PDF Chapter 24 Differential Analysis and Product Pricing Study ...

Chapter 24 Differential Analysis and Product Pricing Study Guide Solutions

Fill-in-the-Blank Equations

1. Differential revenue 2. Differential costs 3. Differential income (Loss) 4. Markup per unit 5. Estimated units produced and sold 6. Total selling and administrative expenses 7. Desired rate of return 8. Target cost 9. Production bottleneck hours per unit

Exercises

1. Charleston Affair currently has a piece of equipment that is no longer needed. The current book value of the piece of the equipment is $12,000. The company has the option to lease the equipment for the next three years for $5,500 each year, or sell the equipment for $16,000. If leased, the equipment would have no residual value at the end of the lease. The company expects that maintenance and other expenses during the lease would total $2,000. If sold, Charleston Affair would pay a 5% commission. Prepare a differential analysis to determine if the company should sell (Alternative 1) or lease (Alternative 2) the equipment.

Revenues Costs Income (loss)

Differential Analysis

Sell (Alt. 1) or Lease (Alt. 2)

Differential Effect Sell (Alt. 1) Lease (Alt. 2) on Income (Alt. 2)

$16,000

$16,500

$ 500

(800)

(2,000)

(1,200)

$15,200

$14,500

$ (700)

Charleston Affair should sell the asset.

1

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2 Chapter 24

2. Wake Coffee Co. has a piece of equipment no longer needed for production. The company purchased the equipment for $75,000 and has accumulated depreciation of $10,000 related to the equipment. Wake Coffee Co. has determined it can either lease the equipment for the next ten years, for yearly revenues of $9,000, or sell the equipment for $70,000. If leased, the company expects to incur repairs and other expenses of $22,000 over the life of the lease. The equipment would also have a $3,500 salvage value. If sold, the broker requires a 4% broker commission. Prepare a differential analysis to determine if the company should sell (Alternative 1) or lease (Alternative 2) the equipment.

Revenues Costs Income (loss)

Differential Analysis

Sell (Alt. 1) or Lease (Alt. 2) Differential Effect on

Sell (Alt. 1) Lease (Alt. 2) Income (Alt. 2)

$70,000

$ 93,500

$ 23,500

(2,800)

(22,000)

(19,200)

$67,200

$ 71,500

$ 4,300

Revenues if leased = $90,000 + $3,500 Wake Coffee Co. should lease the asset.

3. Blair Designs is considering two alternatives for an outdated piece of machinery: leasing the machinery for five years, which would produce revenue of $8,000 year or selling the machinery for $38,000. The asset has a current book value of $25,000. If leased, the company expects to incur $7,000 of expenses for maintenance and taxes, and the equipment will have a $4,000 salvage value. If sold, the broker charges a 5% commission fee. Prepare a differential analysis to determine if the company should sell (Alternative 1) or lease (Alternative 2) the machinery.

Revenues Costs Income (loss)

Differential Analysis

Sell (Alt. 1) or Lease (Alt. 2) Differential Effect on

Sell (Alt. 1) Lease (Alt. 2) Income (Alt. 2)

$38,000

$44,000

$ 6,000

(1,900)

(7,000)

(5,100)

$36,100

$37,000

$ 900

Blair Designs should lease the asset.

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Differential Analysis and Product Pricing 3

Strategy: When determining whether to sell or lease an asset, first determine the revenues in each situation. If sold, the revenue is the selling price, and if leased, the revenue is the lease revenue and the salvage value, if any. Next determine the costs, which usually include a sales commission when selling and cost of upkeep when leasing. Determine the differential effect on income. If positive, the company should proceed with Alternative 2.

4. Product B at Charleston Affair generates sales of $59,000 for 10,000 units. Each unit has variable costs of $4.50 apiece and total fixed costs of $18,000. Prepare a differential analysis to determine if Product B should be continued (Alternative 1) or discontinued (Alternative 2) if the fixed costs are unaffected by the decision.

