Variable Cost and Contribution Margin

CHAPTER 12 PRICING DECISIONS AND COST management 12-1The three major influences on go under decisions be 1. Customers 2. Competitors 3. embodys 12-2Not necessarily. For a wholey- time- sole(prenominal) special articulate, the applicable be ar only(prenominal) those terms that for take down deviate as a result of coincideing the secernate. In this case, teeming harvest-home be exit rarely be relevant. It is more probable that unspoiled fruit damage entrust be relevant appeal for long-term determine decisions. 12-3Two examples of determine decisions with a short-run focus 1. set for a one-time-only special order with no long-term implications. . Adjusting product flick and volume in a competitive commercialise. 12-4Activity- ground appealing helps managers in set decisions in two ways. 1. It gives managers more accurate product- woo information for fashioning set decisions. 2. It helps managers to manage cost during take account engineer by iden tifying the cost refer of eliminating, sm separate(a), or changing unhomogeneous activities. 12-5Two alternative starting points for long haul pricing decisions are 1. Market-based pricing, an important form of which is channelize pricing.The market-based cash advance asks, Given what our nodes lack and how our competitors ordain react to what we do, what damage should we bearing? 2. Cost-based pricing which asks, What does it cost us to make this product and, hence, what expense should we charge that will recoup our be and achieve a invest go through on enthronization? 12-6A address cost per social building block is the estimated long-run cost per unit of a product (or redevelopment) that, when interchange at the target expenditure, enables the club to achieve the targeted run income per unit. 2-7Value engineering is a systematic evaluation of tout ensemble aspects of the value-chain crease functions, with the objective of decrease be while satisfy ing client call for. Value engineering via utility in product and process designs is a principal technique that companies give to achieve target cost per unit. 12-8A value-added cost is a cost that customers descry as adding value, or utility, to a product or service. Examples are cost of materials, direct projection, tools, and machinery.A nonvalue-added cost is a cost that customers do non get the picture as adding value, or utility, to a product or service. Examples of nonvalue-added be are cost of re operate on, scrap, expediting, and breakdown maintenance. 12-9No. It is important to distinguish between when cost are locked in and when be are incurred, beca custom it is difficult to alter or reduce be that have already been locked in. 12-10Cost-plus pricing is a pricing climb up in which managers add a markup to cost in order to determine expenditure. 2-11Cost-plus pricing methods vary depending on the bases use to calculate expenditures. Examples are (a) uncertain star manufacturing cost (b) manufacturing function be (c) varying product cost and (d) sufficient product be. 12-12Two examples where the difference in the cost of two products or serve is much smaller than the differences in their harms follow 1. The difference in damages super charged for a telephone call, hotel room, or car undertakeal during busy versus loosen periods is often much greater than the difference in be to contribute these services. 2.The difference in cost for an airplane seat sell to a passenger traveling on subscriber line or a passenger traveling for joy is roughly the equal. However, airline companies expense discriminate. They routinely charge business travelersthose who are likely to start and complete their travel during the same week excluding the weekenda much high cost than pleasure travelers who generally stay at their destinations over at least one weekend. 12-13Life-cycle budgeting is an estimate of the revenues and be attribu car ry over to individually product from its initial R&D to its final customer servicing and validate. 2-14Three benefits of using a product feel-cycle reporting format are 1. The wax set of revenues and cost associated with each product becomes more visible. 2. Differences among products in the percentage of integral be connected at early stages in the life cycle are highlighted. 3. Inter kinds among business function cost categories are highlighted. 12-15Predatory pricing occurs when a business intentionally prices below its cost in an effort to drive competitors out of the market and restrict supply, and accordingly raises prices earlier than en king-size have.Under U. S. laws, dumping occurs when a non-U. S. company sells a product in the join States at a price below the market value in the country where it is produced, and this lower price materially injures or threatens to materially injure an industry in the building blocked States. Collusive pricing occurs when com panies in an industry conspire in their pricing and production decisions to achieve a price preceding(prenominal) the competitive price and so restrain trade. 12-16(2030 min. ) germane(predicate)-cost approach to pricing decisions, special order. . Relevant revenues, $4. 