Question 1

Dong Fang Company fabricates inexpensive automobiles for sale to 3^rd world countries. Each auto includes one wiring harness, which is currently made in-house. Details of the harness fabrication are as follows: A factory in Indonesia has offered to supply Dong Fang with ready-made units for a price of $14.00 each. Assume that Dong Fang's fixed costs are unavoidable, and that Dong Fang will not be able to use the excess capacity in any profitable manner. If Dong Fang decides to outsource, what will be the impact on Dong Fang's monthly operational income?

Accepted Answer

The answer of Dong Fang Company fabricates inexpensive automobiles for...

Question 2

DC Electronics uses a standard part in the manufacture of several of its radios. The cost of producing 30,000 parts is $90,000, which includes fixed costs of $33,000 and variable costs of $57,000. The company can buy the part from an outside supplier for $2.50 per unit, and avoid 30% of the fixed costs. Assume that factory space freed up by purchasing the part from an outside source can be used to manufacture another product that can earn profit of $11,600. If DC outsources, what will the effect on operating income be?

Accepted Answer

B) Calculations:
$2.50 × 30,000 = $75,000
$57,000 × 70% = $39,900
$75,000 + $39,900 - $11,600 = $103,300
$103,300 - $90,000 = $13,300

Question 3

Shasta Company is trying to decide whether to continue to manufacture a particular component or to buy the component from an outside supplier. Which of the following is IRRELEVANT with respect to this decision?

Accepted Answer

The unavoidable fixed manufacturing costs associated with the manufacture of the component are relevant to the decision because they must be compared to the cost of purchasing the component from an outside supplier. A, B, and C are all relevant factors that should be considered when making the decision.

Question 4

Dong Fang Company fabricates inexpensive automobiles for sale to 3^rd world countries. Each auto includes one wiring harness, which is currently made in-house. Details of the harness fabrication are as follows: A factory in Indonesia has offered to supply Dong Fang with ready-made units for a price of $14.00 each. Assume that Dong Fang's fixed costs could be reduced by $5,000 if they outsource, and that Dong Fang will not be able to use the excess capacity in any profitable manner. If Dong Fang decides to outsource, what will be the impact on Dong Fang's monthly operational income?

Accepted Answer

The answer of Dong Fang Company fabricates inexpensive automobiles for...

Question 5

Alexandria Semiconductors produces 300,000 hi-tech computer chips per month. Each chip uses a component which Alexandria makes in-house. The variable costs to make the component are $0.80 per unit, and the fixed costs run $956,000 per month. Alexandria has been approached by a foreign producer who can supply the component, ready-made and with acceptable quality standards for $0.60 each. If Alexandria chooses to outsource, it could reduce the fixed costs by 50%. Alexandria would have no other use for the facilities currently employed in making the component. If Alexandria decides to outsource, how would that affect the operating income?

Accepted Answer

Current variable cost to make 1 computer chip = $0.80
Current fixed cost to make 300,000 chips = $956,000

Total current cost to make 300,000 chips = (0.80 * 300,000) + $956,000 = $1,196,000

If Alexandria chooses to outsource:
Variable cost per unit = $0.60
Total variable cost to make 300,000 chips = (0.60 * 300,000) = $180,000

Reduced fixed cost to make 300,000 chips = 0.5 * $956,000 = $478,000

Total cost to outsource 300,000 chips = $180,000 + $478,000 = $658,000

Operating income from making 300,000 chips in-house = Revenue - Total cost = Revenue - $1,196,000
Operating income from outsourcing = Revenue - Total cost = Revenue - $658,000

Since the revenue remains the same in both cases, the change in operating income will depend only on the change in total cost.

Therefore, the change in operating income if Alexandria outsources = (Operating income from making in-house) - (Operating income from outsourcing)
= (Revenue - $1,196,000) - (Revenue - $658,000)
= $538,000

Hence, the operating income would go up by $180,000 if Alexandria decides to outsource.

Question 6

When a company is considering the possibility of processing their product further to achieve higher sales revenues, the rule is as follows: if incremental revenues exceed incremental costs, then further processing will enhance operational profits.

Accepted Answer

This is the basic rule of cost-benefit analysis and is applicable in most cases when deciding whether to invest in further processing or not.

Question 7

Lincoln Company produces a part that is used in the manufacture of one of its products. The unit manufacturing costs of this part, assuming a production level of 5,000 units, are as follows:  Erickson Company has offered to sell 5,000 units of the same part to Lincoln Company for $13 per unit. Assuming the company has no other use for its facilities and that the fixed manufacturing costs are unavoidable, what should Lincoln Company do?

Accepted Answer

The answer of Lincoln Company produces a part that is...

