CHAPTER 6RELEVANT INFORMATION AND DECISION MAKING:

PRODUCTION DECISIONS

TRUE / FALSE:

1. Opportunity costs need to be considered when deciding on the use of limited resources.T

2. Opportunity cost depends on alternatives available at a point in time.T

3. Opportunity costs and outlay costs are widely used synonyms.F

4. Opportunity costs apply to resources that will be owned.F

6. Outsourcing is a make-or-buy decision for services.T

7. Qualitative factors do not affect a make-or-buy decision.F

8. 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

9. The key reasons that companies outsource are to improve the company’s focus and reduce operating costs.T

18. Past costs can be good predictors of future costs.T

19. The cost of inventory is relevant when deciding whether to dispose of the inventory in cases of obsolescence.F

20. The disposal value of old equipment is relevant.T

21. Sunk cost is another term for historical cost or past cost.T

22. When making a decision to replace some old equipment with new, the depreciation taken on both the old or new equipment is irrelevant information.

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F

24. Future costs are relevant if they are the same under all feasible alternatives.F

25. Equipment’s book value is the original cost plus depreciation.F

26. Past costs may affect future payments for income taxes.T

34. 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. sunk costb. detrimental costc. opportunity costd. outlay cost

c. opportunity cost

38. 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. $130,000b. $90,000c. $60,000d. $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. sunk costb. opportunity costc. depreciable costd. outlay cost

b. opportunity cost

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40. Janice is considering leaving her current position to open a coffee shop. Janice’s 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. $56,000b. $210,000c. $460,000d. $40,000

b. $210,000

41. Sharon is considering leaving her current position to open a coffee shop. Sharon’s 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. $83,000b. $210,000c. $333,000d. $40,000

a. $83,000

42. Lynnette is considering leaving her current position to open an ice cream shop. Lynnette’s 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. $77,000b. $210,000c. $287,000d. $40,000

d. $40,000

$250,000 - $210,000 = $40,000

43. Beyonce is considering leaving her current position to open a music store. Beyonce’s 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. $85,000b. ($5,000)c. $250,000d. $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 $3Direct labor 5Variable factory overhead 4Fixed factory overhead 2Total costs $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. buy from Scalding Corporation to save $1 per unitb. make the part to save $1 per unitc. buy from Scalding Corporation to save $3 per unitd. 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 $3Direct labor 5Variable factory overhead 4Fixed factory overhead 3Total costs $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. $12b. $15c. $8d. $11

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

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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 $3Direct labor 5Variable factory overhead 4Fixed factory overhead 2Total costs $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. make the part to save $1 per unitb. buy the part to save $3 per unitc. buy the part to save $1 per unitd. make the part to save $3 per unit

c. buy the part to save $1 per unit

Buy: (5,000 x $15) - $20,000 = $55,000Make: (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 $3Direct labor 5Variable factory overhead 4Fixed factory overhead 2Total costs $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 profitb. make the new product and buy the part to earn an extra $1 per unit

contribution to profitc. continue to make the part to earn an extra $1 per unit contribution to profitd. 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 $20Direct labor 15Variable factory overhead 16Fixed factory overhead 10Total costs $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 unitb. buy from Madison to save $6 per unitc. make the part to save $6 per unitd. 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 $20Direct labor 15Variable factory overhead 16Fixed factory overhead 10Total costs $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. buy the part to save $2.50 per unitb. buy the part to save $1 per unitc. make the part to save $2.50 per unitd. 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

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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 Cooper’s lowest net cost for the part.

a. $170,000b. $180,000c. $190,000d. $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 $108,000Direct labor 156,000Variable factory overhead 72,000Fixed factory overhead 168,000Total costs $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. make the part to save $14.40 per unitb. buy the part to save $14.40 per unitc. buy the part to save the company $72,000d. 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

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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 $108,000Direct labor 156,000Variable factory overhead 72,000Fixed factory overhead 168,000Total costs $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. $504,000b. $336,000c. $432,000d. $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 $108,000Direct labor 156,000Variable factory overhead 72,000Fixed factory overhead 168,000Total costs $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 profitb. buy the part and produce the new product and earn an extra $4.80 per unit

contribution to profitc. continue to make the part and earn an extra $4.80 per unit contribution to

profitd. 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 = $76.80Make: $504,000 / 5,000 = $100.80

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60. A key factor in a make-or-buy decision is:

a. whether or not there are idle facilitiesb. the amount of the sunk costsc. gain or loss on the disposal of equipmentd. 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 costsb. Avoidable costsc. Long term relationship with suppliersd. Opportunity costs

c. Long term relationship with suppliers

62. Future costs are relevant in decision making when:

a. they exceed future revenuesb. they are not based on estimatesc. they differ between alternativesd. they are the same between alternatives

c. they differ between alternatives

63. _________________ would be a consideration in a make-or-buy decision.

a. Excess capacityb. Variable factory overheadc. Rental income from unused facilitiesd. 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. Inventory costb. Expected future revenuesc. Scrap value of inventoryd. Expected future costs

a. Inventory cost

83. ____________________ is relevant in a decision to replace equipment.