00 ( 1,000$4,000 Relevant cost exact materials, $1. 60 ( 1,000$1,600 Direct manufacturing sedulousness, $0. 90 ( 1,000900 protean manufacturing knock, $0. 70 ( 1,000700 variable quantity selling cost, 0. 05 ( $4,000 200 arrive relevant cost 3,400 Increase in in operation(p) income$ 600 This calculation assumes that a. The monthly icy manufacturing overhead of $150,000 and $65,000 of monthly fixed selling cost will be same(predicate) by acceptance of the 1,000 unit order. b.The price charged and the volumes sold to other customers are non affected by the special order. Chapter 12 uses the musical phrase one-time-only special order to describe this special case. 2. The presidents cogitate is defective o n at least two counts a. The inclusion of irrelevant beassuming the monthly fixed manufacturing overhead of $150,000 will be unchanged it is irrelevant to the decision. b. The exclusion of relevant costvariable selling costs (5% of the selling price) are excluded. 3. Key issues are . Will the vivacious customer base demand price reductions? If this 1,000-tape order is not freelancer of other gross revenue, cutting the price from $5. 00 to $4. 00 send packing have a large negative effect on hail revenues. b. Is the 1,000-tape order a one-time-only order, or is there the possibility of sales in subsequent months? The fact that the customer is not in Dill Companys normal marketing channels does not necessarily mean it is a one-time-only order. Indeed, the sale could hygienic open a immature marketing channel.Dill Company should be indisposed to consider only short-run variable costs for pricing long-run business. 12-17(2030 min. )Relevant-cost approach to short-run pricing dec isions. 1. Analysis of special order sales, 3,000 units ( $75$225,000 uncertain costs Direct materials, 3,000 units ( $35$105,000 Direct manufacturing get, 3,000 units ( $1030,000 variable quantity manufacturing overhead, 3,000 units ( $618,000 Other variable costs, 3,000 units ( $515,000 Sales commission 8,000 thorough variable costs 176,000 component part boundary line$ 49,000Note that the variable costs, except for commissions, are affected by production volume, not sales dollars. If the special order is accepted, run income would be $1,000,000 + $49,000 = $1,049,000. 2. Whether McMahons decision to quote full price is correct depends on many factors. He is incorrect if the capacity would otherwise be tripping and if his objective is to increase operating income in the short run. If the rear is rejected, San Carlos, in effect, is involuntary to invest $49,000 in immediate gains forgone (an opportunity cost) to preserve the long-run selling-price anatomical structure.M cMahon is correct if he thinks future competition or future price c erstssions to customers will hurt San Carloss operating income by more than $49,000. in that respect is also the possibility that Abrams could become a long-term customer. In this case, is a price that covers only short-run variable costs adequate? Would Holtz be willing to accept a $8,000 sales commission (as distinguished from her well-ordered $33,750 = 15% ( $225,000) for every Abrams order of this size if Abrams becomes a long-term customer? 12-18(15-20 min. Short-run pricing, capacity constraints. 1. Per kilogram of hard quit Milk (8 liters pic $2. 00 per liter) $16 Direct manufacturing labor movement 5 variable star manufacturing overhead 4 determined manufacturing cost allocated 6 gibe manufacturing cost $31 If Colorado Mountains dairy farm bath get all the Holstein take out it needs, and has sufficient production capacity, then the minimum price per kilo it should charge for the hard stop i s the variable cost per kilo = $16 + $5 + $4 = $25 per kilo. 2. If milk is in short supply, then each kilo of hard lay off displaces 2 kilos of soft cheese (8liters of milk per kilo of hard cheese versus 4 liters of milk per kilo of soft cheese). Then, for the hard cheese, the minimum price Colorado Mountains should charge is the variable cost per kilo of hard cheese plus the office marge from 2 kilos of soft cheese, or, 25 + (2 pic $10 per kilo) = $45 per kilo That is, if milk is in short supply, Colorado Mountains should not agree to produce any hard cheese unless the buyer is willing to pay at least $45 per kilo. 12-19 (2530 min. ) Value-added, nonvalue-added costs. 1. Category Examples Value-added costs a. Materials and labor for regular fastenings $800,000 Nonvalue-added costs b. make over costs $ 75,000 c. Expediting costs caused by work delays 60,000 g. Breakdown maintenance of equipment 55,000 occur $190,000 Gray area d.Materials handling costs $ 50,000 e. M aterials procurement and recap costs 35,000 f. Preventive maintenance of equipment 15,000 keep down $ one C,000 Classifications of value-added, nonvalue-added, and white-haired(a) area costs are often not clear-cut. Other classifications of or so of the cost categories are also plausible. For example, some students whitethorn include materials handling, materials procurement, and inspection costs and checkive maintenance as value-added costs (costs that customers perceive as adding value and as being necessary for good repair service) rather than as in the immemorial area.Preventive maintenance, for instance, might be regarded as value-added because it helps prevent nonvalue-adding breakdown maintenance. 