Differential Analysis

Continue (Alt. 1) or Discontinue (Alt. 2) Product B Differential Effect

Continue (Alt. 1) Discontinue (Alt. 2) on Income (Alt. 2)

Revenues

$ 59,000

$

0

$(59,000)

Costs:

Variable

$(45,000)

$

0

$ 45,000

Fixed

(18,000)

(18,000)

0

Total costs $(63,000)

$(18,000)

$ 45,000

Income (loss) $ (4,000)

$(18,000)

$(14,000)

Product B should be continued because the income generated from the product will cover some of fixed costs.

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4 Chapter 24

5. Wake Coffee Co. incurs a loss from operations for the Standard Coffee line. Sales revenues for the line total $72,000, while incurring variable costs of goods sold of $19,500, variable selling expenses of $17,400, and fixed costs of $49,000. Prepare a differential analysis to determine if the Standard Coffee line should be continued (Alternative 1) or discontinued (Alternative 2). Assume the company will incur the fixed costs regardless of the decision.

Differential Analysis

Continue (Alt. 1) or Discontinue (Alt. 2) Standard Coffee

Differential Effect Continue (Alt. 1) Discontinue (Alt. 2) on Income (Alt. 2)

Revenues

$ 72,000

$

0

$(72,000)

Costs:

Variable

$(36,900)

$

0

$ 36,900

Fixed

(49,000)

(49,000)

0

Total costs

$(85,900)

$(49,000)

$ 36,900

Income (loss)

$(13,900)

$(49,000)

$(35,100)

The Standard Coffee Line should be continued.

6. Product BW of Blair Designs generates sales revenue of $40,000. The product incurs variable costs of goods sold of $22,000, fixed selling costs of $22,000, and fixed factory overhead of $21,000. Use a differential analysis to determine if Product BW should be continued (Alternative 1) or discontinued (Alternative 2). Assume that the company will incur the fixed factory overhead regardless of the decision.

Differential Analysis

Continue (Alt. 1) or Discontinue (Alt. 2) Product BW

Differential Effect on

Continue (Alt. 1) Discontinue (Alt. 2)

Income (Alt. 2)

Revenues

$ 40,000

$

0

$(40,000)

Costs:

Variable

$(22,000)

$

0

$ 22,000

Fixed

(43,000)

(21,000)

22,000

Total costs $(65,000)

$(21,000)

$ 44,000

Income (loss)

$(25,000)

$(21,000)

$ 4,000

Product BW should be discontinued.

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Differential Analysis and Product Pricing 5

Strategy: If the company continues the product line, the revenues and costs will be equal to the amounts expected. However, if the company discontinues the product line, no revenue will be earned and no variable costs will be incurred. However, the fixed costs may remain since the company will incur the costs regardless of the number of products finished. Determine the differential effect on income. If positive, the company should decide Alternative 2.

7. Charleston Affair currently makes the King Component, incurring variable costs of $18 per unit and fixed costs of $4 per unit. The company has the option to purchase the component for $20 per unit. Prepare a differential analysis to determine if the company should make (Alternative 1) or buy (Alternative 2) the King Component. Assume that the fixed costs will be incurred in each situation.

Differential Analysis

Make (Alt. 1) or Buy (Alt. 2) King Component Differential Effect

Make (Alt. 1) Buy (Alt. 2) on Income (Alt. 2)

Unit costs:

Purchase price

$ 0

$(20)

$(20)

Variable costs

(18)

0

18

Fixed costs

(4)

(4)

0

Income (loss)

$(22)

$(24)

$ (2)

Charleston Affair should make the King Component.

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6 Chapter 24

8. The Wake Coffee Co. currently produces the Sealable Coffee Bag and incurs the following costs per unit: direct materials, $2; direct labor, $3; variable factory overhead, $2.50; and fixed factory overhead, $3.50. The company also has the option to purchase the product for $9.50 per unit. The seller charges a $1.25 freight fee per unit. Prepare a differential analysis to determine if Wake Coffee Co. should make (Alternative 1) or buy (Alternative 2) the product, assuming that the fixed costs will be incurred regardless of the decision.

