Problem 12-23: Relevant Cost Analysis
Requirement 1: Increased Fixed Selling Expenses
Current Situation:
- Normal sales: 60,000 Daks
- Selling price: $32 per unit
Proposed Change:
- Increase sales by 25%
- Increase fixed selling expenses by $80,000
Calculations:
1. New Sales Volume:
60,000 Daks * 1.25 = 75,000 Daks
2. Incremental Revenue:
(75,000 Daks - 60,000 Daks) * $32/Dak = 15,000 Daks * $32/Dak = $480,000
3. Variable Costs per Unit:
4. Direct materials: $10.00
5. Direct labor: $4.50
6. Variable manufacturing overhead: $2.30
7. Variable selling expenses: $1.20
8. Total Variable Cost per Unit: $10.00 + $4.50 + $2.30 + $1.20 = $18.00
9. Incremental Variable Costs:
15,000 Daks * $18.00/Dak = $270,000
10. Incremental Contribution Margin:
Incremental Revenue - Incremental Variable Costs = $480,000 - $270,000 =
$210,000
11. Net Impact on Profit:
Incremental Contribution Margin - Increase in Fixed Selling Expenses = $210,000 -
$80,000 = $130,000
Conclusion:
Yes, the increased fixed selling expenses of $80,000 would be justified. The company's
net operating income would increase by $130,000 ($210,000 incremental contribution
margin - $80,000 increased fixed selling expenses) if sales are increased by 25%.
Requirement 2: Foreign Market Order
Relevant Costs for the 20,000 Dak Order:
1. Variable Manufacturing Costs per Unit:
◦ Direct materials: $10.00
◦ Direct labor: $4.50
◦ Variable manufacturing overhead: $2.30
◦ Total Variable Manufacturing Cost per Unit: $10.00 + $4.50 + $2.30 = $16.80
2. Order-Specific Costs per Unit:
◦ Import duties: $1.70
◦ Shipping cost: $3.20
3. Total Order-Specific Variable Costs per Unit: $1.70 + $3.20 = $4.90
4. Total Variable Cost per Unit for this Order:
Variable Manufacturing Cost per Unit + Order-Specific Variable Costs per Unit =
$16.80 + $4.90 = $21.70
5. Total Fixed Costs for this Order:
◦ Permits and licenses: $9,000
6. Total Relevant Costs for the Order:
(Total Variable Cost per Unit for this Order * Number of Units) + Total Fixed Costs
for this Order
($21.70 * 20,000 Daks) + $9,000 = $434,000 + $9,000 = $443,000
7. Per Unit Break-Even Price:
Total Relevant Costs for the Order / Number of Units
$443,000 / 20,000 Daks = $22.15 per unit
Conclusion:
The per unit break-even price on this foreign market order is $22.15.
Requirement 3: "Seconds" Daks
Relevant Cost for Setting a Minimum Selling Price:
The relevant unit cost figure for setting a minimum selling price for the 1,000 "seconds"
Daks is $0 (zero).
Explanation:
The costs incurred to produce these 1,000 Daks (direct materials, direct labor,
manufacturing overhead) are sunk costs. They have already been incurred and cannot
be recovered or changed by any future decision regarding these specific units. Whether
the company sells them, scraps them, or keeps them, these past production costs
remain the same.
For decision-making purposes, only future costs and revenues that differ between
alternatives are relevant. Since the problem states that these units are already on hand
and have irregularities, and there are no additional costs mentioned for further
processing or selling them (beyond what would have been incurred for regular units,
which are now sunk), any revenue generated from selling them, even a very low price,
would contribute positively to covering some of the sunk costs. Therefore, the minimum
selling price should be any amount greater than zero, as long as it covers any additional
costs that would be incurred only if they are sold (e.g., a special handling fee, if any,
which is not mentioned here). In the absence of such additional costs, the relevant cost
is zero.