2. meat costs in the gray area are $100,000. Of this, we assume 65%, or $65,000, are value-added and 35%, or $35,000, are nonvalue-added. join value-added costs $800,000 + $65,000 $ 865,000 Total nonvalue-added costs $190,000 + $35,000 225,000 Total costs$1,090,000 Nonv alue-added costs are $225,000 ? $1,090,000 = 20. 64% of total costs.Value-added costs are $865,000 ? $1,090,000 = 79. 36% of total costs. 3. Effect on Costs Classified as Value-Added Nonvalue-Added Gray computer program Area (a) Quality improvement programs to reduce rework costs by 75% (0. 5 ( $75,000) $ 56,250 reduce expediting costs by 75% (0. 75 ( $60,000) 45,000 reduce materials and labor costs by 5% (0. 5 ( $800,000) $ 40,000 Total effect $ 40,000 $101,250 (b) Working with suppliers to reduce materials procurement and inspection costs by 20% (0. 0 ( $35,000) reduce materials handling costs by 25% $ 7,000 (0. 25 ( $50,000) Total effect 12, vitamin D Transferring 65% of gray area costs (0. 5 ( 19,500 $19,500 = $12,675) as value-added and 35% (0. 5 ( $19,500 = $6,825) as nonvalue-added Effect on value-added and nonvalue-added costs $ 12,675 $ 6,825 + 19,500 $ 12,675 $ 6,825 $ 0 (c) Maintenance programs to increase preventive maintenance costs by 50% (0. 0 ( $15,000) +$ 7,500 decrease breakdown maintenance costs by 40% (0. 40 ( $55,000) $ 22,000 Total effect 22,000 + 7,500 Transferring 65% of gray area costs (0. 65 ( $7,500 = $4,875) as value-added and 35% (0. 5 ( $7,500 = $2,625) as nonvalue-added Effect on value-added and nonvalue-added costs +$ 4,875 + 2,625 7,500 +$ 4,875 $19,375 $ 0 Total effect of all programs $ 47,800 $127,450 Value-added and nonvalue-added costs calculate in requirement 2 Expected value-added and nonvalue-added costs as a result of implementing these 865,000 225,000 programs $817,200 $ 97,550 If these programs had been implemented, total costs would have bring down from $1,090,000 (requirement 2) to $817,200 + $97,550 = $914,750, and the percentage of nonvalue-added costs would decrease from 20. 64% (requirement 2) to $97,550 ? 914,750 = 10. 66%. These are strong improvements in Marinos performance. 12- 20(25(30 min. ) Target operating income, value-added costs, service company. 1. The classification of total costs in 2012 into value-added, nonvalue-added, or in the gray area in between follows ValueGrayNonvalue-Total AddedAreaadded(4) = (1) (2) (3) (1)+(2)+(3)Doing calculations and preparing drawings 77% ? $390,000$300,300$300,300 Checking calculations and drawings 3% ? $390,000$11,70011,700 Correcting errors found in drawings 8% ? $390,000$31,20031,200 devising changes in response to client requests 5% ? $390,000 19,50019,500 Correcting errors to meet government mental synthesis code, 7% ? $390,000 27,300 27,300 Total professional labor costs 319,800 11,700 58,500 390,000 Administrative and birth costs at 44% ($171,600 ? $390,000) of professional labor costs 140,712 5,148 25,740 171,600 start 15,000 15,000 Total$475,512$16,848$84,240$576,600Doing calculations and responding to client requests for changes are value-added costs because customers perceive these costs as necessa ry for the service of preparing architectural drawings. Costs incurred on correcting errors in drawings and making changes because they were inconsistent with mental synthesis codes are nonvalue-added costs. Customers do not perceive these costs as necessary and would be unwilling to pay for them. Calvert should seek to head off these costs by making sure that all associates are reasoning(a) regarding building code requirements and by training associates to improve the quality of their drawings. Checking calculations and drawings is in the gray area (some, but not all, checking may be needed). there is room for disagreement on these classifications.For example, checking calculations may be regarded as value added. 2. Reduction in professional labor-hours by a. Correcting errors in drawings (8% ? 7,500)600 hours b. Correcting errors to conform to building code (7% ? 7,500) 525 hours Total 1,125 hours Cost savings in professional labor costs (1,125 hours ? $52)$ 58,500 Cost saving s in variable administrative and support costs (44% ? $58,500) 25,740 Total cost savings$ 84,240 Current operating income in 2012$124,650 Add cost savings from eliminating errors 84,240 run income in 2012 if errors eliminated$208,890 3. Currently 85% ? 7,500 hours = 6,375 hours are billed to clients generating revenues of $701,250.The abideing 15% of professional labor-hours (15% ? 7,500 = 1,125 hours) is lost in making corrections. Calvert bills clients at the rate of $701,250 ? 