Differential Analysis

Make (Alt. 1) or Buy (Alt. 2) Sealable Coffee Bag Differential Effect

Make (Alt. 1) Buy (Alt. 2) on Income (Alt. 2)

Unit costs:

Purchase price $ 0

$ (5.75)

$(5.75)

Freight fee

0

(1.25)

(1.25)

Variable costs

(7.50)

0

7.50

Fixed costs

(3.50)

(3.50)

0

Income (loss)

$(11.00) $(10.50)

$ 0.50

Wake Coffee Co. should buy the Sealable Coffee Bag.

9. Blair Designs currently produces a Subcomponent, incurring variable direct costs of $4.25 per unit, variable factory overhead of $2.25 per unit, and fixed factory overhead of $5.00 per unit. The company could also buy the Subcomponent for $7.50 from an outside provider, which would also charge a freight fee of $2.00 per unit. Prepare a differential analysis to determine if Blair Designs should make (Alternative 1) or buy (Alternative 2) the Subcomponent, assuming that fixed factory overhead will be incurred if the product is made or sold.

Differential Analysis

Make (Alt. 1) or Buy (Alt. 2) Subcomponent Differential Effect

Make (Alt. 1) Buy (Alt. 2) on Income (Alt. 2)

Unit costs:

Purchase price

$ 0

$ (7.50)

$(7.50)

Freight fee

0

(2.00)

(2.00)

Variable costs

(6.50)

0

6.50

Fixed costs

(5.00)

(5.00)

0

Income (loss)

$(11.50)

$(14.50)

$(3.00)

Blair Designs should make the Subcomponent.

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Differential Analysis and Product Pricing 7

Strategy: First, determine the costs associated with making the product, which usually include the variable and fixed costs. Next, determine the costs associated with buying the product, which include the costs to acquire the good (purchase price, freight fees, etc.), and fixed costs since the company will incur the costs regardless of the products produced. Then, determine the differential effect on income, and if positive, the company should proceed with Alternative 2.

10. Charleston Affair is considering replacing an outdated piece of machinery. Use the information below for the old piece of machinery and new machinery to prepare a differential analysis to determine if Charleston Affair should continue (Alternative 1) or replace (Alternative 2) the old machine.

Old machine: Estimated annual variable manufacturing costs Estimated selling price Estimated residual value Estimated remaining useful life

New machine: Purchase price Estimated annual variable manufacturing costs Estimated residual value Estimated useful life

$18,000 $10,000

$6,500 7 years

$110,000 $5,000 $1,500 7 years

Differential Analysis

Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2) Differential Effect

Continue (Alt. 1) Replace (Alt. 2) on Income (Alt. 2)

Revenues:

Proceeds from sale of old machine

$

0

$ 10,000

$ 10,000

Residual Value

6,500

1,500

(5,000)

Costs:

Purchase price

$

0

$(110,000)

$(110,000)

Variable manufacturing costs (7 years) (126,000)

(35,000)

91,000

Total costs

$(126,000)

$(145,000)

$ (19,000)

Income (loss)

$(119,500)

$(133,500)

$ (14,000)

Charleston Affair should continue with the old machine.

?2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to publicly accessible website, in whole or in part.

8 Chapter 24

11. Wake Coffee Co. has an outdated piece of machinery that the company is considering replacing. Use the information below for the two pieces of machinery. Prepare a differential analysis to determine if the company should continue with the old piece of machinery (Alternative 1) or replace the piece of machinery (Alternative 2).

Old machine Estimated annual variable manufacturing costs Estimated selling price Estimated remaining useful life

New machine Purchase price Estimated annual variable manufacturing costs Estimated residual value Estimated useful life

$15,000 $3,200 5 years

$42,000 $6,000 0 5 years

Differential Analysis

Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2)

Differential Effect on Continue (Alt. 1) Replace (Alt. 2) Income (Alt. 2)

Revenues:

Proceeds from sale of old machine

$

0

$ 3,200

$ 3,200

Costs:

Purchase price

$

0

$(42,000)

$(42,000)

Variable manufacturing costs (5 years)

(75,000)

(30,000)

45,000

Total costs

$(75,000)

$(72,000)

$ 3,000

Income (loss)

$(75,000)

$(68,800)

$ 6,200

Wake Coffee Co. should replace the old machine.

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