ANSWER –CASE 1

(a) HCD2 requires $100 ÷ $20 = 5 direct labor hours per unit. The new order
requires 1,000 = 200 × 5 direct labor hours, so the existing capacity is
adequate. The contribution margin per unit of HCD2 for the new order =
$400 − (75 + 100 + 125) = $100. The increase in profit is $20,000 = 200
units × $100 contribution margin.

(b) HCD1 HCD2

Sales price $400 $500
Variable cost:
Direct material $60 $75
Direct labor 80 100
Variable overhead 100 240 125 300
Contribution margin per unit $160 $200
DLH per unit      4  5
Contribution margin per DLH $40 per DLH $40 per DLH

The new order requires a total of 1,500  5  300 DLH, but only
1,000  15,000 – 14,000 DLH are available. This will leave a
capacity shortage of 500  1,500 – 1,000 DLH. The contribution
margin per DLH is $40 for each product, so the company can
forego sales of either product with the same effect. Therefore, the
change in profit is

Total contribution margin – opportunity cost

= (300 units  $100 contribution margin per unit) – (500 DLH  $40
contribution margin per DLH)

= $30,000 – $20,000

= $10,000 increase.
(c) If the plant is worked overtime to manufacture HCD2 for the new
order, the contribution margin is negative $12.50 as shown below:

Unit Variable Cost for Overtime

Material 1  75  $75.00
Labora 1.5  100  150.00
Variable overhead 1.5  125  187.50
Total variable cost $412.50
Sales price 400.00
Contribution margin $(12.50)
a
or 5 hours  $30 per hour

Change in Profit During

200  100  $20,000 Regular hours
100  (12.50)  (1,250) Overtime hours
Increase $18,750
CASE 2

A. Insource (Make) Outsource (Buy)

Smart phones:
$140  50,000 $7,000,000 $7,000,000
Component:
$35.00  50,000 1,750,000
$34.00  50,000 1,700,000
Relevant costs $8,750,000 $8,700,000

Insource (Make) Outsource (Buy)

Smart phones:
$140  50,000 $7,000,000 $7,000,000
Component:
$30.00  50,000 1,500,000
$34.00  50,000 1,700,000
Relevant costs $8,500,000 $8,700,000

B. Premier should make the gear model G37 because it costs $87,000
less to make than to buy. (Fixed overhead is irrelevant and may be
dropped from the analysis.)

Make Buy
Cost of purchase: $135  10,000 = $1,350,000 
Direct material cost: $60  10,000 = $600,000
Direct labor cost: $30  10,000 = 300,000 —
Variable overhead: $40  10,000 = 400,000 —
Fixed overhead $20 10,000 = 200,000 200,000
Savings in facility-sustaining costs               —     (120,000)
Relevant costs $1,500,000 $1,430,000 
CASE 3

Steve should consider selling the part for $1.85 because his division’s profits
would increase $12,800:

Accept Reject
Revenues (2 × $1.85 × 8,000)……………………$29,600 $0
Variable expenses (2 × $1.05 × 8,000)………… 16,800 0
Total…………………………………………… $12,800 $0

Pat’s divisional profits would increase by $18,400:

Accept Reject
Revenues ($32 × 8,000)……………………… $ 256,000 $0
Variable expenses:
Direct materials ($17 × 8,000)………………… (136,000) 0
Direct labor ($7 × 8,000)……………………… (56,000) 0
Overhead ($2 × 8,000)………………………… (16,000) 0
Component ($2 × $1.85 × 8,000)……………… (29,600) 0
Total relevant benefits……………………… $ 18,400 $0

2. Pat should accept the $2 price. This price will increase the cost of the
component from $29,600 to $32,000 (2 × $2 × 8,000) and yield an incremental
benefit of $16,000 ($18,400 – $2,400).

Steve’s division will see an increase in profit of $15,200 (8,000 units × 2

components per unit × $0.95 contribution margin per component).

