Managerial Accounting

MADM
2017-18 Term 3

Session 1

1.36
a. Angelas goal in this decision problem is to make the most money or maximize profit.
b. Angela has three options:
(i) Raise the price of the Jelly donuts from $1.20 to $1.50 each.
(ii) Keep the price at $1.20 per jelly donut but make 100 more jelly donuts and 100 less
chocolate donuts.
(iii) Not do anything.
c. Cash flow associated with option (i): Net cash inflow per glazed donut: $0.40 (= price of
$0.80 cost of $0.40). Net cash inflow per jelly donut: $0.90 (= 1.50 0.60). Net cash
inflow per chocolate donut: $0.50 (= 1.00 0.50). Total expected cash flows to Angela from
this option: 300 * $0.40 + 250 * $0.90 + 200 * $0.50 = $445.
Cash flow associated with option (ii): Net cash inflow per glazed donut: $0.40 (= price of
$0.80 cost of $0.40). Net cash inflow per jelly donut: $0.60 (= 1.20 0.60). Net cash
inflow per chocolate donut: $0.90 (= 1.00 0.50). Total expected cash flows to Angela from
this option: 300 * $0.40 + 350 * $0.60 + 100 * $0.50 = $380.
Cash flow associated with option (iii) = 300 * $0.40 + 250 * $0.60 + 200 * $0.50 = $370.
d. Based on the calculations in part c. above, Angela should raise the price of her Jelly donuts to
$1.50.

1.38
a. Rachels cash outflow associated with Option 1 is $1,050 (airfare of $750 + one night
hotel stay for $175 + other expenses of $125). With Option 2, Rachels cash outflow
would be $725 (car rental of $150 + two nights hotel stay for $350 + other expenses
of $225).
b. The opportunity cost of Option 1 is the value of Option 2, which is ($725). The
opportunity cost of Option 2 is the value of Option 1, which is ($1,050).
c. The value of Option 2 is greater than its opportunity cost (i.e., $725 is lower in cost
than $1,050). Yes, Option 2 is better for her based on the expenses given.
d. Well, drives can be long and exhausting, and Rachel may not feel alert at the
conference. This is a cost that Rachel has to bear with the second option. She might
well feel that the extra $325 she has to spend is well worth avoiding strenuous
driving. On the other hand, often fights get canceled due to factors beyond ones
control. With driving, there is a little more control. This is an intangible benefit
associated with Option 2.

1.41
a. The opportunity cost of any option is the value of the next-best option. Assume Jon
could use the same color paint for another job. Whats Jons next-best option? The
 problem makes it clear that the paint is unique and has few, if any, alternative uses.
Given this, Jons opportunity cost of using the paint for another job is $0. This
estimate assumes that there is no cost to storing the paint.

b. Jons next-best option is to dispose of the paint at a cost of $40. Jon can avoid this
cost by using the paint for another job. Thus, the opportunity cost of using the paint
for another job is ($40). Jon should therefore be willing to pay someone up to $40 to
let him use the paint in their job.

c. The fact that Jon received a non-refundable advance of $350 does not change the
opportunity cost in any way. The revenue and the cash costs are past events and are
sunk. Both value and opportunity cost are forward looking because this amount
does not change relative to the status quo, the $350 is not relevant to the decision
at hand.

1.56
a. Compare selling 225 confirmed seats to selling only 210 seats. If the airline only sells
210 seats, then there is high likelihood that not all 210 passengers will show up. In
this case, the plane will have one or more empty seats. If these seats could be filled
with paying passengers, then the airlines profit increases there are few additional
costs associated with the extra passengers. The chance of lost profit due to empty
seats decreases as the airline sells more than 210 seats.

The airline must balance this cost with the cost of bumping passengers. If the airline
sells 225 tickets, then there is a chance that more than 210 passengers will show up.
The airline has to provide compensation to the bumped passengers. The additional
rewards (e.g., a travel certificate, hotel accommodations, meal vouchers, etc.) and
negative goodwill reduces the airlines profit.

Airlines use sophisticated models to estimate these two costs and to determine the optimal
number of seats to sell. (For instance, they would not sell 300 tickets on a 210 seat flight.)
Historical records help agents tailor the amount of overbooking to the time and the day of the
flight, as well as to the profile (business/vacation/family) of the average passenger.

b. If bumped, the passenger gives up the confirmed seat. The major cost of being
bumped is the convenience associated with traveling on the scheduled flight and
arriving earlier at the destination. This cost varies widely across passengers, resulting
in some rushing to the podium to claim their reward while others wait. For instance, a
college student going home for the holidays probably is more willing to give up the
seat than a businessperson attending an important meeting. That is, cost and value are
specific to each individuals goals.

c. Like the airline, the passengers are trading off benefits with sacrifices. Suppose the
current reward exceeds the costs associated with taking a later flight. You know (from
prior experience) that the reward increases with time. You therefore decide to wait to
 get the maximum possible reward. However, waiting has a cost. Another passenger
may volunteer before you and claim the (lower) reward. In this case, the option of
giving up your seat expires, and you have given up the chance to get a reward (which
had positive value). You must subjectively tradeoff these two factors when deciding
whether to claim the current reward or to wait for the next reward level.

Note: We consider expected costs and benefits, when unknown future events (will someone
else volunteer first?) affect our realized costs and benefits. The problem also illustrates the
role of uncertainty when making decisions.

d. If a passenger is involuntarily bumped, the cost of missing the scheduled flight

exceeds the offered reward. That is, the airline is imposing a cost on the passenger by
involuntarily removing them from the flight. This cost will translate into ill will,
damage to public image, and future lost business for the airline.

This cost varies across passengers. The potential cost is much higher if the airline
bumps a full fare-paying businessperson who travels every week than if the airline
bumps a discount-fare passenger who is traveling alone and who is not a frequent
flier. Bumping part of a group is more expensive (image wise) than bumping single
passengers. Individual circumstances again shape the airlines costs.

Naturally, airlines consider these variations when picking passengers to bump

involuntarily. Airlines develop detailed passenger profiles to help the ticket agent
select passengers the airlines options include the set of all passengers with
confirmed seats and the decision is which one to pick.