6,375 = $ cx per professional labor-hour. If the 1,125 professional labor-hours before long not being billed to clients were billed to clients, Calverts revenues would increase by 1,125 hours ? $110 = $123,750 from $701,250 to $825,000 ($701,250 + $123,750). Costs remain unchanged Professional labor costs$390,000 Administrative and support (44% ? $390,000) 171,600 Travel 15,000 Total costs$576,600 Calverts operating income would be Revenues$825,000 Total costs 576,600 operating(a) income$248,400 12-21(25 30 min. Target prices, target costs, activity-based costing. 1. Snappys operating income in 2011 is as follows Total for 250,000 Tiles Per building block (1) (2) = (1) ? 250,000 Revenues ($4 ( 250,000) $1,000,000 $4. 00 Purchase cost of roofing tiles ($3 ( 250,000) 750,000 3. 0 Ordering costs ($50 ( 500) 25,000 0. 10 Receiving and storage ($30 ( 4,000) 120,000 0. 48 Shipping ($40 ( 1,500) 60,000 0. 24 Total costs 955,000 3. 82 operational income $ 45,000 $0. 18 2.Price to retailers in 2012 is 95% of 2011 price = 0. 95 ( $4 = $3. 80 cost per tile in 2012 is 96% of 2011 cost = 0. 96 ( $3 = $2. 88. Snappys operating income in 2012 is as follows Total for 250,000 Tiles Per Unit (1) (2) = (1) ? 250,000 Revenues ($3. 80 ( 250,000) $950,000 $3. 0 Purchase cost of tiles ($2. 88 ( 250,000) 720,000 2. 88 Ordering costs ($50 ( 500) 25,000 0. 10 Receiving and storage ($30 ( 4,000) 120,000 0. 48 Shipping ($40 ( 1,500) 60,000 0. 24 Total costs 925,000 3. 0 Oper ating income $ 25,000 $0. 10 3. Snappys operating income in 2012, if it makes changes in ordering and material handling, will be as follows Total for 250,000 Tiles Per Unit (1) (2) = (1) ? 50,000 Revenues ($3. 80 ( 250,000) $950,000 $3. 80 Purchase cost of tiles ($2. 88 ( 250,000) 720,000 2. 88 Ordering costs ($25 ( 200) 5,000 0. 02 Receiving and storage ($28 ( 3,125) 87,500 0. 35 Shipping ($40 ( 1,500) 60,000 0. 4 Total costs 872,500 3. 49 Operating income $ 77,500 $0. 31 Through better cost management, Snappy will be able to achieve its target operating income of $0. 30 per tile despite the fact that its revenue per tile has decreased by $0. 20 ($4. 00 $3. 80), while its purchase cost per tile has decreased by only $0. 12 ($3. 00 $2. 88). 12-22 (20 min. ) Target costs, effect of product-design changes on product costs. 1. and 2.Manufacturing costs of HJ6 in 2010 and 2011 are as follows 2010 2011 Per UnitPer Unit Total (2) = Total (4) = (1)(1) ? 3,500 (3)(3) ? 4 ,000 Direct materials, $1,200 ? 3,500 $1,100 ? 4,000$4,200,000$1,200$4,400,000$1,100 Batch-level costs, $8,000 ? 70 $7,500 ? 80 560,000 160 600,000 150 Manuf. operations costs, $55 ? 21,000 $50 ? 22,000 1,155,000 330 1,100,000 275 engineer change costs, $12,000 ? 14 $10,000 ? 10 168,000 48 100,000 25 Total$6,083,000$1,738$6,200,000$1,550 3. pic= pic ? 90% = $1,738 ? 0. 90 = $1,564. 20 Actual manufacturing cost per unit of HJ6 in 2011 was $1,550.Hence, health check Instruments did achieve its target manufacturing cost per unit of $1,564. 20 4. To reduce the manufacturing cost per unit in 2011, Medical Instruments reduced the cost per unit in each of the four cost categoriesdirect materials costs, batch-level costs, manufacturing operations costs, and engineering change costs. It also reduced machine-hours and occur of engineering changes dothe quantities of the cost drivers. In 2010, Medical Instruments used 6 machine-hours per unit of HJ6 (21,000 machine-hours (3,500 units). In 2011, Medical Instruments used 5. 5 machine-hours per unit of HJ6 (22,000 machine-hours ( 4,000 units). Medical Instruments reduced engineering changes from 14 in 2010 to 10 in 2011.Medical Instruments achieved these gains through value engineering activities that retained only those product features that customers wanted while eliminating nonvalue-added activities and costs. 12-23(20 min. )Cost-plus target return on investment pricing. 1. Target operating income = target return on investment ( invested nifty Target operating income (25% of $900,000)$225,000 Total fixed costs 375,000 Target donation strand$600,000 Target division per room- iniquity, ($600,000 ? 15,000) $40 Add variable costs per room-night 5 Price to be charged per room-night $45 Proof Total room revenues ($45 ( 15,000 room-nights)$675,000 Total costs Variable costs ($5 ( 15,000)$ 75,000 icy costs 375,000Total costs 450,000 Operating income$225,000 The full cost of a room = variable cost per room + fixed cost p er room The full cost of a room = $5 + ($375,000 ? 15,000) = $5 + $25 = $30 Markup per room = Rental price per room wide-cut cost of a room = $45 $30 = $15 Markup percentage as a fraction of full cost = $15 ? $30 = 50% 2. If price is reduced by 10%, the repress of rooms Beck could rent would increase by 10%. The new price per room would be 90% of $45 $ 40. 50 The number of rooms Beck packs to rent is 110% of 15,000 16,500 The contribution margin per room would be $40. 50 $5$ 35. 50 section margin ($35. 50 ( 16,500)$585,750Because the contribution margin of $585,750 at the reduced price of $40. 50 is less than the contribution margin of $600,000 at a price of $45, Blodgett should not reduce the price of the rooms. Note that the fixed costs of $375,000 will be the same under the $45 and the $40. 50 price alternatives and hence, are irrelevant to the analysis. 12-24(20(25 min. )Cost-plus, target pricing, working backwards. 