Question 1

Letze Corporation would like to determine the relative profitability of the company's products for purposes of making volume trade-off decisions. The company has provided the following data for product I69Y: 
What is the profitability index for product I69Y?
A) $109,120
B) 0.20
C) $22.00 per minute
D) $4.40 per minute

Accepted Answer

The profitability index is calculated by dividing the present value of cash inflows by the initial investment. In this case, the present value of cash inflows is $1,091,200 ($100,000 x 0.10 x 11 years) and the initial investment is $248,000 ($200,000 + $48,000). Therefore, the profitability index is 4.4 ($1,091,200 / $248,000). The best choice would be to continue producing product I69Y, as it has a positive profitability index, indicating that it generates more cash inflows than its initial investment.

Question 2

When a company has a production constraint, the selling price of any new product should cover both its variable cost and the opportunity cost involved in using the constrained resource.

Accepted Answer

This is true as the company needs to ensure that the revenue generated by the sale of the new product should at least cover the cost of producing it, including the cost of using the constrained resource. Failing to do so will result in a loss for the company.

Question 3

Wang Corporation would like to determine the relative profitability of a number of jobs. For example, the revenue from Job Q86D is $105,300 and its avoidable costs amount to $63,180, resulting in an incremental profit of $42,120. Furthermore, the job requires 270 hours of the constrained resource. What is the profitability index for job Q86D?
A) 0.40
B) $234 per hour
C) $156 per hour
D) $390 per hour

Accepted Answer

The profitability index is calculated as the incremental profit per unit of the constrained resource.

Profitability index = incremental profit/units of constrained resource
                = 42,120/270
                = $156 per hour

Therefore, the answer is C. Choice B, $234 per hour, is not a profitability index but rather the total revenue divided by the number of hours of work. Choice A and D are not even in the correct format for a profitability index answer.

Question 4

When long-term investment funds are the constraint and the company is choosing from among potential long-term projects, the profitability index should be computed by dividing the total expected revenues from the project by the amount of long-term investment funds required by the project.

Accepted Answer

The profitability index is computed by dividing the present value of future cash flows by the initial investment, not by dividing total expected revenues by the investment.

Question 5

The profitability index for a volume trade-off decision involving products should be computed by dividing the unit contribution margin of a product by the selling price of the product.

Accepted Answer

The profitability index is computed by dividing the present value of expected cash inflows by the initial investment. It is not calculated by dividing the unit contribution margin by the selling price of a product.

Question 6

When long-term investment funds are the constraint and the company is choosing from among potential long-term projects, the profitability index should be computed by dividing the net present value of a project by the expected total revenues from the project.

Accepted Answer

The profitability index should be computed by dividing the net present value of a project by the expected total costs of the project, not revenues.

Question 7

Dombrowski Corporation would like to determine the relative profitability of the company's products for purposes of making volume trade-off decisions. For example, the selling price of product V48Q is $150.00, its unit variable cost is $135.00, and its unit contribution margin is $15.00. One unit of the product requires 6 minutes of the constrained resource. Monthly sales are 5,800 units. What is the profitability index for product V48Q?
A) $2.50 per minute
B) 0.10
C) $25.00 per minute
D) $87,000

Accepted Answer

The profitability index is calculated by dividing the unit contribution margin by the time required for one unit of the constrained resource. For product V48Q, it is $15.00 / 6 minutes = $2.50 per minute.

Question 8

Rognstad Corporation would like to determine the relative profitability of a number of jobs. For illustration purposes, the company has provided the following data for job M38S: 
What is the profitability index for job M38S?
A) $360 per hour
B) 0.20
C) 0.40
D) $144 per hour

Accepted Answer

The answer of Rognstad Corporation would like to determine the...

Question 9

If a company is considering accepting a number of jobs, but there is insufficient production capacity to do all of them, then the profitability index can be used to rank the jobs and decide which should be accepted.

Accepted Answer

The profitability index is a ratio of the present value of expected cash inflows to the initial investment required. By calculating the profitability index for each job, the company can rank the jobs based on their potential profitability relative to the investment required. This can help in deciding which jobs to accept if there is insufficient production capacity to do all of them.

Question 10

Mccraig Corporation would like to determine the relative profitability of a number of jobs. For example, job S35A has revenues of $52,000 and avoidable costs of $36,400, resulting in an incremental profit of $15,600. The job requires 260 hours of the constrained resource. The job is responsible for 8% of the company's total profit for the period. What is the profitability index for job S35A?
A) $60 per hour
B) $200 per hour
C) 0.30
D) 0.08

Accepted Answer

The profitability index is calculated as incremental profit divided by the hours of constrained resource required. For job S35A, it is $15,600 / 260 hours = $60 per hour.

Question 11

The opportunity cost of using one unit of the constrained resource in a volume trade-off decision is equal to:
A) the profitability index for the company's best selling product.
B) the profitability index for the product whose production would be cut back if necessary.
C) the profitability index of the product with the fastest growing sales.
D) the profitability index of the company's most profitable product.

Accepted Answer

The opportunity cost in a volume trade-off decision is the potential benefit that is lost by choosing one option over another. Therefore, the correct answer is the profitability index for the product whose production would be cut back if necessary. This is because if a decision has to be made to allocate the constrained resource to one product over another, it would come at a cost of reducing the production of the other product. Hence, the profitability index of that product would indicate the impact of this decision on the company's overall profitability.