Requirement 4: Plant Shutdown
Scenario 1: Operate at 30% of normal levels for two months
• Production:
◦ Normal annual production: 60,000 Daks
◦ Normal monthly production: 60,000 Daks / 12 months = 5,000 Daks/month
◦ Production at 30% level: 5,000 Daks/month * 0.30 = 1,500 Daks/month
◦ Total production for two months: 1,500 Daks/month * 2 months = 3,000 Daks
• Costs for two months:
◦ Variable Manufacturing Costs:
▪ Variable manufacturing cost per unit = Direct materials + Direct labor +
Variable manufacturing overhead
▪ Variable manufacturing cost per unit = $10.00 + $4.50 + $2.30 = $16.80
▪ Total variable manufacturing costs = 3,000 Daks * $16.80/Dak = $50,400
◦ Fixed Manufacturing Overhead:
▪ Total annual fixed manufacturing overhead = $300,000
▪ Monthly fixed manufacturing overhead = $300,000 / 12 = $25,000
▪ Fixed manufacturing overhead for two months = $25,000/month * 2
months = $50,000
◦ Fixed Selling Expenses:
▪ Total annual fixed selling expenses = $210,000
▪ Monthly fixed selling expenses = $210,000 / 12 = $17,500
▪ Fixed selling expenses for two months = $17,500/month * 2 months =
$35,000
• Total Costs if Operating at 30%:
$50,400 (Variable Mfg) + $50,000 (Fixed Mfg OH) + $35,000 (Fixed Selling) =
$135,400
Scenario 2: Close the plant entirely for two months
• Costs for two months:
◦ Fixed Manufacturing Overhead:
▪ Normal fixed manufacturing overhead for two months = $50,000
▪ Fixed manufacturing overhead if closed = $50,000 * 0.60 = $30,000
◦ Fixed Selling Expenses:
▪ Normal fixed selling expenses for two months = $35,000
▪ Reduction in fixed selling expenses = $35,000 * 0.20 = $7,000
▪ Fixed selling expenses if closed = $35,000 - $7,000 = $28,000
• Total Costs if Plant is Closed:
$30,000 (Fixed Mfg OH) + $28,000 (Fixed Selling) = $58,000
Impact on Profits of Closing the Plant:
• Savings from Closing: Total Costs if Operating at 30% - Total Costs if Plant is
Closed $135,400 - $58,000 = $77,400
Conclusion:
Closing the plant for the two-month period would result in a $77,400 increase in profits
(or reduction in losses) compared to operating at 30% of normal levels. Therefore, it
would be more profitable to close the plant for the two-month period.
Requirement 5: Outside Manufacturer Offer
To compute the unit cost that is relevant for comparison to the price quoted by the
outside manufacturer, we need to identify the costs that would be avoided if Andretti
Company accepts the offer and stops producing Daks in-house.
Avoidable Costs per Unit (if manufactured by outside party):
1. Direct Materials: $10.00 (Avoided if not produced in-house)
2. Direct Labor: $4.50 (Avoided if not produced in-house)
3. Variable Manufacturing Overhead: $2.30 (Avoided if not produced in-house)
◦ Total Variable Manufacturing Cost per Unit: $10.00 + $4.50 + $2.30 = $16.80
4. Variable Selling Expenses:
◦ Original variable selling expenses: $1.20
◦ If outside manufacturer pays for shipping, variable selling expenses would be
two-thirds of their present amount. This means one-third of the variable
selling expenses would be avoided.
◦ Avoidable portion of variable selling expenses = $1.20 * (1/3) = $0.40
5. Fixed Manufacturing Overhead:
◦ Total annual fixed manufacturing overhead: $300,000
◦ Fixed manufacturing overhead per unit (at 60,000 units): $5.00
◦ If the offer is accepted, fixed manufacturing overhead costs would be reduced
by 75%. This 75% reduction is an avoidable cost.
◦ Avoidable fixed manufacturing overhead per unit = $5.00 * 0.75 = $3.75
Relevant Unit Cost for Comparison:
Sum of all avoidable costs per unit:
$16.80 (Variable Manufacturing) + $0.40 (Avoidable Variable Selling) + $3.75 (Avoidable
Fixed Manufacturing Overhead) = $20.95
Conclusion:
The unit cost that is relevant for comparison to the price quoted by the outside
manufacturer is $20.95.