3. Yes. At full price, the total cost of the component is $36,800 (2 × $2.30 ×
8,000), an increase of $7,200 over the original offer. This still leaves an increase
in profits of $11,200 ($18,400 – $7,200). (See the answer to Requirement 1.)
CASE 5

1. Because the fixed costs will not change as a result of the order, they are not
relevant to the decision. The cost of the new machine is relevant, and this
cost will have to be recovered by the current order because there is no
assurance of future business from the retail chain.
Total—5,000
Unit units
Sales from the order ($50 × 84%).................................. $42 $210,000
Less costs associated with the order:
Direct materials........................................................... 15 75,000
Direct labor.................................................................. 8 40,000
Variable manufacturing overhead................................ 3 15,000
Variable selling expense ($4 × 25%)........................... 1 5,000
Special machine ($10,000 ÷ 5,000 units)....................    2    10,000
Total costs.......................................................................  29  145,000
Net increase in profits..................................................... $13 $ 65,000

2. Sales from the order:

Reimbursement for costs of production (variable
production costs of $26 plus fixed manufacturing
overhead cost of $9 = $35 per unit; $35 per unit × 5,000
units)................................................................................... $175,000
Fixed fee ($1.80 per unit × 5,000 units)................................      9,000
Total revenue............................................................................ 184,000
Less incremental costs—variable production costs
($26 per unit × 5,000 units)...................................................  130,000
Net increase in profits............................................................... $ 54,000

3. Sales:
From the U.S. Army (above)................................................. $184,000
From regular channels ($50 per unit × 5,000 units)..............  250,000
Net decrease in revenue............................................................ (66,000)
Less variable selling expenses avoided if the Army’s order is
accepted ($4 per unit × 5,000 units)......................................    20,000
Net decrease in profits if the Army’s order is accepted............ $(46,000)
Note: This answer assumes that regular customers will return after this one-
time special order rather than buy from a competitor in the future.
CASE 6
1. A product should be processed further if the incremental revenue from the
further processing exceeds the incremental costs. The incremental revenue
from further processing of the Grit 337 is:
Selling price of the silver polish, per jar.......................... $4.00
Selling price of 1/4 pound of Grit 337 ($2.00 ÷ 4)..........  0.50
Incremental revenue per jar.............................................. $3.50
The incremental variable costs are:
Other ingredients.............................................................. $0.65
Direct labor....................................................................... 1.48
Variable manufacturing overhead (25% × $1.48)............ 0.37
Variable selling costs (7.5% × $4)...................................  0.30
Incremental variable cost per jar...................................... $2.80
Therefore, the incremental contribution margin is $0.70 per jar ($3.50 –
$2.80). The $1.60 cost per pound ($0.40 per 1/4 pound) required to produce
the Grit 337 would not be relevant in this computation because it is incurred
regardless of whether the Grit 337 is further processed into silver polish or
sold outright.

2. Only the cost of advertising and the cost of the production supervisor are
avoidable if production of the silver polish is discontinued. Therefore, the
number of jars of silver polish that must be sold each month to justify
continued processing of the Grit 337 into silver polish is:
Production supervisor................ $3,000
Advertising—direct...................  4,000
Avoidable fixed costs................. $7,000

Avoidable fixed costs $7,000

= = 10,000 jars per month
Incremental CM per jar $0.70 per jar

Therefore, if 10,000 jars of silver polish can be sold each month, the
company would be indifferent between selling it or selling all of the Grit 337
as a cleaning powder. If the sales of the silver polish are greater than 10,000
jars per month, then continued processing of the Grit 337 into silver polish
would be advisable because the company’s total profits will be increased. If
the company can’t sell at least 10,000 jars of silver polish each month, then
production of the silver polish should be discontinued. To verify this, we
show on the next page the total contribution to profits of sales of 9,000,
10,000 and 11,000 jars of silver polish, contrasted to sales of equivalent
amounts of Grit 337 sold outright (i.e., 10,000 jars of silver polish would
require the use of 2,500 pounds of Grit 337 that otherwise could be sold
 outright as cleaning powder, etc.):