1. Investment$8,400,000 Return on investment18% Operatin g income (18% ( $8,400,000)$1,512,000 Operating income per unit of XR500 ($1,512,000 ( 1,500)$1,008 Full cost per unit of XR500 (1,008 ? 0. 09)$11,200 merchandising price (($11,200 + $1,008))$12,208 Markup percentage on variable cost ($1,008 ( $8,450)11. 93%Total fixed costs = (Full cost per unit Variable cost per unit) ( Units sold = ($11,200 $8,450) ( 1,500 units = $4,125,000 2. plowshare margin per unit = $12,208 $8,450 = $3,758 Increase in sales = $10% ( 1,500 units = 150 units Increase in contribution margin = $3,758 ( 150 units =$563,700 little Advertising costs 500,000 Increase in operating income$ 63,700 Road Warrior should evanesce $500,000 in advertising because it increases operating income by $63,700. 3. Revenues ($12,208 ? 1,400 units) $17,091,200 Target full cost at 9% markup ($17,091,200 ? 1. 9) $15,680,000 Less Target total fixed costs ($4,125,000 $125,000) 4,000,000 Target total variable costs $11,680,000 Divided by number of units ? 1,400 units Targe t variable cost per unit $ 8,342. 86 12-25(20 min. ) Life-cycle product costing. 1. pic plowshare margin per unit = exchange price Variable cost per unit = $50 $25 = $25 Total fixed costs over = aspiration fixed costs + Production fixed + Marketing and distribution life of robot costs fixed costs = $650,000 + $3,560,000 + $2,225,000 = $6,435,000 BEP in units = pic 2a. Option A Revenues ($50 pic 500,000 units) $25,000,000 Variable costs ($25 pic 500,000 units) 12,500,000 touch on costs 6,435,000 Operating income $ 6,065,000 2b. Option B Revenues family 2 ($70 pic 100,000 units) $ 7,000,000 Years 3 & 4 ($40pic600,000 units) 24,000,000 Total revenues 31,000,000 Variable costs ($25 pic 700,000 units) 17,500,000 Fixed costs 6,435,000 Operating income $ 7,065,000 Over the products life-cycle, Option B results in an overall higher operating income of $1,000,000 ($7,065,000 $6,065,000). 12-26(30 min. )Relevant-cost approach to pricing decisions. 1. Revenues (1,000 crates at $117 per crate) $117,000 Variable costs Manufacturing $35,000 Marketing 17,000 Total variable costs 52,000 Contribution margin 65,000 Fixed costs Manufacturing $30,000 Marketing 13,000 Total fixed costs 43,000 Operating income $ 22,000 Normal markup percentage $65,000 ? $52,000 = 125% of total variable costs. 2. Only the manufacturing-cost grade is relevant to considering this special order no additional marketing costs will be incurred. Variable manufacturing cost per crate = $35,000 ? 1,000 crates = $35 per crate.The relevant manufacturing costs for the 200-crate special order are Variable manufacturing cost per unit $35 ( 200 crates$ 7,000 Special packaging 3,000 Relevant manufacturing costs$10,000 any(prenominal) price above $50 per crate ($10,000 ? 200) will make a positive contribution to operating income. Therefore, based on financial considerations, Stardom should accept the 200-crate special order at $55 per crate that will vex revenues of $11,000 ($55 ( 200) and relevant (incremental) costs of $10,000. The reasoning based on a comparison of $55 per crate price with the $65 per crate assimilation cost ignores monthly cost-volume-profit relationships.The $65 per crate absorption cost includes a $30 per crate cost component that is irrelevant to the special order. The relevant range for the fixed manufacturing costs is from 500 to 2,000 crates per month the special order will increase production from 1,000 to 1,200 crates per month. Furthermore, the special order requires no incremental marketing costs. 3. If the new customer is likely to remain in business, founder should consider whether a strictly short-run focus is withdraw. For example, what is the likelihood of demand from other customers increasing over time? If volley accepts the 200-crate special offer for more than one month, it may preclude accepting other customers at prices exceeding $55 per crate.Moreover, the existing customers may learn about Bursts willingness to set a price based on variable cost plus a small contribution margin. The longer the time frame over which Burst keeps selling 200 crates of canned peaches at $55 a crate, the more likely it is that existing customers will approach Burst for their own special price reductions. If the new customer wants the assume to extend over a longer time period, Burst should treat a higher price. 12-27(2530 min. )Considerations other than cost in pricing decisions. 1. leaf node nights on weeknights 18 weeknights ? 100 rooms ? 0% = 1,620 Guest nights on weekend nights 12 weekend nights ? 100 rooms ? 20% = 240 Total node nights in April = 1,620 + 240 = 1,860 Breakfasts served 1,620 weeknight invitee nights ? 1. 0 = 1,620 240 weekend guest nights ? 2. = 600 Total breakfasts served in April = 1,620 + 600 = 2,220 Total costs for April Depreciation $ 20,000 Administrative costs 35,000 Fixed housekeeping and supplies 12,000 Variable housekeeping and supplies (1,860 ? $25) 46,500 Fixed breakfast costs 5,000 Variable breakfast costs (2,220 ? 5) 11,100 Total costs for April $129,600 Cost per guest night ($129,600 ? 1,860) $69. 68 Revenue for April ($68 ? 