Question 8

CM Manufacturing has provided the following unit costs pertaining to a component they manufacture and use in the production of one of their main products:  A supplier has offered to provide the component to CM manufacturing for $500 per unit. If CM Manufacturing were to buy the component from the supplier, they could use the released facilities to manufacture a product which would generate contribution margin of $16,000 annually. Assuming that CM Manufacturing needs 2,000 components annually and the fixed manufacturing overhead is unavoidable, what would be the impact on operating income if the company outsources?

Accepted Answer

The answer of CM Manufacturing has provided the following unit...

Question 9

When a company is considering the possibility of processing their product further to achieve higher sales revenues, they must carefully study the production costs needed to make the basic productbefore processing furtherin order to come to an informed decision.

Accepted Answer

The answer of When a company is considering the possibility...

Question 10

A chemical company spent $480,000 to produce 144,000 gallons of a chemical, which can be sold for $4.32 per gallon. The chemical can be further processed into a weed killer which can be sold for $6.40 per gallon; it will cost $256,320 to process the chemical into a weed killer. Which of the following is TRUE?

Accepted Answer

C) Calculations:
($6.40 - $4.32) × 144,000 = $299,520
$299,520 - $256,320 = $43,200

Question 11

Which of the following phrases MOST accurately describe opportunity cost?

Accepted Answer

Opportunity cost refers to the benefit given up by not choosing an alternative course of action. It is the value of the next best alternative foregone. Therefore, option C most accurately describes opportunity cost. Option A describes the cost incurred to gain an opportunity, while option B describes the benefit gained from choosing a particular course of action. Option D describes sunk costs, which are costs that have already been incurred and cannot be recovered.

Question 12

Victory Company makes a special kind of racing tire. Variable costs are $220, and fixed costs are $30,000 per month. Victor sells 500 units per month at a price of $300. If Victory upgrades the quality of the tire, they believe they can boost the price to $342. If so, the variable cost will go up to $230 and the fixed costs will rise by 50%. The CEO wishes to increase his operational income by 25%. If Victory decides to upgrade the product according to the data above, the CEO will reach his goal.

Accepted Answer

To calculate the current operational income, we can use the formula:

Operational Income = Revenue - Total Costs
Total Costs = Variable Costs + Fixed Costs
Revenue = Price x Quantity

Using the given values:

Variable Costs = $220
Fixed Costs = $30,000
Price = $300
Quantity = 500

Total Costs = $220 x 500 + $30,000 = $141,000
Revenue = $300 x 500 = $150,000

Operational Income = $150,000 - $141,000 = $9,000

Now let's calculate the new operational income if the company upgrades the tire:

Variable Costs = $230
Fixed Costs = $30,000 x 1.5 = $45,000
Price = $342
Quantity = 500

Total Costs = $230 x 500 + $45,000 = $170,000
Revenue = $342 x 500 = $171,000

Operational Income = $171,000 - $170,000 = $1,000

This is a decrease in operational income, not an increase. Therefore, the answer is B.

Question 13

Action Products is deciding whether to outsource production of a certain component that is included in all of its products. It currently costs Action Products $0.95 to make each component in-house. If Action Products outsources, it can buy the component ready-made for $0.80 each. If Action Products outsources, it could shut down the production facilities it is currently using to manufacture the component, and save $10,000 a year in fixed costs. After analyzing both options, Action Products decided to continue making the component in-house. In the analysis done, which of the following items would be considered an opportunity cost?

Accepted Answer

The opportunity cost refers to the benefits a company misses out on when choosing one alternative over another. In this case, by deciding not to outsource, Action Products misses out on the opportunity to save $10,000 per year in fixed costs, making this the opportunity cost of their decision.

Question 14

Arlo Company makes bulk quantities of cleaning fluids. They currently sell 1,000 containers a month at a price of $22 per unit. If they added a newer scent, they could charge $22.75 per unit for the improved product. It would cost them a total of $700 per month to make that alteration. If they decide to process further, it will improve their operational income.

Accepted Answer

By adding the newer scent and charging a higher price, the company's revenue per unit would increase from $22 to $22.75, resulting in a potential increase in revenue. The added cost of $700 per month can be covered by selling just over 31 additional units per month ($700 / ($22.75 - $22) = 31.11). As a result, the company's operational income could increase if they decide to pursue this option.

Question 15

Alexandria Semiconductors produces 300,000 hi-tech computer chips per month. Each chip uses a component which Alexandria makes in-house. The variable costs to make the component are $0.80 per unit, and the fixed costs run $956,000 per month. Alexandria has been approached by a foreign producer who can supply the component, ready-made and with acceptable quality standards for $0.60 each. The fixed costs are unavoidable, and Alexandria would have no other use for the facilities currently employed in making the component. If Alexandria decides to outsource, how would that affect the operating income?