Question 12

Relative profitability is concerned with ranking business segments for the purpose of making trade-offs among the segments.

Accepted Answer

Relative profitability is a tool used to compare the profitability of different business segments so that trade-offs can be made among them. Therefore, the statement is true.

Question 13

A company that makes horsehair cowboy belts cannot meet the demand for belts due to a limited supply of artisans who know how to make the belts. To determine which models of the cowboy belts should be emphasized, the company should rank the models by dividing the selling price of each model by the amount of time an artisan requires to make the model.

Accepted Answer

The answer of A company that makes horsehair cowboy belts...

Question 14

The opportunity cost of using a unit of the constrained resource in a volume trade-off decision is determined by the profitability index of the company's least profitable product--even if none of that product is currently being made.

Accepted Answer

The opportunity cost is determined by the profitability index of the most profitable product that could be produced with the constrained resource, not the least profitable one.

Question 15

Manchester Corporation would like to determine the relative profitability of the company's products for purposes of making volume trade-off decisions. For example, the selling price of product G94T is $304.00 and its unit variable cost is $243.20. One unit of the product requires 16 ounces of the constrained resource. Monthly sales are 9,300 units. What is the profitability index for product G94T?
A) $565,440
B) 0.20
C) $3.80 per ounce
D) $19.00 per ounce

Accepted Answer

The answer of Manchester Corporation would like to determine the...

Question 16

Relative profitability measures should only be used when:
A) absolute profitability measures fail to provide a decision.
B) absolute profitability measures cannot be used.
C) a constraint forces a trade-off among segments.
D) market shares are falling.

Accepted Answer

Relative profitability measures, such as contribution margin ratio or return on investment, are useful when there is a constraint that forces the company to make trade-offs among segments or products. In such situations, absolute profitability measures may not provide a clear decision because they do not consider the impact of resource allocation on other segments. Therefore, relative profitability measures can help the company to prioritize its resources and maximize its overall profit. Absolute profitability measures should be used whenever possible, and relative measures should be used as a supplement to provide additional insights. Market share is not related to the use of profitability measures.

Question 17

Alberding Corporation would like to determine the relative profitability of the company's products for purposes of making volume trade-off decisions. For illustration, the company has provided the following data for product S06K: 
What is the profitability index for product S06K?
A) $6.00 per gram
B) $2.40 per gram
C) 0.40
D) $367,200

Accepted Answer

The answer of Alberding Corporation would like to determine the...

Question 18

Tevlin Corporation would like to determine the relative profitability of a number of jobs. For illustration purposes, the company has provided the following data for job H90X: 
What is the profitability index for job H90X?
A) $224 per hour
B) $560 per hour
C) $336 per hour
D) 0.40

Accepted Answer

The answer of Tevlin Corporation would like to determine the...

Question 19

In the absence of a constraint, all business segments that are relatively profitable should be retained.

Accepted Answer

The answer of In the absence of a constraint, all...

Question 20

Relative profitability should be measured by dividing the incremental profit from a segment by the amount of the constrained resource required by that segment.

Accepted Answer

This statement accurately describes the concept of relative profitability, which is a method to determine the profitability of a product or customer segment based on the usage of a limited resource. By dividing the incremental profit (additional profit earned from selling the product or serving the customer) by the amount of constrained resource required (such as labor hours, raw materials, or machine time), a company can identify which segments are the most profitable and optimize its resource allocation accordingly.

Quiz 18: Profitability Analysis

Letze Corporation would like to determine the relative profitability of the company's products for purposes of making volume trade-off decisions. The company has provided the following data for product I69Y: What is the profitability index for product I69Y?

When a company has a production constraint, the selling price of any new product should cover both its variable cost and the opportunity cost involved in using the constrained resource.

When long-term investment funds are the constraint and the company is choosing from among potential long-term projects, the profitability index should be computed by dividing the total expected revenues from the project by the amount of long-term investment funds required by the project.

The profitability index for a volume trade-off decision involving products should be computed by dividing the unit contribution margin of a product by the selling price of the product.

When long-term investment funds are the constraint and the company is choosing from among potential long-term projects, the profitability index should be computed by dividing the net present value of a project by the expected total revenues from the project.

Rognstad Corporation would like to determine the relative profitability of a number of jobs. For illustration purposes, the company has provided the following data for job M38S: What is the profitability index for job M38S?

If a company is considering accepting a number of jobs, but there is insufficient production capacity to do all of them, then the profitability index can be used to rank the jobs and decide which should be accepted.

The opportunity cost of using one unit of the constrained resource in a volume trade-off decision is equal to:

Relative profitability is concerned with ranking business segments for the purpose of making trade-offs among the segments.

The opportunity cost of using a unit of the constrained resource in a volume trade-off decision is determined by the profitability index of the company's least profitable product--even if none of that product is currently being made.

Relative profitability measures should only be used when:

Alberding Corporation would like to determine the relative profitability of the company's products for purposes of making volume trade-off decisions. For illustration, the company has provided the following data for product S06K: What is the profitability index for product S06K?

Tevlin Corporation would like to determine the relative profitability of a number of jobs. For illustration purposes, the company has provided the following data for job H90X: What is the profitability index for job H90X?

In the absence of a constraint, all business segments that are relatively profitable should be retained.

Relative profitability should be measured by dividing the incremental profit from a segment by the amount of the constrained resource required by that segment.