1,860) $126,480 Total costs for April 129,600 Operating income/(loss) $ (3,120) 2. new-sprung(prenominal) weeknight guest nights 18 weeknights ? 100 rooms ? 5% = 1,530 unexampled weekend guest nights 12 weeknights ? 100 rooms ? 50% = 600 Total guest nights in April = 1,530 + 600 = 2,130 Breakfasts served 1,530 weeknight guest nights ? 1. 0 = 1,530 600 weekend guest nights ? 2. = 1,500 Total breakfasts served in April = 1,530 + 1,500 = 3,030 Total costs for April Depreciation $20,000 Administrative costs 35,000 Fixed housekeeping and supplies 12,000 Variable housekeeping and supplies (2,130 ? $25) 53,250 Fixed breakfast costs 5,000 Variable breakfast costs (3,030 ? $5) 15,150 Total costs $140,400 Revenue (1, 530 ? $80) + (600 ? 50) $152,400 Total costs for April 140,400 Operating income $ 12,000 Yes, this pricing arrangement would increase operating income by $15,120 from an operating loss of $3,120 to an operating income of $12,000 ($12,000 + $3,120 = $15,120). 3. The weeknight guests are business travelers who have to stay at the hotel on weeknights to conduct business for their organizations. They are probably not stipendiary personally for their hotel stays, and they are more interested in the hotels post in the business park than the price of the stay, as long as it is reasonable. The demand of business travelers is inelastic.In contrast, the weekend guests are families who are staying at the hotel for pleasure and are paying for the hotel from their personal incomes. They are willing to consider other hotel options or even not travel at all if the price is high and unaffordable. The demand of pleasure travelers is elastic. Because of the differences in preferences of the we eknight and weekend guests, Executive Suites can price discriminate between these guests by charging $30 more on weeknights than on weekends and still have weeknight travelers stay at the hotel. 4. Executive Suites would need to charge a minimum of $35 per night for the last-minute rooms, an sum of money equal to the variable cost per room. Variable cost per room night = $25 per room night + $5 ? breakfasts = $35. Any price above $35 would increase Executive Suites operating income. 12-28 (25 min. ) Cost-plus, target pricing, working backward. 1. In the following table, work backwards from operating income to calculate the selling price Selling price $ 10. 14 (plug) Less Variable cost per unit 3. 75 Unit contribution margin $ 6. 39 Number of units produced and sold ? 00,000 units Contribution margin $3,195,000 Less Fixed costs 3,000,000 Operating income $ 195,000 a)Total sales revenue = $10. 14 pic 500,000 units = $5,070,000 b)Selling price = $10. 14 (from above) Alterna tively, Operating income $ 195,000 Add fixed costs 3,000,000 Contribution margin 3,195,000 Add variable costs ($3. 75 ? 500,000 units) 1,875,000 Sales revenue $5,070,000 pic )Rate of return on investment = pic d)Markup % on full cost Total cost = ($3. 75 pic 500,000 units) + $3,000,000 = $4,875,000 Unit cost = pic Markup % = pic Or pic 2. clean fixed costs =$3,000,000 $200,000 = $2,800,000 New variable costs = $3. 75 $0. 60 = $3. 15 New total costs = ($3. 15 ? 500,000 units) + $2,800,000 = $4,375,000 New total sales (5% markup) = $4,375,000 pic 1. 4 = $4,550,000 New selling price = $4,550,000 ? 500,000 units = $9. 10 Alternatively, New unit cost = $4,375,000 ? 500,000 units = $8. 75 New selling price = $8. 75 pic 1. 04 = $9. 10 3. New units sold = 500,000 units ? 90% = $450,000 units Budgeted Operating Income for the Year Ending December 31, 20xx Revenues ($9. 10 pic 450,000 units) $4,095,000 Variable costs ($3. 15 pic 450,000 units) 1,417,500 Con tribution margin 2,677,500 Fixed costs 2,800,000 Operating income (loss) $ (122,500) 12-29(4045 min. ) Target prices, target costs, value engineering, cost incurrence, locked-in cost, activity-based costing. 1. Old CE100 New CE100 Cost Change Direct materials costs $182,000 $2. 20 pic 7,000 = $15,400 less $166,600 Direct manufacturing labor costs 28,000 $0. 50 pic 7,000 = $3,500 less 24,500 Machining costs 31,500 Unchanged because capacity same 31,500 Testing costs 35,000 (20% pic 2. 5 pic 7,000) ? 2 = $7,000 28,000 Rework costs 14,000 (See Note 1) 5,600 Ordering costs 3,360 (See Note 2) 2,100 Engineering costs 21,140 Unchanged because capacity same 21,140 Total manufacturing costs $315,000 $279,440 Note 1 10% of old CE100s are reworked. That is, 700 (10% of 7,000) CE100s made are reworked. Rework costs = $20 per unit reworked ( 700 = $14,000. If rework go to 4% of New CE100s manufactured, 280 (4% of 7,000) New CE100s manufactured will require rework. Rework co sts = $20 per unit ( 280 = $5,600. Note 2 Ordering costs for New CE100 = 2 orders/month ( 50 components ( $21/order = $2,100Unit manufacturing costs of New CE100 = $279,440 ? 7,000 = $39. 92 2. Total manufacturing cost reductions based on new design= $315,000 $279,440 = $35,560 Reduction in unit manufacturing costs based on new design= $35,560 ? 7,000 = $5. 08 per unit. The reduction in unit manufacturing costs based on the new design can also be calculated as Unit cost of old design, $45 ($315,000 ? 