2.28
a. No, the tuition cost is not relevant as long as you have decided to enroll for the
semester.
b. Because the text book costs mush less and Class B is equally interesting and has the
same reputation as Class A.
c. Both classes A and B meet at the same time. So when choosing between Class A and
B the class time is not relevant. But Classes A and C meet at different times, so the
class time is relevant. Yes, the meeting time is relevant for the overall decision which
class to choose because it differs for one of the options.
2.37

a. The following table provides the required classifications, including a brief

explanation for each classification. We note that Olivia seems to be committed to
taking one job or the other thus, the status quo of doing nothing (not accepting
either job) does not appear to be a viable option.
Cost /Benefit Relevant? Rationale
 Salaries Yes The amount of the benefit differs
between Olivias two options.
Commissions Yes The benefit is available with one
option only the stereo store job.
Transportation No It is the same for both decision
options.
Rent and utilities No This cost is the same for both
options.

b. The following table shows the relevant costs and benefits:

Department
Cost/Benefit Store Stereo Store
Salary $640 $400
Commissions 0 300
Total $640 $700

Considering only relevant costs and benefits, we find that the Stereo Store job is
preferred by $60.

2.51
a. The following decision options are available to Gamma Machinery:
Option 1: Keep the current lathe and do not purchase the new lathe.
Option 2: Purchase the new lathe today for $400,000 and sell its current lathe
today for $170,000.
Option 3: Purchase the new lathe today for $400,000 and keep its current
lathe for two years.

For Gamma, the status quo is keeping its current lathe and not purchasing the new lathe.
Since this corresponds to option 1, the status quo is a feasible option.

b. The following cash flows are both controllable and relevant for option 2:
Controllable and Relevant Cash Flows Option 2:
Additional cash inflow of $130,000 per year from the new
lathe (= $250,000 $120,000) two years $260,000
+ Cash inflow from selling the existing lathe today $170,000
- Cash outflow to purchase new lathe ($400,000)

Thus, the value of Option 2, measured in terms of net cash inflows, = $30,000.
The following cash inflows and outflows are controllable for option 3.
Controllable and Relevant Cash Flows Option 3:
Additional cash inflow of $130,000 per year from the new
lathe (= $250,000 $120,000) two years $260,000
Cash inflow of $50,000 per year from operating the current
lathe two years $100,000
- Cash outflow to purchase new lathe ($400,000)

Thus, the value of Option 3, measured in terms of net cash inflows, = ($40,000).
Because option 2 has the highest value, this is Gammas best option. (as the status quo,
the value of option 1 = $0).
c. If the status quo is no longer feasible, controllability and relevance could differ. The
controllable costs and benefits for Gammas two options are identical to those we
computed in part [b].
In terms of relevant costs and benefits, the only items that differ between the two options
are the cash inflow from selling the existing lathe ($170,000) and the cash inflow from
operating the current lathe for the next two years ($100,000). While controllable, both the
cash outflow to purchase the new lathe ($400,000) and the cash inflow associated with
the new lathe ($260,000) are not relevant as they do not differ between Gammas two
options.
Session 2
5.33
a.
A 50% increase changes Ajays variable costs from $1.00 per package to $1.00 (1 +
.50), or $1.50 per package.
The original unit contribution margin = $3.00 - $1.00 = $2.00
The original breakeven volume = $600/2 = 300 packages.
Consequently, the revised unit contribution margin = $3.00 $1.50 = $1.50 per package.

Setting target profit to zero in the expression for profit, we obtain:

0 = $1.50 Breakeven volume $600.

$600
OR, Breakeven volume = = 400 packages.
$1.50
Or, Ajay has to sell 100 additional packages.

b. Writing-out Ajays profit in detail, we have:

Profit before taxes = (Price Unit variable cost) number of packages Fixed costs.

Substituting using the given data, we have:

$2,400 = (Price $1.00) 3,000 $600.

OR, Price = $2.00.

5.38

a. Since profit and taxes = $0 at the breakeven point, we know that the profit expression
reduces to:

$0 = $1.00 Breakeven volume $600,000.

Thus, Breakeven volume = 600,000 pounds.

b.
 SpringFreshs profit before taxes = ($1.00 750,000 pounds) $600,000 = $150,000.

Taxes paid = $150,000 .25 = $37,500.

Profit after taxes = $150,000 .75 = $112,500.

5.39
Profit after taxes = [(Unit contribution margin Quantity) Fixed costs] (1 Tax
rate).

$120,000 = [($1.00 Required volume in pounds) $600,000] .75.

Thus, Required volume = 760,000 pounds.

5.41

c.

For Arena, the contribution margin ratio is 1 0.30 = 0.70 (70% of billings).

Further, Arenas monthly fixed costs = $14,000 and the tax rate is 35%.

Consequently, Arenas monthly profit is:

Profit after taxes = [(.70 Billings) $14,000] .65.

At the breakeven point, profit after taxes = profit before taxes = $0 (i.e., no tax is due
because there is no profit). Consequently, we have (since the tax rate is irrelevant at
breakeven):

$0 = (0.70 Breakeven revenue) $14,000.

Solving, we find breakeven billings = $20,000.

d. Using the profit expression in [a], we have:

Profit before taxes = (0.70 $50,000) $14,000 = $21,000.

 Profit after taxes = $21,000 .65 = $13,650.

e. Again, using the profit expression in (a), we have:

$7,280 = [(0.70 Required billings) $14,000] .65.

Required billings = $36,000.

5.43

Employing the CVP relation, we can compute the profit at alternative prices to determine
the price that yields the maximum profit. The following table contains the detailed
computations.

Variable
Price Revenue Costs Fixed Costs Profit
$32.50 $9,750 $1,800 $3,000 $4,950
$30.00 $10,500 $2,100 $3,000 $5,400
$27.50 $11,000 $2,400 $3,000 $5,600
$25.00 $11,250 $2,700 $3,000 $5,550
$22.50 $11,250 $3,000 $3,000 $5,250

By inspection, we find $27.50 to be the profit-maximizing price. Greg earns $5,600 in profit
at this price.

5.46
f. Let us employ a weighted unit contribution margin approach to solve the problem.
For Mountain Maples, we have:

2,400 total trees sold 800, or 1/3 are Butterfly, and 1,600, or 2/3, are Moonfire. Thus,
we have:

Weighted unit contribution margin = 1/3 $100 + 2/3 $50.

= $66.67.

In turn, Mountain Maples profit becomes:

Profit before taxes = ($66.67 total number of trees sold) $75,000.

At the breakeven point, we have: $0 = ($66.67 Breakeven number of trees) $75,000.

Solving, we find that the total number of trees sold to breakeven = 1,125.
 Of these, 1,125 1/3 = 375 Butterfly; 1,125 2/3 = 750 Moonfire.

g. Using the weighted unit contribution margin approach, we have:

$50,000 = ($66.67 total number of trees) $75,000.

The total number of trees = 1,875.

Of these, 1,875 1/3 = 625 are Butterfly, and

1,875 2/3 = 1,250 are Moonfire

h. The change in the product mix affects Mountain Maples weighted contribution.

