DECISION MAKING QUESTIONS

SPECIAL ORDER

1. Ratzlaff Company has a current production capacity level of 20,000 units per month. Unit costs at this
level are:

Direct materials $0.25

Direct labor 0.40
Variable overhead 0.15
Fixed overhead 0.20
Marketing/distribution - variable 0.40

Current monthly sales are 18,000 units. Jim Company has contacted Ratzlaff Company about purchasing
1,500 units at $2.00 each. Current sales would not be affected by the one-time-only special order, and
variable marketing/distribution costs would not be incurred on the special order. What is Ratzlaff
Company’s change in operating profits if the special order is accepted?

Manufacturing cost per unit = $0.25 + $0.40 + $0.15 = $0.80

Ignore the Fixed overhead when there is extra capacity
1,500 x ($2.00 – $0.80) = $1,800 increase

ELIMINATE DIVISION

2.. Konrade’s Engine Company manufactures part TE456 used in several of its engine models. Monthly
production costs for 1,000 units are as follows:
Direct materials $ 40,000
Direct labor 10,000
Variable overhead costs 30,000
Fixed overhead costs 20,000
Total costs $100,000
It is estimated that 10% of the fixed overhead costs assigned to TE456 will be avoided if the company
purchases TE456 from the outside supplier. Konrade’s Engine Company has the option of purchasing the part
from an outside supplier at $85 per unit.

Should Konrade’s Engine Company purchases 1,000 TE456 parts from the outside supplier per month?

Avoidable costs ($40,000 + $10,000 + $30,000 + ($20,000 x 10%) = $82,000

$82,000 – ($85 x 1,000 units) = decrease of $3,000
MAKE OR BUY

3. Schmidt Corporation produces a part that is used in the manufacture of one of its products. The costs
associated with the production of 10,000 units of this part are as follows:

Direct materials $ 45,000

Direct labor 65,000
Variable factory overhead 30,000
Fixed factory overhead 70,000
Total costs $210,000

Of the fixed factory overhead costs, $30,000 is avoidable.

Phil Company has offered to sell 10,000 units of the same part to Schmidt Corporation for $18 per unit.
Assuming there is no other use for the facilities, should Schmidt make or buy this part from outside?

Avoidable costs total $170,000 = $45,000 + $65,000 + $30,000 + $30,000.

$18 – ($170,000/10,000) = $1

ELIMINATE DIVISION

. Camera Corner is considering eliminating Model AE2 from its camera line because of losses over the past
quarter. The past three months of information for Model AE2 are summarized below. The next three
months are projected to look the exact same:
Sales (1,000 units) $300,000
Manufacturing costs:
Direct materials 150,000
Direct labor ($15 per hour) 60,000
Total Overhead 100,000
Operating loss ($10,000)
Total Overhead costs are 70% variable and the remaining 30% is depreciation of special equipment for
model AE2 that has no resale value.

Should the company stop making this model?

$300,000 – $150,000 – $60,000 – $70,000 = $20,000 This product contributes $20,000 toward corporate
profits, therefore, discontinuing this product will decrease operating income by $20,000.
$300,000 – $150,000 – $60,000 – $70,000 = $20,000 This product contributes $20,000 toward corporate
profits, therefore, discontinuing this product will decrease operating income by $20,000.
MAKE OR BUY

Carley Company produces 2,000 parts per year, which are used in the assembly of one of its products. The
variable cost of manufacturing each part is $64 and the fixed manufacturing costs total $36 per unit for a
total unit product cost of $100. The part can be purchased from an outside supplier at $80 per unit. If the
part is purchased from the outside supplier, two-thirds of the fixed manufacturing costs can be eliminated.

What would the annual impact be on the company’s net operating income as a result of buying the part from
the outside supplier?

Per Unit  
Production Differential Total Differential
“Cost” per  Costs Costs–2,000 Units
  Unit  Make Buy  Make  Buy
Variable manufacturing costs $ 64 $64   $128,000  
Fixed manufacturing costs   36        
Outside purchase price     $80   $160,000
Fixed manufacturing costs eliminated      (24)   (48,000)
Total cost $100 $64 $56 $128,000 $112,000
Difference in favor of purchasing $8 $16,000

Drop Segment or not

The management of Bayside Company is considering whether one of the departments in its retail stores
should be eliminated. The contribution margin in the department is $150,000 per year. Fixed expenses
allocated to the department are $130,000 per year. It is estimated that $120,000 of these fixed expenses will
be eliminated if the department is discontinued.

If the department is eliminated, what will be the impact on the company’s overall net operating income?

CM that would be lost if department is discontinued $(150,000)

Less fixed costs that can be avoided if department is discontinued 120,000
Increase (decrease) in net operating income $ (30,000)

Based on this information alone, because the company’s net operating income would decrease by $30,000
per year, management should not eliminate this department.