9,000 10,000 11,000

Jars of Jars of Jars of
Polish; Polish; Polish;
or 2,250 or 2,500 or 2,750
pounds pounds pounds
of Grit of Grit of Grit
337 337 337
Sales of Silver Polish:
Sales @ $4.00 per jar.................................. $36,000 $40,000 $44,000
Variable expenses:
Production cost of Grit 337 @ $1.60 per
pound....................................................... 3,600 * 4,000 * 4,400 *
Further processing and selling costs of the
polish @ $2.80 per jar.............................  25,200  28,000  30,800
Total variable expenses..................................  28,800  32,000  35,200
Contribution margin.......................................    7,200    8,000    8,800
Avoidable fixed costs:
Production supervisor................................. 3,000 3,000 3,000
Advertising.................................................    4,000    4,000    4,000
Total avoidable fixed costs............................    7,000    7,000    7,000
Total contribution to common fixed costs
and to profits............................................... $    200 $ 1,000 $ 1,800
Sales of Grit 337:
Sales @ $2.00 per pound............................ $ 4,500 $ 5,000 $ 5,500
Variable expenses:
Production cost of Grit 337 @ $1.60 per
pound.......................................................    3,600 *    4,000 *    4,400 *
Contribution to common fixed costs and to
profits.......................................................... $    900 $ 1,000 $ 1,100
* This cost will be incurred regardless of whether the Grit 337 is further
processed into silver polish or sold outright as cleaning powder; therefore, it is
not relevant to the decision, as stated earlier. It is included in the computation
above for the specific purpose of showing that it will be incurred under either
alternative. The same thing could have been done with the depreciation on the
mixing equipment.
CASE 7

1. Sewing
Debbie Trish Sarah Mike Kit
Direct labor cost per unit....... $ 3.20 $2.00 $ 5.60 $ 4.00 $ 1.60
Direct labor hours per unit*
(a).......................................    0.40  0.25    0.70    0.50   0.20
Selling price.......................... $13.50 $5.50 $21.00 $10.00 $ 8.00
Variable costs:
Direct materials.................. 4.30 1.10 6.44 2.00 3.20
Direct labor........................ 3.20 2.00 5.60 4.00 1.60
Variable overhead...............   0.80  0.50   1.40   1.00   0.40
Total variable costs................   8.30  3.60  13.44   7.00   5.20
Contribution margin (b)........ $ 5.20 $1.90 $ 7.56 $ 3.00 $ 2.80
Contribution margin per
DLH (b) ÷ (a)..................... $13.00 $7.60 $10.80 $ 6.00 $14.00
* Direct labor cost per unit ÷ 8 direct labor hours.

2. Estimated
DLH Per Sales Total
Product Unit (units) Hours
Debbie.............................. 0.40 hours 50,000 20,000
Trish................................. 0.25 hours 42,000 10,500
Sarah................................. 0.70 hours 35,000 24,500
Mike................................. 0.50 hours 40,000 20,000
Sewing Kit........................ 0.20 hours 325,000  65,000
Total hours required......... 140,000

3. Because the Mike doll has the lowest contribution margin per labor hour, its
production should be reduced by 20,000 dolls (10,000 excess hours divided
by 0.5 hours production time per doll = 20,000 dolls). Thus, production and
sales of the Mike doll will be reduced to one-half of that planned, or 20,000
dolls for the year.
(continued)
4. Because the additional capacity would be used to produce the Mike doll, the
company should be willing to pay up to $14 per hour ($8 usual rate plus $6
contribution margin per hour) for added labor time. Thus, the company could
employ workers for overtime at the usual time-and-a-half rate of $12 per
hour ($8 × 1.5 = $12), and still improve overall profit.

5. Additional output could be obtained in a number of ways including working

overtime, adding another shift, expanding the workforce, contracting out
some work to outside suppliers, and eliminating wasted labor time in the
production process. The first four methods are costly, but the last method can
add capacity at very low cost.
Note: Some would argue that direct labor is a fixed cost in this situation and
should be excluded when computing the contribution margin per unit.
However, when deciding which products to emphasize, no harm is done by
misclassifying a fixed cost as a variable cost—providing that the fixed cost is
the constraint. If direct labor were removed from the variable cost category,
the net effect would be to bump up the contribution margin per direct labor-
hour by $8 for each of the products. The products will be ranked exactly the
same—in terms of the contribution margin per unit of the constrained
resource—whether direct labor is considered variable or fixed. However, this
only works when the fixed cost is the cost of the constraint itself.