With the new information, we have:

Weighted contribution margin = (.50 $100) + (.50 $50)

= $75.00

The weighted contribution margin is higher than in part [a] because the product mix has
shifted toward Butterfly, which has the highest contribution margin per tree.

Consequently, the total number of trees required to break even will decrease:

0 = ($75.00 Breakeven number of trees) $75,000.

Breakeven number of trees = 1,000.

Of these, 1,000 .50 = 500 are Butterfly, and

1,000 .50 = 500 are Moonfire

5.48

a. In this setting, we must use the weighted contribution margin ratio approach given the
absence of unit-level data. Accordingly,:

Profit before taxes = (RevenueN Contribution margin rationN) +

(RevenueU Contribution margin ratioU) Fixed costs,

The subscripts N and U stand for new and used. Additionally, we know that
$1,500,000/$2,000,000, or 75% of the revenue is from new cars, and
$500,000/$2,000,000, or 25% of the revenue is from used cars.
 Further, we can calculate the contribution margin ratio for each product using the
product-level financial data. We have:

1,500,000 750,000
(Contribution margin ratio)N = = .50.
1,500,000

500,000 200,000
(Contribution margin ratio)U = = .60.
500,000

Thus, the weighted contribution margin ratio = (.50 .75) + (.60 .25) = .525.

We can now write Selects profit in terms of the weighted contribution margin ratio and
total revenues:

Profit before taxes = (.525 Total revenue) $840,000.

Setting profit equal to $0, we find:

Breakeven total revenue = $1,600,000.

This translates into $1,600,000 .75 = $1,200,000 in new auto sales and $1,600,000
.25 = $400,000 in used auto sales.

b. To answer this question, we plug in our desired profit in the equation for profit
developed in part [a]. We now have:

$1,050,000 = (.525 Total revenue) $840,000.

Solving, we find:

Total revenue = $3,600,000.

This translates into $3,600,000 .75 = $2,700,000 in new auto sales and $3,600,000
.25 = $900,000 in used auto sales.

5.62
i. Tornados profit for the most recent year can be calculated as follows:

F1 F3 F5 Total
Revenues* $3,750,000 $3,000,000 $4,000,000 $10,750,000
Variable costs** $1,875,000 $1,650,000 $2,400,000 $5,925,000
Contribution margin $1,875,000 $1,350,000 $1,600,000 $4,825,000
Fixed costs $3,860,000
Profit $965,000

* = quantity sold selling price per unit

** = quantity sold variable cost per unit

j. There are at least two ways to answer this question. The longer and more tedious way
is to convert the increase (decrease) in sales to units for each of the three alternatives
i.e., assume that Tornado focuses its advertising campaign on the F1, F3, or F5
market. We can then multiply the sales quantities by the appropriate contribution
margin to compute the net increase in margin under each alternative. Naturally, we
select the option with the highest margin.

The second, and more straightforward, approach is to use contribution margin ratios
which deal with dollars directly. Using the given data, we have:

F1 F3 F5
Selling price per unit $150 $200 $400
Variable cost per unit $75 $110 $240
Contribution margin .50 .45 .40
ratio*

* = (unit selling price unit variable cost)/ unit selling price

That is, an increase of $1 in sales yields the greatest contribution if it is from the F1
market. Consequently, it makes most sense for Tornado to focus its campaign on the F1
market. The net effect on profit will be:

Gain from F1 market $300,000 .50 $600,000

Loss from F3 market ($27,000) .45 $60,000
Loss from F5 market ($24,000) .40 $60,000
Increase in fixed costs ($150,000) given
Net increase in profit $99,000

The skeptical student may wish to construct tables assuming the advertising campaign
were focused on the F3 or F5 market to verify that the strategy of focusing on these
markets indeed leads to lower profit than focusing on the F1 market.

This problem is useful in highlighting the difference between unit contribution margins
and contribution margin ratios. The unit contribution margin calculates the absolute
profit, and the contribution margin ratio calculates profitability. Thus, we see that
although the F5 has the largest contribution margin and, thus, on a per unit basis
contributes the most to absolute profit, it has the lowest profitability per $1 of sales.

k. Management is making a number of assumptions. First, they are assuming that the
advertising campaign will work and lead to a substantial increase sales for the
 targeted vacuum cleaner. Second, by assuming that the increase in revenue will be
constant at $600,000 regardless of the vacuum cleaner chosen, management is
assuming that the demand kick in units will be smallest for the F5 and largest for
the F1 (the F3 will be in the middle). Specifically, estimated demand for each vacuum
cleaner, should it be selected is:

F1: $600,000/150 = 4,000 units.

F3: $600,000/200 = 3,000 units.

F5: $600,000/400 = 1,500 units.

These proportions are roughly comparable to the current sales mix. Moreover,
management is assuming that the market is thinner for the F1 and thicker for the F5
this assumption makes some sense since, ceteris paribus, as price increases we expect
quantity demanded (in aggregate) to decrease, particularly when there are substitute
products available.

Finally, management is assuming that the advertising campaign will cannibalize existing
sales in other words, if the advertising campaign were targeted toward the F3 market,
some consumers who would have purchased the F1 or the F5 would, instead, purchase
the F3. Again, the constant loss in revenue assumption stipulates that fewer F5 customers
will defect than F1 customers, and so on. Moreover, this assumption reflects that while
the vacuum cleaners are, to some extent, substitutes, the elasticity of demand likely
differs across the products.
Session 3

5.44

a. Ones first inclination is to compare the profit across the various popcorn machines.
However, for the same number of customers, revenue is equal across the three machines.
Thus, we can rank order popcorn machines according to their total costs. In other words,
the problem can be formulated as a cost minimization problem as the machine that
minimizes cost also maximizes profit.

We start by assessing the number of patrons at which the small popcorn machine will
cost the same as the medium popcorn machine. We have:

$6,000 + (0.50 number of patrons) = $12,000 + (0.35 number of patrons).

$6,000
The number of patrons at which the cost is the same = = 40,000.
.15

Thus, when a theater expects less than 40,000 moviegoers a year (or approximately 110
per day), it is optimal to rent the small popcorn machine.

Comparing the medium and the large popcorn machines, we have:

$12,000 + (0.35 number of patrons) = $18,500 + (0.25 number of patrons).

$6,500
The number of patrons at which the cost is the same = = 65,000.
.10

Thus, when a theater expects more than 65,000 moviegoers a year (or approximately 178
per day), it is optimal to rent the large popcorn machine.

Additionally, the above analysis informs us that when a theater expects between 40,000
and 65,000 moviegoers a year, it is optimal to rent the medium popcorn machine.

