 18% profit margin to all jobs, computed on the basis of total cost. In this client's case the
profit margin amounted to $73,800 ($410,000 x 18%), producing a bid price of $483,800. Assume that 70%
of construction overhead is fixed.
Required:
A. Suppose that business is presently very slow, and the client countered with an offer on this home of
$390,000. Should Robinson accept the client's offer? Why?
B. If Robinson has more business than he can handle, how much should he be willing to accept for the
home? Why?

Special Order, Outsourcing

5. Cornell Corporation manufactures faucets. Several weeks ago, the firm received a special-order inquiry
from Yale, Inc. Yale desires to market a faucet similar to Cornell's model no. 55 and has offered to
purchase 3,000 units. The following data are available:
 Cost data for Cornell's model no. 55 faucet: direct materials, $45; direct labor, $30 (2 hours at $15
per hour); and manufacturing overhead, $70 (2 hours at $35 per hour).
 The normal selling price of model no. 55 is $180; however, Yale has offered Cornell only $115
because of the large quantity it is willing to purchase.
 Yale requires a design modification that will allow a $4 reduction in direct-material cost.
 Cornell's production supervisor notes that the company will incur $8,700 in additional set-up costs
and will have to purchase a $3,300 special device to manufacture these units. The device will be
discarded once the special order is completed.
 Total manufacturing overhead costs are applied to production at the rate of $35 per labor hour. This
figure is based, in part, on budgeted yearly fixed overhead of $624,000 and planned production
activity of 24,000 labor hours.
 Cornell will allocate $5,000 of existing fixed administrative costs to the order as "…part of the cost
of doing business."

Required:
A. One of Cornell's staff accountants wants to reject the special order because "financially, it's a loser."
Do you agree with this conclusion if Cornell currently has excess capacity? Show calculations to
 support your answer.
B. If Cornell currently has no excess capacity, should the order be rejected from a financial
perspective? Briefly explain.
C. Assume that Cornell currently has no excess capacity. Would outsourcing be an option that Cornell
could consider if management truly wanted to do business with Yale? Briefly discuss, citing several
key considerations for Cornell in your answer.

Outsourcing
6. St. Joseph Hospital has been hit with a number of complaints about its food service from patients,
employees, and cafeteria customers. These complaints, coupled with a very tight local labor market, have
prompted the organization to contact Nationwide Institutional Food Service (NIFS) about the possibility of
an outsourcing arrangement.

The hospital's business office has provided the following information for food service for the year just
ended: food costs, $890,000; labor, $85,000; variable overhead, $35,000; allocated fixed overhead, $60,000;
and cafeteria food sales, $80,000.

Conversations with NIFS personnel revealed the following information:

 NIFS will charge St. Joseph Hospital $14 per day for each patient served. Note: This figure has
been "marked up" by NIFS to reflect the firm's cost of operating the hospital cafeteria.
 St. Joseph's 250-bed facility operates throughout the year and typically has an average occupancy
rate of 70%.
 Labor is the primary driver for variable overhead. If an outsourcing agreement is reached, hospital
labor costs will drop by 90%. NIFS plans to use St. Joseph facilities for meal preparation.
 Cafeteria food sales are expected to increase by 15% because NIFS will offer an improved menu
selection.
Required:
A. What is meant by the term "outsourcing"?
B. Should St. Joseph outsource its food-service operation to NIFS?
C. What factors, other than dollars, should St. Joseph consider before making the final decision?

Store Closure
7. Papa Fred's Pizza store no. 16 has fallen on hard times and is about to be closed. The following figures are
available for the period just ended:
Sales $205,000
Cost of sales 67,900
Building occupancy costs:
Rent 36,500
Utilities 15,000
Supplies used 5,600
Wages 77,700
Miscellaneous 2,400
Allocated corporate overhead 16,800
All employees except the store manager would be discharged. The manager, who earns $27,000 annually,
would be transferred to store no. 19 in a neighboring suburb. Also, no. 16's furnishings and equipment are
fully depreciated and would be removed and transported to Papa Fred's warehouse at a cost of $2,800.

Required:
A. What is store no. 16's reported loss for the period just ended?
B. Should the store be closed? Why?
C. Would Papa Fred's likely lose all $205,000 of sales revenue if store no. 16 were closed? Explain.