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Case
Assignment
Essential
Hospital Supply, Inc. produced hydraulic hoists that were used by hospitals to move
bedridden patients. The costs of manufacturing and marketing hydraulic hoists at the
companys normal volume of 3000 units per month are shown in Exhibit 1.
EXHIBIT 1
$ 550
825
420
660
$ 2455
275
770
1045
_______
$ 3500
======
The following questions refer only to the data given in Exhibit 1. Unless otherwise stated,
assume there is no connection between the situations described in the questions; treat
them independently. Unless otherwise stated, assume a regular selling price of $ 4350 per
unit. Ignore income tax and any other costs not mentioned in Exhibit 1 or in a question
itself.
Questions:
1.
2.
3.
4.
customers, Hospital Supply plans to produce 4000 units during March, which will
use all available capacity. If the government order is accepted, 500 units normally
supplied to regular customers would be lost to a competitor. The contract given by
the government would reimburse the governments share of March production
costs, plus a fixed fee (profit) of $ 275,000. (There would be no marketing costs
incurred on the governments units) What impact would accepting the government
contract have on March income?
An inventory of 200 units of an obsolete model of the hoist remains in the
stockroom. These must be sold through regular channels at reduced prices or the
inventory will soon be valueless. What is the minimum price that should be
acceptable in selling these units?
$
$
$
$
$
$
2.00
4.50
2.00
7.50
4.00
3.50
$ 5.00
$ 7.20
$ 3.00
$13.80
$ 7.00
$ 6.80
Tiger Prides managers have decided to revise their current assignment of overhead costs to
reflect the following ABC cost information:
Activity
Supervision
Inspection
Activity cost
$100,920
$124,000
Activity-cost driver
Direct labor hours (DLH)
Inspections
Activities demanded
T-SHIRTS
SWEATSHIRTS
0.75 DLH/unit
1.2 DLH/unit
45,000 DLHs
42,000 DLHs
60,000 inspections
80.
17,500 inspections
Under the revised ABC system, the activity-cost driver rate for the supervision activity is
a.
$2.58
b.
$2.40
c.
$2.24
d.
$1.16
Answer: d
Difficulty:
$100,920 / 87,000 dlh = $1.16 per dlh
Objective:
81.
Under the revised ABC system, supervision costs allocated to Sweatshirts will be
a.
$48,720.
b.
$100,800.
c.
$100,920.
d.
none of the above.
Answer: a
Difficulty: 1
Objective:
$100,920 / 87,000 dlh = $1.16 per dlh x 42,000 dlh = $48,720
82.
Under the revised ABC system, total overhead costs allocated to Sweatshirts will be
a.
$ 48,720.
b.
$ 76,720.
c.
$224,920.
d.
none of the above.
Answer: b
Difficulty: 2
Objective:
$124,000 / 77,500 inspections = $1.60 per inspection x 17,500 = $28,000
$48,720 + $28,000 = $76,720
83.
Under the revised ABC system, overhead costs per unit for the Sweatshirts will be
a.
$1.39 per unit.
b.
$1.60 per unit.
c.
$2.19 per unit.
d.
$2.47 per unit.
Answer: c
Difficulty:
$76,720 / 35,000 sweatshirts = $2.19
84.
Objective:
Using an ABC system, next years estimates show manufacturing overhead costs will total
$228,300 for 52,000 T-shirts. If all other T-shirt costs and sales prices remain the same, the
profitability that can be expected is
a.
$5.41 per t-shirt.
b.
$4.39 per t-shirt.
c.
$1.11 per t-shirt.
d.
($0.81) per t-shirt.
Answer: c
Difficulty: 3
Objective: 5
(52,000 ($16 - $2.00 - $4.50 - $4.00) ) - $228,300 = $57,700 / 52,000 = $1.11
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 = $2,280.
Break even volume
$4,290,000
1,882 units
$2,280
$4,350 - 2,070
$8,185,461
$4,350
Before Price
After Price
Impact:
Reduction
Reduction
Difference
Price...................................................................................................................................................................................
$
4,350
$
3,850
$
(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)
-Fixed mktg. costs...............................................................................................................................................................
(2,310,000)
(2,310,000)
-Income.........................................................................................................................................................................
$ 2,550,000
$ 1,940,000
$(610,000)
Note that the differential contribution margin and differential income are the same.
Question 3
Recommendation: Don't accept contract
Without
With Government Contract
Govt.
Impact:
Contract
Regular
Government
Total
Difference
Revenue.............................................................................................................................................................................
$17,400,000 $15,225,000
$1,420,000 $16,645,000
$(755,000)
Variable mfg.......................................................................................................................................................................
(7,180,000)
(6,282,500)
(897,500)
(7,180,000)
-Variable mktg. costs...........................................................................................................................................................
(1,100,000)
(962,500)
-(962,500)
137,500
Contribution margin........................................................................................................................................................
9,120,000
7,980,000
522,500
8,502,500
(617,500)
Fixed mfg. costs.................................................................................................................................................................
(1,980,000)
(1,980,000)
-Fixed mktg. costs...............................................................................................................................................................
(2,310,000)
(2,310,000)
-Income.........................................................................................................................................................................
$ 4,830,000
$ 4,212,500
$(617,500)
Government revenue = (500 * $1,795) +.125 ($1,980,000) + $275,000 = $1,420,000, assuming the government's "share" of
March fixed manufacturing costs is .125 (500/4,000).
A shorter approach to question 3 (but harder for some students to understand) is this:
Question 6
What price is equivalent to in-house cost of production?
All Production
1,000 Units
In-house
Contracted
Total revenue......................................................................................................................................................................
$13,050,000
$13,050,000
Total variable manufacturing costs.....................................................................................................................................
(5,385,000)
(3,590,000)
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......................................................................................................................................................................
$ 2,550,000
$ 4,994,000 - X
$4,994,000 - X = $2,550,000
X = $2,444,000 or $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:
Question 7