Thus, we have the following decision rule:

Midwest Cinema Theaters

Popcorn Machine Rental Model
Annual # of Moviegoers (M) Popcorn Machine Size
M < 40,000 Small
40,000 < M < 65,000 Medium
M > 65,000 Large

Note: Instructors also may wish to graphically represent the tradeoff this is perhaps
best accomplished by asking students to graph, for each size popcorn machine, how
 popcorn costs (y-axis) varies as a function of the number of patrons (x-axis). This allows
students to see where the lines cross The instructor can then shade the low cost frontier
to see how the preferred machine depends on expected volume.

b. Operating leverage = Fixed costs/Total costs

= Fixed costs/(Fixed costs + Variable costs).
For each popcorn machine, we have:

Fixed Costs Variable Costs Operating Leverage

Small $6,000 $32,500 .1558
(= 65,000 $0.50)
Medium $12,000 $22,750 .3453
(= 65,000 $0.35)
Large $18,500 $16,250 .5323
(= 65,000 $0.25)

As discussed in the text, operating leverage frequently is used as a measure of risk

ceteris paribus, the higher the operating leverage, the higher the risk. Thus, while we see
that the large popcorn machine is preferred for volumes of 65,000 moviegoers and
higher, it also carries the highest risk, a factor that Leticia may wish to consider in her
decision.

5.54

a. To calculate breakeven revenue, we start with the profit calculation using the
contribution-margin ratio:

Profit = (Contribution margin ratio Revenue) Fixed costs.

Setting profit = $0,

Breakeven revenue = Fixed costs/Contribution margin ratio.

Given the information in the problem for each cost structure, we have:

Monthly breakeven revenue under current cost structure:

Fixed costs $36,000 per month

Contribution margin ratio 40%

Breakeven Revenue $36,000/0.40 = $90,000

 Monthly breakeven revenue under new cost structure:

Fixed costs $60,000 per month

Contribution margin ratio 60%

Breakeven revenue $60,000/0.60 = $100,000

Thus, Cecelias breakeven revenue will increase by $10,000 if she acquires the new
machines. Even though her contribution margin ratio increases (which, ceteris paribus,
pushes the breakeven point down) by acquiring the new machines, the substantial
increase in fixed costs drives the breakeven point up.

b. As in part [a], the profit is:

Profit = (Contribution margin ratio Revenue) Fixed costs.

We now plug in the various parameters to determine profit under each cost structure.

Current cost structure:

Profit at $95,000 in revenue = (0.40 $95,000) $36,000 = $2,000.
Profit at $150,000 in revenue = (0.40 $150,000) $36,000 = $24,000.

New cost structure:

Profit at $95,000 in revenue = (0.60 $95,000) $60,000 = ($3,000).
Profit at $150,000 in revenue = (0.60 $150,000) $60,000 = $30,000.

Thus, Cecelia prefers her current cost structure if monthly revenues are expected to be
$95,000, and she prefers to acquire the new machines if revenues are expected to be
$150,000.

c. We can find this point of indifference, or crossover point, by equating the profit
equation under the two cost structures and solving for revenue. Let the required
revenue level be $R. The profit at $R is:

Current cost structure: (0.40 $R) $36,000.

New cost structure: (0.60 $R) $60,000.

Equating the two profit equations, we have:

(0.40 $R) $36,000 = (0.60 $R) $60,000.

 $R = ($60,000 $36,000)/(0.60 0.40) = $120,000.

With $120,000 of revenue, Cecelia makes the same profit of $12,000 with either cost
structure. Also notice that for sales greater than $120,000, Cecelia prefers to acquire the
new machines whereas for sales less than $120,000 Cecelia prefers her current cost
structure. That is, the slope of the profit line is higher under the new cost structure than
the old cost structure. Instructors may wish to graph the two cost structures to illustrate
this point.

6.32
a. Magic Maids decision appears to feature both excess supply and excess demand. It is
likely that Magic Maids fixed overhead costs (rent and administrative salaries) will
not change due to the special job it appears that there is enough administrative
capacity to handle the job. There is excess demand for cleaning supplies; if the
current jobs do not use up available stock, the firm could store the supplies for use
later. Finally, there might be limited excess capacity for some resources. If 60% of
the job could be completed during normal business hours, then the company clearly
has some slack and excess capacity in terms of labor hours. For the remaining 40% of
the job, however, Magic Maids employees will have to work overtime thus, there
is excess demand for this input. This shows us that different resources in the firm
have differing capacity levels a decision may impose constraints on one resource
but not another. We have to consider the opportunity cost of each resource when
computing the total cost of a job.

Note: A precise definition of capacity is at the level of individual resources. Thus, when
computing the cost of an option, we have to consider opportunity costs at the level of
individual resources.

b. The following table details the incremental cost associated with cleaning the 150
offices, compared to the status quo of not cleaning the offices:

Item Detail Amount

Cleaning materials 150 offices 12.50 per office 1,875
Labor1 150 3 .40 15 1.5 4,050
Variable overhead 150 offices 7.50 per office 1,125
Incremental cost 7,050

1
: There are 150 offices that need to be cleaned, and each office requires 3 hours to
clean. Since 60% of the job could be completed during regular business hours, Magic
Maids will only have to provide extra remuneration for 40% of the hours. Further,
employees are paid 1.50 times their hourly wage of 15 for each overtime hour
worked.
 Note that fixed overhead, which is comprised of rent and administrative salaries, is not
relevant as it is very unlikely that the total amount of fixed overhead will change if Magic
Maids accepts the engagement.

Magic Maids incremental cost associated with cleaning the conglomerates 150 offices
amount to 7,050.

c. Magic Maids can use the cost number for pricing the local conglomerates request to
clean the 150 offices. 7,050/150 = 47 per office likely would represent the
minimum price that Magic Maids would charge. This price is well below Magic
Maids normal price of 120.

The actual price charged will consider other factors. For instance, the clients other
options become relevant. If this is a one-time deal with no prospect of repeat business,
then Magic Maids might well charge a premium over the normal price. The prospect of
getting a foot in the door to bid for future business would push the price downward.
Long-term implications also matter. If the conglomerate becomes part of Magic Maids
client base, then the company likely would wish to make sure that the price charged in
the long term would cover all incremental costs (measured over the long term), and not
only the incremental costs measured over the short-term.

6.44
d. The key is to realize that Justine has excess demand as the pumps currently use all
available capacity. Thus, taking the order requires Justine to give up some pumps. At
500 valves x 3 hours per valve, the valve order will consume 1,500 hours. Dividing
the total 10,000 hours available by the total production of 2,500 pumps, Justine
calculates that it takes 4 hours to produce a pump. At this rate, 1,500 hours can be
used to make 375 pumps. Justine divides the $125,000 in monthly contribution by
2,500 pumps to calculate that each pump yields $50 in contribution margin. Thus, we
have:

Contribution from Valves 500 valves $30 per valve $15,000

Less: Lost contribution from pumps 375 pumps $50 per pump 18,750
Net change in profit ($3,750)

Justine will lose $3,750 if it takes the order. The fixed costs of $75,000 (CM of $125,000
profit of $50,000) are not relevant for this decision.

