Name:
Incremental Analysis Exercises
1. Greco Corporation is comparing two different options. The company currently follows Option
1, with revenues of $80,000 per year, maintenance expenses of $5,000 per year, and operating
expenses of $38,000 per year. Option 2 provides revenues of $80,000 per year, maintenance
expenses of $12,000 per year, and operating expenses of $32,000 per year. Option 1 employs a
piece of equipment that was upgraded 2 years ago at a cost of $22,000. If Option 2 is chosen, it
will free up resources that will increase revenues by $3,000.
Complete the following table to show the change in income from choosing Option 2 versus
Option 1. Designate any sunk costs with an “S.”
Net Income
Option 1 Option 2 Increase Sunk (S)
(Decrease)
$80,000 $80,000 0
Revenues
Maintenance $5,000 $12,000 (7,000)
expenses
Operating $38,000 $32,000 6,000
expenses
Equipment $22,000 0 S
upgrade
Opportunity $3,000 3,000
0
cost
$34,000 $36,000 $2,000
NI Total
=> Option 2 results in a net income increase of $2,000 per year.
2. Accept a special order? We could obtain additional business by making a major price
concession to a specific customer. Cupcake Cuties produces 100,000 Smoothie blenders per
month, which is 80% of plant capacity. Variable manufacturing costs are $8 per unit. Fixed
manufacturing costs are $400,000, or $4 per unit. The blenders are normally sold directly to
retailers at $20 each. Cuties has an offer from Kensington Co. (a foreign wholesaler) to purchase
an additional 2,000 blenders at $11 per unit. Acceptance of the offer would not affect normal
sales of the product, and the additional units can be manufactured without increasing plant
capacity. What should management do? (note that fixed costs don’t change so they are not
considered)
Net Income
Reject Order Accept Order Increase
(Decrease)
Revenues 0 $22,000 (2,000 * $11) $22,000
Costs 0 $16,000 (2,000 * $8) ($16,000)
Net Income 0 $6,000 $6,000
=> Special order would be accept because a net income increase by $6,000
Name:
3. Make or buy? Greco Corp makes motorcycles and scooters. It incurs the following annual
costs in producing 25,000 ignition switches for scooters:
Direct materials $50,000
Direct Labor $75,000
Variable Manufacturing Overhead $40,000
Fixed Manufacturing Overhead $60,000
Total Manufacturing Costs $225,000
Total cost per unit (225,000/25,000) $9.00
Instead of making switches, Greco could purchase the switches at a price of $8. If switches are
purchased, all variable costs are eliminated; $10,000 of fixed manufacturing overhead will be
eliminated What should management do?
Make Buy Net Income
Increase (Decrease)
Direct materials $50,000 0 $50,000
Direct labor $75,000 0 $75,000
Variable $40,000 0 $40,000
manufacturing costs
Fixed manufacturing $60,000
$60,000 0
costs
Purchase price
$200,000 ($200,000)
(25,000 x $8)
Total Annual Cost $225,000 $200,000 $25,000
3A: in the previous example, we assume there is no opportunity to convert the production
capacity to another use. Now, assume that the production capacity freed up by buying switches
can be converted to another use that generates an additional $38,000 in Net Income. Now what
should management do?
Name:
4. Sell or process further? Woodmasters makes tables and sells unfinished tables for $50.
Manufacturing costs for each unfinished table is: Direct materials $15; direct labor $10; Variable
manufacturing overhead $6; fixed manufacturing overhead $4; for a total of $35.
Woodmasters has unused production capacity that is expected to continue indefinitely.
Woodmasters could finish the tables and sell them at $60 per unit. For each finished table, direct
materials will increase $2 and direct labor will increase $4. Variable manufacturing overhead
costs will increase by $2.40 (60% of direct labor). No increase is anticipated in fixed
manufacturing overhead. Should Woodmasters sell the unfinished tables or process them further?
Sell unfinished Process further Net Income increase
(decrease)
Sales price per unit $50 $60 $10
Cost per unit
Direct materials $15 $17 ($2)
Direct labor $10 $14 ($4)
Variable MO $6 $8.4 ($2.4)
Fixed MO $4 $4 0
TOTAL COSTS $35 $43.4 ($8.4)
Net Income per Unit $15 $16.6 ($1.6)