7,000 units) Unit cost of new design, $39. 92 = $5. 08 Therefore, the target cost reduction of $6 per unit is not achieved by the redesign. 3. Changes in design have a easily larger impact on costs per unit relative to improvements in manufacturing expertness ($5. 08 versus $1. 50).One explanation is that many costs are locked in once the design of the radio-cassette is completed. Improvements in manufacturing efficiency cannot reduce many of these costs. Design choices can influen ce many direct and overhead cost categories, for example, by reducing direct materials requirements, by reducing defects requiring rework, and by designing in less components that translate into fewer orders placed and lower ordering costs. 12-30(25 min. )Cost-plus, target return on investment pricing. 1. Target operating income = Return on roof in dollars = $13,000,000pic10% = $1,300,000 2. Revenues* $6,000,000 Variable costs ($3. 50 + $1. 0)pic500,000 cases 2,500,000 Contribution margin 3,500,000 Fixed costs ($1,000,000 + $700,000 + $500,000) 2,200,000 Operating income (from requirement 1) $1,300,000 * solve backwards for revenues Selling price = pic$12 per case. Markup % on full cost Full cost = $2,500,000 + $2,200,000 = $4,700,000 Unit cost = $4,700,000 ? 500,000 cases = $9. 40 per case Markup % on full cost = pic27. 66% 3. Budgeted Operating Income For the year ending December 31, 20xx Revenues ($14 pic 475,000 cases*) $6,650,000 Variable costs ($5 pic 475,000 cases ) 2,375,000 Contribution margin 4,275,000 Fixed costs 2,200,000 Operating income $2,075,000 *New units = 500,000 casespic95% = 475,000 casesReturn on investment = pic15. 96% Yes, increasing the selling price is a good idea because operating income increases without increasing invested capital, which results in a higher return on investment. The new return on investment exceeds the 10% target return on investment. 12-31(20 min. )Cost-plus, time and materials, ethics. 1. As shown in the table below, Garrison will tell Briggs that she will have to pay $460 to get the air learn system repaired and $440 to get it superceded. COST ram Materials Total Cost purify option (5 hrs. pic $30 per hr. $100) $150 $100 $250 interchange option (2 hrs. pic $30 per hr. $200) 60 200 260 PRICE (100% markup on labor cost 60% markup on materials) Labor Materials Total Price Repair option ($150 pic 2 $100 pic 1. 6) $300 $160 $460 deputise option ($60 pic 2 $200 pic 1. 6) 120 320 440 2.If the repair and counterchange options are equally effective, Briggs will choose to get the air conditioning system replaced for $440 (rather than spend $460 on repairing it). 3. R&C Mechanical will earn a greater contribution toward overhead in the repair option ($210 = $460 $250) than in the replace option ($180 = $440 $260). Therefore, Garrison will recommend the repair option to Briggs which is not the one she would prefer. Recognizing this conflict, Garrison may even present only the repair option to Ashley Briggs. Of course, he runs the danger of Briggs walking away and thinking of other options (at which point, he could present the replace option as a compromise). The problem is hat Garrison has captain information about the repairs needed but his incentives may cause him to not reveal his information and instead use it to his advantage. It is only the sellers desire to build a reputation, to have a long-term relationship with the customer, and to have the custo mer recommend the seller to other potential buyers of the service that encourages an honest discussion of the options. The ethical course of action would be to aboveboard present both options to Briggs and have her choose. To have their employees act ethically, organizations do not reward employees on the terms of the profits earned on various jobs. They also develop codes of conduct and core values and beliefs that specify appropriate and inappropriate behaviors. 12-32(25 min. )Cost-plus and market-based pricing. 1.California Temps full cost per hour of supplying contract labor is Variable costs$13 Fixed costs ($168,000 ? 84,000 hours) 2 Full cost per hour$15 Price per hour at full cost plus 20% = $15 ( 1. 20 = $18 per hour. 2. Contribution margins for different prices and demand realizations are as follows Contribution Margin per Variable Cost per Hour Hour Demand in Hours Total Contribution Price per Hour (2) (3) = (1) (2) (4) (5) = (3) ? 4) (1) $16 $13 $3 124,00 0 $372,000 17 13 4 104,000 416,000 18 13 5 84,000 420,000 19 13 6 74,000 444,000 20 13 7 61,000 427,000 Fixed costs will remain the same regardless of the demand realizations.Fixed costs are, therefore, irrelevant since they do not differ among the alternatives. The table above indicates that California Temps can maximize contribution margin ($444,000) and operating income by charging a price of $19 per hour. 3. The undetermined approach to pricing in requirement 1 does not explicitly consider the effect of prices on demand. The approach in requirement 2 models the interaction between price and demand and determines the optimal level of profitability using concepts of relevant costs. The two different approaches lead to two different prices in requirements 1 and 2. As the chapter describes, pricing decisions should consider both demand or market considerations and supply or cost factors.The approach in requirement 2 is the more balanced approach. In most cases, of course, man agers use the cost-plus method of requirement 1 as only a starting point. They then modify the cost-plus price on the basis of market considerationsanticipated customer reaction to alternative price levels and the prices charged by competitors for similar products. 