Alternate approach

We could also solve the problem by examining the contribution per labor hour. Each
pump yields a contribution of $50 / 4 hours = $12.50 per labor hour. In turn, each valve
yields a contribution of only $30/3 hours = $10 per labor hour. Accepting the valve order
diverts resources toward less profitable uses. Because 1,500 hours would be diverted, the
loss is 1,500 hours ($12.50 $10.00) per hour = $3,750.
 e. Profit will be unchanged if valves also contributed $18,750 to profit. Thus, the
contribution margin per valve should be $18,750/500 valves = $37.50 per valve.

Alternately, profit will be unchanged if valves also contribute $12.50 per labor hour. As
each valve consumes three hours, the minimum contribution margin is $12.50 x 3 hours =
$37.50 per valve.

6.45
f. The traditional allocation of a sales persons 125 hours would lead to the following
revenue per month for a typical sales territory:

Customer
Type # of Time Total Time Revenue Total
Customers per Visit Time* Left** per Visit Revenue
Large 10 5 hours 50 hours 75 hours $45,000 $450,000
Medium 25 2 hours 50 hours 25 hours $30,000 $750,000
Small 25 1 hour 25 hours 0 $15,000 $375,000
$1,575,000
Total Revenue

* = (# of customers) (Time per visit).

** = 125 hours cumulative total time.
Thus, the typical sales person generates monthly revenue of $1,575,000.
g. The key to Treys success is to realize that time is a scarce resource. Since sales
persons cannot visit all potential customers, the revenue-maximizing strategy
prioritizes customers by their revenue per hour of time (spent in visits). As shown
below, this ranking changes the traditional ordering of customers:
Customer Time Revenue Revenue per
Type per Visit per Visit Hour of Time
Large 5.0 hours $45,000 $9,000
Medium 2.0 hours $30,000 $15,000
Small 1.0 hours $15,000 $15,000

Thus, medium and small customers should get top priority because they generate $15,000
in revenue per hour of time spent whereas large customers generate only $9,000 in
revenue per hour of time spent.
Such an allocation leads to the following revenue per month:

Customer
Type # of Time Total Time Revenue Total
Customers per Visit Time* Left** per Visit Revenue
Medium 25 2 hours 50 hours 75 hours $30,000 $750,000
Small 50 1 hour 50 hours 25 hours $15,000 $750,000
Large 5* 5 hours 25 hours 0 $45,000 $225,000
 $1,725,000
Total Revenue
* = (# of customers) (Time per visit).
** = 125 hours cumulative total time.

Thus, we see why Trey is SuperSounds top sales person he generates revenue of
$1,725,000, or $1,725,000 $1,575,000 = $150,000 more than other sales persons.
Moreover, Trey optimally allocates his time across SuperSounds customer base.

Note: Does prioritizing by sales per visit hour maximize not only revenue but also
company profit? The answer is it depends such a strategy also maximizes profit only
if the contribution margin ratio is the same for all three customer types. If different
customer groups order a different mix of products (resulting in different contribution
margin ratios), the firm needs to prioritize customers by their contribution per visit hour
to maximize profit.

Note (advanced): Instructors could also use this problem to underscore the agency
conflict and choice of performance measures. For instance, the provided solution of
maximizing revenue might be optimal from the sales persons perspective if their
incentives are based on revenue. However, the effort allocation might not be optimal
from the firms perspective. The store can manage this discrepancy by compensating the
sales person based on contribution margin. However, there is more room for dispute in
measuring contribution margin, which reduces its value as a performance measure.
Formally, while contribution margin aligns incentive more (is more congruent), it also is
harder to measure (has greater noise) than revenue.

6.54
a. In this problem, it is important to recognize that all of the common fixed costs
allocated to the dry cleaning operations would not disappear if the dry cleaning
business were to be closed. Specifically, the dry cleaning business currently generates
a segment margin of $300,000 ($800,000 $500,000). This margin would not be
available if the dry cleaning business were to close. However, the common fixed
costs would decrease by $200,000; thus, the net reduction in profit is $300,000
$200,000 = $100,000. That is, SpringFreshs profit will decrease by $100,000 to
$200,000 if it eliminates the dry cleaning department.

This effect is perhaps most easily seen (and verified) by constructing an income
statement without the dry cleaning business. We present such an income statement
below:

Laundry Only
Revenue $3,000,000
Variable costs $1,000,000
Contribution margin $2,000,000
Direct fixed costs $1,000,000
Common fixed costs* $800,000
 Profit $200,000

* = $1,000,000 $200,000.

Again, we see that SpringFreshs overall profit decreases by $100,000 to $200,000.

Assuming the accuracy of the estimate of the reduction in common fixed costs,
SpringFresh should not eliminate its dry cleaning operations.

This particular problem underscores that income statements can be misleading in terms of
what a particular department or product actually contributes to overall profitability. The
key in making this assessment is determining what revenues and costs actually disappear
if the department is eliminated.

b. Increasing the volume of laundry will increase the contribution margin available to
cover fixed costs. Based on the data provided, we find that each $1.00 of revenue in
laundry provides $0.67 in contribution margin ($2,000,000 in contribution margin
divided by $3,000,000 in revenue). Thus, an increase of 10% in laundry sales will
increase the laundry contribution margin by 10% as well. This implies that the
laundry contribution margin will increase to $2,200,000. Our revised income
statement with laundry only looks as follows:

Laundry Only
Revenue $3,300,000 $3,000,000 1.1
Variable costs $1,100,000 $1,000,000 1.1
Contribution margin $2,200,000 $2,000,000 1.1
Direct fixed costs $1,000,000
Common fixed costs* $800,000 $1,000,000 $200,000
Profit $400,000

Here, we see that SpringFreshs overall profit increases by $100,000 to $400,000.

Assuming the accuracy of the estimates, SpringFresh should eliminate its dry cleaning
operations as profit increases.

In constructing this income statement, however, notice the assumption that neither the
traceable fixed costs nor the common fixed costs would increase if the volume of laundry
were to increase by 10%. This is a questionable assumption. Management judgment is
key in determining whether the increase in the fixed costs, if any, would exceed
$100,000, or the expected net increase in the firms profit.
Session 4

9.33
a. The following table provides the required income statements.