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a. Cost of old equipmentb. Book value of old equipmentc. Depreciation accrued on old equipmentd. 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 whichthe equipment is expected to be used

b. the decline in equipment value due to obsolescencec. the difference between the original cost and current market valued. All of these answers are correct.

a. the periodic cost of equipment spread over the future periods in whichthe equipment is expected to be used

85. Book value is defined as:

a. disposal valueb. disposal value less accumulated depreciationc. cost less accumulated depreciationd. 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:

Replacement Old Machine Machine

Original cost $99,000 $88,000Useful life in years 9 6Current age in years 3 0Book value $33,000 -Disposal value now $28,000 -Disposal value in 5 years 0 0Annual cash operating costs $17,000 $14,000

___________________________________ is a sunk cost.

a. The annual cash operating costs of the old machineb. The annual cash operating costs of the replacement machinec. The disposal value of the old machined. The original cost of the old machine

d. The original cost of the old machine88. 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:

Replacement Old Machine Machine

Original cost $60,000 $35,000Useful life in years 10 5Current age in years 5 0Book value $25,000 -Disposal value now $8,000 -Disposal value in 5 years 0 0Annual cash operating costs $10,000 $4,000

The total relevant costs to consider if the old machine is kept are:

a. $60,000b. $50,000c. $52,000d. $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:

Replacement Old Machine Machine

Original cost $57,000 $35,000Useful life in years 17 5Current age in years 12 0Book value $39,000 -Disposal value now $8,000 -Disposal value in 5 years 0 0Annual cash operating costs $7,000 $4,000

The difference in cost between keeping the old machine and replacing the old machine, ignoring income taxes, is:

a. $22,000 in favor of keeping the old machineb. $12,000 in favor of keeping the old machinec. $37,000 in favor of replacing the old machined. $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:

Replacement Old Machine Machine

Original cost $295,000 $188,000Useful life in years 11 5Current age in years 6 0Book value $130,000 -Disposal value now $52,000 -Disposal value in 5 years 0 0Annual cash operating costs $39,000 $24,000

____________________________ is irrelevant.

a. The original cost of the replacement machineb. The disposal value of the old machinec. The book value of the old machined. The annual operating cost of the old machine

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:

Replacement Old Machine Machine

Original cost $333,000 $222,000Useful life in years 6 5Current age in years 1 0Book value $198,000 -Disposal value now $132,000 -Disposal value in 5 years 0 0Annual cash operating costs $45,000 $34,000

__________________________ is a sunk cost.

a. The disposal value of the old machineb. The original cost of the old machinec. The annual cash operating costs of the old machined. The annual cash operating costs of the replacement machine

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:

Replacement Old Machine Machine

Original cost $200,000 $160,000Useful life in years 10 5Current age in years 5 0Book value $100,000 -Disposal value now $32,000 -Disposal value in 5 years 0 0Annual cash operating costs $20,000 $14,000

Ignoring income taxes, the difference in cost between the old and new machine is:

a. $98,000 in favor of the old machineb. $98,000 in favor of the new machinec. $40,000 in favor of the new machined. $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. adding the book value of the old equipment to the cost of the new equipmentb. adding the disposal value and the book value of the old equipmentc. subtracting the book value from the cash received for the old equipmentd. 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. the disposal value of the old equipment is irrelevantb. the book value of the old equipment is irrelevantc. the cost of the new equipment is relevantd. 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. increase by $1b. decrease by $1c. increase to $13d. 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. $7b. $19c. $5a. $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. increase by $35,000b. decrease by $8 per unitc. decrease by $2 per unitd. 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. fixed overhead costsb. operating costsc. product production costsd. 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 $93,000 $60,000Useful life in years 13 6Current age in years 7 0Book value $57,000 -Disposal value now $45,000 -Disposal value in 6 years 0 0Annual cash operating costs $15,000 $11,000

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 Replace Difference

Cash operating costs $90,000 $66,000 $24,000 Disposal value of old equipment - (45,000) 45,000 New equipment,

acquisition cost -__ 60,000 (60,000)

Total relevant costs $90,000 $81,000 $9,000

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

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