12-33Cost-plus and market-based pricing. 1. Single rate = pic $11. 91 per test-hour (TH) Hourly guardianship rate for HTT and ACT = $11. 91pic1. 45 = $17. 27 2. Labor and supervision = pic= $4. 64 per test-hour Setup and adroitness costs = pic= $503. 275 per setup-hour Utilities = pic= $36. 80 per machine-hour (MH) 3. HTT ACT Total Labor and supervision $295,104 $196,736 $ 491,840 ($4. 64? 63, 600 42,400 test-hours)1 Setup and facility cost 100,655 301,965 402,620 ($503. 275? 200 600 setup-hours)2 Utilities 184,000 ($36. 80? ,000 5,000 machine-hours)3 184,000 368,000 Total cost $579,759 $682,701 $1,262,460 Number of test hours (TH) ? 63,600 TH ? 42,400 TH Cost per testing hour $9. 12 per TH $ 16. 1 0 per TH Mark-up ? 1. 45 ? 1. 5 Billing rate per testing hour $ 13. 22 per TH $ 23. 35 per TH 1106,000 test-hours pic 60% = 63,600 test-hours 106,000 test-hourspic40% = 42,400 test-hours 2800 setup-hours ? 25% = 200 setup-hours 800 setup-hours ? 75% = 600 setup-hours 310,000 machine-hours ? 50% = 5,000 machine-hours 10,000 machine-hours ? 50% = 5,000 machine-hours The billing rates based on the activity-based cost structure make more sense.These billing rates reflect the ways the testing procedures consume the firms resources. 4. To stay competitive, Best Test needs to be more efficient in condom testing. Roughly 44% of arctic testings total cost pic occurs in setups and facility costs. Perhaps the setup activity can be redesigned to achieve cost savings. Best Test should also look for savings in the labor and supervision cost per test-hour and the total number of test-hours used in arctic testing, as well as the utility cost per machine-hour and the total number of m achine hours used in arctic testing. This may require redesigning the test, redesigning processes, and achieving efficiency and productivity improvements. 12-34(2530 min. )Life-cycle costing. 1. Total Project Life-Cycle Costs Variable costs Metal extraction and processing ($100 per ton ? 50,000 tons) $5,000,000 Fixed costs Metal extraction and processing ($4,000 ? 24 months) 96,000 Rent on evanescent buildings ($2,000 ? 7 months) 54,000 Administration ($5,000 ? 27 months) 135,000 Clean-up ($30,000 ? 3 months) 90,000 Land restoration 475,000 Selling land 150,000 Total life-cycle cost $6,000,000 2. Projected Life Cycle Income didactics Revenue ($150 per ton pic 50,000 tons) $7,500,000 Sale of land (plug after inputting other numbers) 500,000 Total life-cycle cost (6,000,000) Life-cycle operating income ($40 per ton ? 50,000 tons) $2,000,000 Mark-up percentage on project life-cycle cost = pic pic = 33? % 3. Revenue ($140 per ton pic 50,000 tons) $7,00 0,000 Sale of land 400,000 Total revenue $7,400,000 Total life-cycle cost at mark-up of 33? % $5,550,000 ($7,400,000 ? 1. 33333) New Life would need to reduce total life-cycle costs by $ 450,000 ($6,000,000 $5,550,000) Check Revenue $7,000,000 Sale of land 400,000 Total life-cycle cost (5,550,000) Life-cycle operating income $1,850,000 Mark-up percentage = pic= 33? 12-35(30 min. ) denudeline pricing, considerations other than cost in pricing. 1. If the number is $500, a. origin Eagle would expect to have 200 business and 100 pleasure travelers. b. Variable costs per passenger would be $65. c. Contribution margin per passenger = $500 $65 = $435. If the fare is $2,100, a. Air Eagle would expect to have 180 business and 20 pleasure travelers. b. Variable costs per passenger would be $175. c. Contribution margin per passenger = $2,100 $175 = $1,925. Contribution margin from business travelers at prices of $500 and $2,100, respectively, follow At a price of $ 500 $435 ? 200 passengers = $ 87,000At a price of $2,100 $1,925 ? 180 passengers= $346,500 Air Eagle would maximize contribution margin and operating income by charging business travelers a fare of $2,100. Contribution margin from pleasure travelers at prices of $500 and $2,100, respectively, follow At a price of $500 $435 ? 100 passengers= $43,500 At a price of $2,100 $1,925 ? 20 passengers= $38,500 Air Eagle would maximize contribution margin and operating income by charging pleasure travelers a fare of $500. Air Eagle would maximize contribution margin and operating income by a price differentiation strategy, where business travelers are charged $2,100 and pleasure travelers $500.In deciding between the alternative prices, all other costs such as fuel costs, allocated annual lease costs, allocated ground services costs, and allocated flight gang salaries are irrelevant. Why? Because these costs will not change some(prenominal) price Air Eagle chooses t