Contribution Margin Statement

Item Amount Amount
(current year) (next year)
Revenue $1,500,000 $1,700,000
Cost of Goods sold (25% of sales) 375,000 425,000
Contribution $1,125,000 $1,275,000
Fixed costs 900,000 900,000
Profit before taxes $ 225,000 $ 375,000

Notice that fixed costs remain at $900,000 even though the volume of operations has
increased. This is a reasonable assumption while fixed costs might increase some, they
are not likely to increase dramatically because of a modest increase in sales. Further, the
recent hire implies that David has just crossed a step.

b. The following table provides the required statement.

Contribution Margin Statement

Item Amount Amount
(current year) (next year)
Revenue $1,500,000 $2,800,000
Cost of Goods sold (25% of sales) 375,000 700,000
Contribution $1,125,000 $2,100,000
Fixed costs 900,000 1,600,000
Profit before taxes $ 225,000 $ 500,000

Our view of fixed costs changes based on the volume of operation. David seems to have
a normal range of operations of about $1.5 million. His fixed costs of $900,000 support
operations at this level. However, the capacity provided by this expenditure is unlikely to
support a much higher volume of sales. For instance, David might need to make more trips,
spend more on stocking and tracking inventory, hire additional sales persons, open a branch
outlet, and so on. All of these actions contribute to higher fixed costs.

This problem reinforces that fixed costs are fixed only for a given volume of operations
and for a given time frame. These costs do become controllable if we significantly change
the volume of operations or consider a long time frame. In Davids case, estimating the
higher fixed cost might be hard. One reasonable approach is to say that fixed costs are 60%
of sales revenue ($900,000/$1,500,000). Then, at a volume of $2.8 million in sales, David
would estimate fixed costs at $1,680,000.
 Note: Part (b) provides an estimate of $1.6 million toward fixed costs. The difference
underscores that using an allocation to project capacity costs assumes that the underlying
relation would be the same. In Davids case, it is likely that, because of scale economies,
fixed costs do not increase proportionately with sales volume. Methods such as direct
estimation are better equipped to deal with such effects, but require more effort and
expertise.

9.35
a.

Let us begin by constructing the income statement. The allocation rate is

$1,400,000/300,000 units = $4.66667 per unit. We have (rounding the common fixed cost
numbers down to the nearest $):

Standard Deluxe Total

Number of units 250,000 50,000 300,000

Revenue $3,500,000 $900,000 $4,400,000

($14 250,000; $18 50,000)
Variable costs 2,000,000 450,000 2,450,000
($8 250,000; $9 50,000)
Contribution margin $1,500,000 $450,000 1,950,000
Common fixed costs 1,166,667 233,333 1,400,000
($4.66667 per unit)
Profit before taxes $ 333,333 $ 216,667 $550,000

Let us repeat the exercise with the new product mix. Notice that the common cost for each
segment now is the new product volume the allocation rate of $4.66667 per unit. We
have:

Standard Deluxe Total

Number of units 150,000 150,000 300,000

Revenue $2,100,000 $2,700,000 $4,800,000

Variable costs 1,200,000 1,350,000 2,550,000
Contribution margin $900,000 $1,350,000 2,250,000
Common fixed costs* 700,000 700,000 1,400,000
Profit before taxes $ 200,000 $ 650,000 $850,000
* The new product mix consists of 50% Standard and 50% Deluxe. Thus, we allocate
50% of the common fixed costs to each product (50% $1,400,000 = $700,000)

b.
Let us repeat the exercise with the new product mix. We have to compute the allocation
rate for labor hours though. Using the data for the current year, we have total cost =
$1,400,000 and total labor hours = (2 hrs 250,000 units) + (50,000 units 4 hours per
 unit) = 700,000. Thus, the rate is $2 per labor hour ($1,400,000/700,000). With this rate,
the following table provides the projected income statement. Notice that the common cost
for each segment now is the new product volume number of labor hours per product
the allocation rate of $2 per labor hour.

Standard Deluxe Total

Number of units 150,000 150,000 300,000

Revenue $2,100,000 $2,700,000 $4,800,000

Variable costs 1,200,000 1,350,000 2,550,000
Contribution margin $900,000 $1,350,000 2,250,000
Common fixed costs 600,000 1,200,000 1,800,000
($2 2 150,000; $2 4
150,000)
Profit before taxes $ 300,000 $ 150,00 $450,000

c.
We believe that the pessimistic estimate in part (b) is likely more accurate than the
optimistic estimate in part (a). This is because the allocation in part (a) assumes that each
product, whether it is standard or deluxe, consumes the same amount of capacity resource.
This is not likely a good assumption because the deluxe product takes twice the amount of
labor taken to make a standard product. While some costs surely vary by units, other costs
(perhaps the majority of costs) bear a closer relation to labor hours. Thus, neither the
estimate in part (a) nor the estimate in part (b) is likely to be accurate. However, the
estimate in part b (using labor hours as the basis) is likely more accurate. Based on
this analysis, Bradshaw might rethink its decision to alter its product mix.

9.44
a.
Contribution margin is price less all variable costs. For Xenon, variable costs include
materials, labor, and variable overhead. We know the cost of materials and labor but need
allocations to determine the cost of variable overhead.

Total variable overhead costs = 1/3 of total overhead = 1/3 $1,500,000 = $500,000.

Dividing through by the total labor cost, we have:

Variable overhead per labor $ = $500,000/$1,000,000 = $0.50/labor $.

Because the pump has $30 of labor cost, Xenon will allocate $30 $0.50 = $15 toward
variable overhead.

Collecting this information, we have:

Sales Price $90.00 per unit Given

 Less: Materials 12.00 Given
Labor 30.00 Given
Variable overhead 15.00 $30.00 $0.50 / labor $
Equals: Contribution margin 33.00 per unit

b.
Gross Margin is price less all manufacturing related costs, including variable and fixed
overhead. We know the cost of materials and labor but need allocations to determine the
cost of variable and fixed overhead.

From part [a], we know that variable overhead rate is $0.50 per labor $.

Additionally, total fixed overhead costs = 2/3 of total overhead = 2/3 $1,500,000 =
$1,000,000.
Dividing through by the total labor cost, we have:

Fixed overhead per labor $ = $1,000,000/$1,000,000 = $1.00/labor $.

Because the pump has $30 of labor cost, Xenon will allocate $30 $1.00 = $30 per pump
toward fixed overhead.

