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Chapter 25: 9E (page 1410)

Dan Jacobs, production manager for GreenLife, invested in computer-controlled production machinery last year. He purchased the machinery from Superior Design at a cost of \(3,000,000. A representative from Superior Design has recently contacted Dan because the company has designed an even more efficient piece of machinery. The new design would double the production output of the year-old machinery but would cost GreenLife another \)4,500,000. Jacobs is afraid to bring this new equipment to the company president鈥檚 attention because he convinced the president to invest $3,000,000 in the machinery last year.

Explain what is relevant and irrelevant to Jacobs鈥檚 dilemma. What should he do?

Short Answer

Expert verified

The production manager must prepare anincremental analysis before making any decision.

Step by step solution

01

Meaning of Relevant Information

Relevant information is an important requirement to draft effective decisions associated with thefuture activities of a business concern. Such information enables an administration to make a purchase or make decisions when anoutsourcing alternative is available.

02

Bifurcation of relevant and irrelevant information

The information associated with theadditional cost and double production output is relevant for the business to make necessary decisions.

Also, the cost spent by the business on the old machinery is sunk cost, which has becomeirrelevant information for the business entity.

Hence, Dan Jacobs, the production manager must prepare adifferential analysis to determine the annualoperating income between the two machines.

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Most popular questions from this chapter

StoreAll produces plastic storage bins for household storage needs. The company makes two sizes of bins: large (50 gallon) and regular (35 gallon). Demand for the products is so high that StoreAll can sell as many of each size as it can produce. The company uses the same machinery to produce both sizes. The machinery can be run for only 3,300 hours per period. StoreAll can produce 10 large bins every hour, whereas it can produce 17 regular bins in the same amount of time. Fixed costs amount to \(115,000 per period. Sales prices and variable costs are as follows:

Regular Large

Sales price per unit \)8.00 $10.40

Variable cost per unit 3.50 4.40

Requirements

1. Which product should StoreAll emphasize? Why?

2. To maximize profits, how many of each size bin should StoreAll produce?

3. Given this product mix, what will the company鈥檚 operating income be?

Nautical manufactures flotation vests in Tampa, Florida. Nautical鈥檚 contribution margin income statement for the month ended December 31, 2018, contains the following data:

NAUTICAL

Income Statement

For the Month Ended December 31, 2018

Sales in Units 29,000

Net Sales Revenue \(551,000

Variable Costs:

Manufacturing 116,000

Selling and Administrative 111,000

Total Variable Costs 227,000

Contribution Margin 324,000

Fixed Costs:

Manufacturing 123,000

Selling and Administrative 92,000

Total Fixed Expenses 215,000

Operating Income \)109,000

Suppose Water Works wishes to buy 4,800 vests from Nautical. Nautical will not incur any variable selling and administrative expenses on the special order. The Nautical plant has enough unused capacity to manufacture the additional vests. Water Works has offered \(15 per vest, which is below the normal sales price of \)19.

Requirements

1. Identify each cost in the income statement as either relevant or irrelevant to Nautical鈥檚 decision.

2. Prepare a differential analysis to determine whether Nautical should accept this special sales order.

3. Identify long-term factors Nautical should consider in deciding whether to accept the special sales order.

This problem continues the Piedmont Computer Company situation from Chapter 24. Piedmont Computer Company鈥檚 payroll accountant has submitted her resignation and will be leaving the company in two weeks. The company must decide if it will hire a replacement or outsource the payroll position. The current employee earns a salary of \(40,000. Medical insurance, employer payroll taxes, and contributions to the pension plan for this position cost \)7,600. The company has already invested \(22,000 in payroll software. Required annual updates to remain in compliance with all state and federal laws are \)495. The company also spends \(1,750 per year in professional development for this position to ensure the employee stays up-to-date with payroll changes. Piedmont Computer Company pays its employees weekly. Payroll Professionals will processthe company鈥檚 weekly payroll for \)1,000 per week. This fee also includes preparing all necessary payroll tax returns, reports, and W-2s.

Requirements

1. Prepare a differential analysis to determine if Piedmont Computer Company should replace the employee or outsource the payroll function.

2. What other factors should Piedmont Computer Company consider in making this decision?

Explain the difference between price-takers and price-setters.

Oak Petroleum has spent \(202,000 to refine 63,000 gallons of petroleum distillate, which can be sold for \)6.00 per gallon. Alternatively, Oak can process the distillate further and produce 58,000 gallons of cleaner fluid. The additional processing will cost \(1.80 per gallon of distillate. The cleaner fluid can be sold for \)9.10 per gallon. To sell the cleaner fluid, Oak must pay a sales commission of \(0.12 per gallon and a transportation charge of \)0.19 per gallon.

Requirements

1. Diagram Oak鈥檚 decision alternatives, using Exhibit 25-18 as a guide.

2. Identify the sunk cost. Is the sunk cost relevant to Oak鈥檚 decision?

3. Should Oak sell the petroleum distillate or process it into cleaner fluid? Show the expected net revenue difference between the two alternatives.
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