Accepted Answer

C) Calculations:
(300,000 × $0.80) + $956,000 = $1,196,000
(300,000 × $0.60) + $956,000 = $1,136,000
$1,196,000 - $1,136,000 = $60,000

Question 16

Gnome Company is trying to decide whether to continue to manufacture a particular component or to buy the component from an outside supplier. Which of the following is RELEVANT to this decision?

Accepted Answer

A) The potential uses of the facilities that are currently used to manufacture the component are relevant because if the component is no longer manufactured in-house, the company could use these facilities for other productive activities, potentially generating additional revenue or savings.

Question 17

When a company is considering the possibility of processing their product further to achieve higher sales revenues, the rule is as follows: as long as the additional processing generates higher sales revenues, it is the preferred alternative.

Accepted Answer

The answer of When a company is considering the possibility...

Question 18

Dong Fang Company fabricates inexpensive automobiles for sale to 3^rd world countries. Each auto includes one wiring harness, which is currently made in-house. Details of the harness fabrication are as follows: A factory in Indonesia has offered to supply Dong Fang with ready-made units for a price of $14.00 each. Assume that Dong Fang's fixed costs are unavoidable, but that Dong could use the vacated production facilities to earn an additional $7,500 of profit per month. If Dong Fang decides to outsource, what will be the impact on Dong Fang's monthly operational income?

Accepted Answer

The answer of Dong Fang Company fabricates inexpensive automobiles for...

Question 19

DC Electronics uses a standard part in the manufacture of several of its radios. The total cost of producing 30,000 parts is $90,000, which includes fixed costs of $33,000 and variable costs of $57,000. The company can buy the part from an outside supplier for $2.50 per unit, and avoid 30% of the fixed costs. If DC Electronics decides to outsource the production of the part, how will it impact operating income?

Accepted Answer

Total variable cost per unit = ($57,000 ÷ 30,000) = $1.90
Total cost per unit = ($90,000 ÷ 30,000) = $3.00
If DC Electronics buys the part from an outside supplier, it will save on variable costs per unit (i.e. $0.10 per unit) but will still have to pay the fixed costs of $33,000. The new total cost of producing 30,000 parts will be:
New total cost = $33,000 + ($2.50 × 30,000) = $108,000
Total cost per unit = ($108,000 ÷ 30,000) = $3.60
Operating income if DC Electronics makes the part:
Revenue ($3.00 × 30,000) = $90,000
Total cost ($90,000) = $57,000 (variable cost) + $33,000 (fixed cost) = $90,000
Operating income = $0
Operating income if DC Electronics buys the part from an outside supplier:
Revenue ($3.00 × 30,000) = $90,000
Total cost ($108,000) = $2.50 × 30,000 (variable cost) + $33,000 (fixed cost) = $108,000
Operating income = $90,000 - $108,000 = -$18,000
Operating income decreases by $18,000 if the part is bought from an outside supplier. However, the reduction in fixed costs ($33,000 × 30%) would reduce the impact by $9,900. Therefore, the total impact on operating income is a decrease of $18,000 - $9,900 = $24,900.

Question 20

Nordin Avionics makes aircraft instrumentation. Their basic navigation radio requires $80 in variable costs and requires $2,000 per month in fixed costs. If they process the radio further to enhance its functionality, it will require an additional $25 per unit of variable costs, but no change to the fixed costs. The marketing manager believes they would be able to boost their price of the radio from $260 to $280. In making this decision, the amount of fixed costs per month is a relevant piece of information.

Accepted Answer

Fixed costs remain constant regardless of the level of production or sales volume, so they are not relevant when deciding on variable production changes like enhancing a product's functionality.

Quiz 20: Short-Term Business Decisions

Shasta Company is trying to decide whether to continue to manufacture a particular component or to buy the component from an outside supplier. Which of the following is IRRELEVANT with respect to this decision?

When a company is considering the possibility of processing their product further to achieve higher sales revenues, the rule is as follows: if incremental revenues exceed incremental costs, then further processing will enhance operational profits.

When a company is considering the possibility of processing their product further to achieve higher sales revenues, they must carefully study the production costs needed to make the basic productbefore processing furtherin order to come to an informed decision.

Which of the following phrases MOST accurately describe opportunity cost?

Gnome Company is trying to decide whether to continue to manufacture a particular component or to buy the component from an outside supplier. Which of the following is RELEVANT to this decision?

When a company is considering the possibility of processing their product further to achieve higher sales revenues, the rule is as follows: as long as the additional processing generates higher sales revenues, it is the preferred alternative.