Collecting this information, we have:

Per Pump
Sales Price $90.00 Given
Less: Materials 12.00 Given
Labor 30.00 Given
Variable overhead 15.00 $30.00 $0.50/labor $
Fixed overhead 30.00 $30.00 $1.00/labor $
= Inventoriable cost 87.00
Equals: Gross Margin $3.00

Note: While the gross margin on Xenons pump is lower than its contribution margin,
this is not always the case. For example, the gross margin could exceed the contribution
margin if allocated fixed manufacturing costs are less than variable selling costs.

c.
Now, Xenon has to compute two separate fixed overhead rates, corresponding to the two
cost pools. We have:
Costs Denominator Rate
Volume
Materials related pool $240,000 $600,000 $0.40 / materials $
Labor related pool $760,000 $1,000,000 $0.76 / labor $
 Using these rates, we compute:
Per Pump
Sales Price $90.00 Given
Less: Materials & components 12.00 Given
Labor 30.00 Given
Variable overhead 15.00 $30.00 $0.50 / labor $
Fixed overhead (materials) 4.80 $12.00 $0.40 / material $
Fixed overhead (labor) 22.80 $30.00 $0.76 / labor $
= Inventoriable cost 84.60
Equals: Gross Margin $5.40

We can understand the difference in gross margins (inventoriable costs) by appealing to the
property that the allocated cost is proportional to the driver volume in a cost object. When
Xenon allocates cost using labor $, the overhead allocated to the pump is a multiple of the
labor $ in the pump. The percent of overhead allocated to the pump equals the percent labor
contained in the pump.

Globally, materials cost is 60% of labor cost (60% = $600,000/$1,000,000), meaning that
an average product has $0.60 of materials cost for each $1 of labor cost. However, the
pumps only have $12 of materials for $30 of labor, meaning that pumps use
proportionately less materials than the average product ($12/$30 = 40%). The ratio of
the pumps materials cost to total materials cost is therefore smaller than the ratio
of the pumps labor cost to total labor cost. Thus, when Xenon breaks out some
overhead (in this case $240,000) and allocates this amount using materials $, the amount
allocated to the pumps will decrease. Naturally, inventoriable cost also decreases, thereby
increasing gross margin.

9.53
a.
Let us begin by calculating unit contribution and profit margins.

Item Standard Custom

Price $130 $175
Unit Contribution margin $65 $105
Unit profit margin $25 $65
Variable cost = (1- CMR) * price $65 $70
Allocated fixed cost = Contribution $40 $40
margin profit margin

Comparing the allocated fixed cost for the Standard and the Custom products, it seems that
Sunder employs the number of units as the allocation basis. This is the mechanism that
would lead to an identical allocated amount for each product. (If Sunder used machine
hours instead, the custom product should receive twice the allocation received by the
standard product.)
Also notice that Sunders total profit is (75,000 $25) + (25,000 $65) = $3,500,000.

b.
We now need to calculate the rate per machine hour. For this calculation, we need the total
overhead cost and the total number of machine hours.

We can use the allocated rate per unit (in part a) to back out total overhead. The rate is $40
per unit and there are 100,000 units (= 75,000+25,000). Thus, the overhead cost must be
100,000 $40 = $4,000,000. We compute total machine hours as (75,000 standard 2
hours /unit) + (25,000 deluxe 4 hours /unit) = 250,000 hours. Combining the two
estimates, we have the rate per machine hour as $16 per machine hour. Thus, we have:

Item Standard Custom

Price $130 $175
Variable cost $ 65 $ 70
Unit Contribution margin $ 65 $105
Allocated fixed cost $ 32 $ 64
(2 hours $16 ; 4 hours $16)
Unit profit margin $ 33 $ 41

Notice that the profit margin for the standard product has increased from $25 to $33 while
that for the custom product has decreased from $65 to $41. However, Sunders total profit
is still (75,000 * $33) + (25,000 * $41) = $3,500,000. This equivalence emphasizes that the
allocation only divides the cost. The total is unaltered.

c.
The following table provides the required information. Notice that we treat capacity costs
as controllable for this decision. As the number of units changes, the capacity costs change
proportionately because the rate per unit stays the same.

Item Standard Custom

New Units 50,000 50,000
Profit Margin per unit $ 25 $ 65
Total profit $1,250,000 3,250,000

Thus, Sunder expects to make $4,500,000 in profit with the new product mix. Also, notice
that total capacity costs stay at $4,000,000 although we changed the mix. We get this result
because the total number of units did not change even though the mix changed. Further, our
allocation scheme is as if each unit consumes the same amount of capacity resources,
regardless of the type of product.
 Based on this projection, changing the product mix appears to be a good idea as it increases
expected profit.

d.
The following table provides the required information. Notice that we treat capacity costs
as controllable for this decision. As the number of units made changes, the capacity costs
change proportionately because the rate per unit stays the same.

Item Standard Custom

New Units 50,000 50,000
Profit Margin per unit $ 33 $ 41
Total profit $1,650,000 2,050,000

Thus, Sunder expects to make $3,700,000 in profit with the new product mix. Also notice
that total capacity costs increases to $4,800,000. Total machine hours are (50,000 2) +
(50,000 4) = 300,000 hours, and the rate is $16 per machine hour.

Even though the total number of units did not change, the change in mix increased the
number of machine hours, increasing the total expected capacity cost.

While switching product mix still increases profit, the idea is not so compelling now. The
change in results underscores the importance of picking the right driver to estimate the
change in capacity costs. In this instance, machine hours probably are better suited as
deluxe products seem to require more work than standard products do.

9.54
:a.
Residential Commercial Total
Number of customers 200 300 500
Number of pickups per week 200 300 5 = 1,500 1,700
Revenue* $320,000 $3,600,000 $3,920,000
Variable costs* 56,000 720,000 776,000
Contribution margin $264,000 $2,880,000 3,144,000
Traceable fixed costs 150,000 225,000 375,000
Segment margin $114,000 $2,655,000 $2,769,000
Common fixed costs NA NA 1,100,000
Profit before taxes $1,669,000
* Residential Revenue = 200 ($800,000/500 customers)
Commercial Revenue = 300 ($1,200,000/100 customers)
* Residential Variable costs = 200 ($140,000/500 customers)
Commercial Variable costs = 300 ($240,000/100 customers)
b.
Let us first construct the allocation rates. We have $1.1 million in common fixed costs and
$2 million in total revenue. Thus, the allocation rate (for charging to segments) is $1.1/$2.0
= 55% of revenue. With this rate, we have the current income statement as:

Residential Commercial Total

Number of customers 500 100 600
Number of pickups per week 500 500 1,000
Revenue $800,000 $1,200,000 $2,000,000
Variable costs $140,000 $240,000 $380,000
Contribution margin $660,000 $960,000 1,620,000
Traceable fixed costs 150,000 225,000 375,000
Segment margin $510,000 $735,000 $1,245,000
Common fixed costs 440,000 660,000 1,100,000
($800,000.55;$1,200,000.55)
Profit before taxes $70,000 $75,000 $ 145,000

Now, let us re-do the income statement, except let us assume that both segment and
common fixed costs vary in proportion to sales revenue. That is, sales revenue is the driver
for fixed costs. Then, as we calculated above, the rate for common fixed costs is 55% of
revenue. With respect to traceable fixed costs, the rates are $150,000/$800,000 = 18.75%
for residential customers and $225/$1,200 = 18.75% for commercial customers.

With these rates, we have:

Residential Commercial Total

Number of customers 200 300 500
Number of pickups per week 200 300 5 = 1,700
1,500
Revenue $320,000 $3,600,000 $3,920,000
Variable costs 56,000 720,000 776,000
Contribution margin $264,000 $2,880,000 3,144,000
Traceable fixed costs 60,000 675,000 735,000
($320,000.1875;$3,600,000.1875)
Segment margin $204,000 $2,205,000 $2,409,000
Common fixed costs 176,000 1,980,000 2,156,000
($320,000.55;$3,600,000.55)
Profit before taxes $ 28,000 225,000 $253,000

While profit increases relative to current levels, it is substantially lower than the estimate in
part (a). The key difference, of course, is framing the problem as a long-run instead of a
short-term problem. This change means that fixed costs are potentially controllable, and we
estimate the new level using sales revenue as the cost driver.

c.
Now, let us re-do the income statement, except let us assume that both segment and
common fixed cost vary in proportion to the number of pickups. That is, pickups are the
driver for fixed costs. Then, the rate for common fixed costs is $1,100,000/1,000 = $1,100
per weekly pick up. With respect to traceable fixed costs, the rates are $150,000/500 =
$300 per weekly residential pickup and $450 per weekly commercial pickup.

With these rates, we have:

Residential Commercial Total

Number of customers 200 300 500
Number of pickups per week 200 300 5 = 1,500 1,700
Revenue $320,000 $3,600,000 $3,920,000
Variable costs 56,000 720,000 776,000
Contribution margin $264,000 $2,880,000 3,144,000
Traceable fixed costs* 60,000 675,000 735,000
Segment margin $204,000 $2,205,000 $2,409,000
Common fixed costs* 220,000 1,650,000 1,870,000
Profit before taxes $ (16,000) $ 555,000 $539,000

d.
The estimate in part (a), $1,669,000, is not reliable. The estimate assumes that capacity
costs would not change either in response to the change in the product mix or the change in
sales volume. This assumption seems odd because it is likely that commercial and
residential customers differ in terms of their resource demands. For example, commercial
clients need five times as many pickups as residential clients.

The estimates in parts (b) and (c) compute the expected change in capacity costs by using
allocations. However, they differ in terms of the driver used. It is difficult to uniquely
identify the single best driver some costs might be driven by sales volume while others
might more closely relate to the number of pickup. Thus, neither measure is completely
accurate although we expect that the number of pickups is a better estimate than sales
revenue.

N&Ns management could be quite confident that the change in the nature of the business
would increase their profit. The best estimate might be a weighted average of the
estimates in parts (b) and (c), where the weights correspond to managements belief that
the underlying activity (pickups or revenue) is the true driver of capacity costs.
Session 5
10.39
a. Let us begin by computing the overhead rate. Her total overhead is $390,000 and her
total labor cost is [(1,000 $75per unit) + (5,000 $50 per unit)] = $325,000. Thus,
her overhead rate is $390,000/$325,000 = $1.20/labor $.
With this rate in hand, we can compute her profit per print as follows.
Deluxe Standard
Prints / year 1,000 5,000

Price per print $350 $210

Materials 100 65
Labor 75 50
Overhead (@$1.20/labor $) 90 60
Profit /print $85 $35

This analysis suggests that deluxe frames are more than twice as profitable as
Standard frames. In addition, it is easy to verify that Sonja makes total profit of
$260,000 (= ($85 1,000) + ($35, 5,000)) at this volume and mix.
b. The following table provides the required income statement.
Deluxe Standard Total
1,000 5,000

Revenue $350,000 $1,050,000 $1,400,000

Materials 100,000 325,000 425,000
Labor 75,000 250,000 325,000
Labor related overhead 36,000 120,000 156,000
Batch related overhead 68,250 68,250 136,500
Product related overhead 29,250 29,250 58,500
Product Profit $ 41,500 $257,500 $299,000
Facility costs 39,000
Profit $260,000
Profit/unit $41.5 $51.5

Notice that we have a labor overhead rate of $0.48/labor $, which we compute as the
labor related overhead cost of $156,000 divided by the labor cost of $325,000.
Likewise, we have 20 batches each of the deluxe and standard products (1,000/50,
5,000/250). Thus, the cost per batch is $136,500/40 batches = $3,412.50.
Product related overhead is equally allocated between the product lines. We do not
allocate facility level costs as these are not controllable at the product level.
b. Based on the answers to parts a and b, what insights could you offer to Sonja?
 Sonja might wish to reconsider her emphasis on deluxe frames. She also might wish to
consider other options such as raising the price of a deluxe frame. Finally, she could also
improve margins (and this might be smartest thing to do) by figuring out how she could
manage her costs. For example, could she somehow reduce the cost per batch by
investing in automated equipment, or being able to store picture settings in an electronic
format?
10.53
a. This problem is a useful exercise in illustrating how different cost objects consume
the same resources in different mixes.

Short Long
Regular room rate $1,800 /day $3,600 $21,600
Spending on meals $450/day 900 5,400
Miscellaneous items $400/$2,500 400 2,500
Total revenue $4,900 $29,500
Costs
Variable cost $150/day 300 1,800
Room maintenance $300 per three days 300 1,200
Check in and check out $150/$250 150 250
Concierge service Varies 200 750
Guest spending on meals $450/day; Variable 360 2,160
etc cost is 40%
Guest spending on $400/ $2,500 for 160 1,000
miscellaneous services long-stay guests.
Profit per stay $3,430 $22,340
Profit per day $1,715 $1,861.67

b. The above analysis indicates that long-stay guests are more profitable than short-stay
guests. The difference in profitability arises from several factors: First, batch level
expenses such as the cost of check-in are spread out over more days. Second, the
intensity of resource usage (e.g., concierge) decreases as time passes. Third, the
amount of money spent on miscellaneous services increases as the hotel is able to
cross-sell some items (e.g., laundry, massages and so on.) However, the offset is that
long-stay guests might also increase some costs such as the welcome basket.

It appears that Vanessa might consider offering a 5-10% discount off the regular room
rate to long-stay guests. After all, maximizing utilization is the key to profits in the hospitality
industry, which has high fixed costs. (Note the ratio of profit to revenue).