CHAPTER 7

Incremental Analysis

MULTIPLE CHOICE:
LEARNING OBJECTIVE 2

1. Special Orders – Accept or Reject

1. Marx Company has a current production capacity level of 200,000 units per
month.
At this level of production, variable costs are $0.50 per unit and fixed costs are
$0.50 per unit. Current monthly sales are 183,000 units. Heaven Company has
contacted Marx Company about purchasing 15,000 units at $1.00 each. Current
sales would not be affected by the special order and no additional fixed costs
would be incurred on the special order. Marx Company's change in profits if the
order is accepted will be:

a. a $15,000 increase
b. a $15,000 decrease
c. a $7,500 increase
d. a $7,500 decrease

15,000 x ($1.00 - $0.50) = $7,500 increase

2. Groucho Company has a current production capacity level of 200,000 units per
month. At this level of production, variable costs are $0.80 per unit and fixed
costs are $0.50 per unit. Current monthly sales are 184,500 units. Super
Company has contacted Groucho Company about purchasing 20,000 units at
$2.00 each. Current sales would not be affected by the special order and no
additional fixed costs would be incurred on the special order. If Groucho
Company decides to accept the special order, Groucho Company’s costs will
increase by:

a. $20,000
b. $24,000
c. $16,000
d. $40,000

20,000 x $0.80 = $16,000

3. Each quarter Sioux Company produces 30,000 units of a product that has variable

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 costs of $60 per unit. Total fixed costs for the quarter are $990,000. A special
order is received for 1,000 units at a price of $77 per unit. In deciding to accept
or reject this special order, it is appropriate to consider the:

a. old fixed cost per unit of $33.00

b. difference between the offered price and the variable cost per unit
c. new fixed cost per unit of $31.94
d. difference between the two fixed costs per unit, which is $1.06

$77 - $60 = $17

4. Gatton, Inc., provided the following information regarding its one and only product -
scissors:

Fixed manufacturing costs $420,000

Fixed selling and administrative costs 80,000
Fixed manufacturing costs 42,000
Fixed selling and administrative costs 80,000
Variable manufacturing costs 1,030,000
Variable selling and administrative costs 120,000
Selling unit price 100

Units produced and sold 20,000

Assuming there is excess capacity, the effect of accepting a special order for
1,000 units at a price of $80.00 per scissors will be:

a. net income would increase by $1,000

b. net income would increase by $22,500
c. net income would decrease by $80,000
d. net income would decrease by $200,000

($1,030,000 + $120,000) / 20,000 units = $57.50, therefore,

1,000 x ($80.00 - $57.50) = $22,500

5. Denison Corporation has been producing and selling 60,000 skillets a year. The
company has the capacity to produce 75,000 skillets with its present facilities. The
following information is also available:

Selling price per unit $44

Variable costs per unit:
Manufacturing 19
Selling and Administrative 15
Fixed costs in total:

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 Manufacturing $220,000
Selling and Administrative 20,000

______________ is the variable cost per unit for a skillet using the contribution
approach.

a. $10.00
b. $34.00
c. $38.00
d. None of these answers is correct.

$19 + $15 = $34

6. In a special order decision, fixed costs that do not differ between two alternatives are:

a. of major importance to the decision

b. considered opportunity costs
c. important only if they are a material dollar amount
d. irrelevant

LEARNING OBJECTIVE 3

2. Make or Buy
7. Finch Company manufactures a part for its production cycle. The costs per unit for
5,000 units of this part are as follows:

Direct materials $3
Direct labor 5
Variable factory overhead 4
Fixed factory overhead 2
Total costs $14

The fixed factory overhead costs are unavoidable. Scalding Corporation has
offered to sell 5,000 units of the same part to Finch Company for $15 a unit.
Assuming no other use for the facilities, Finch Company should:

a. buy from Scalding Corporation to save $1 per unit

b. make the part to save $1 per unit
c. buy from Scalding Corporation to save $3 per unit
d. make the part to save $3 per unit

$15 - ($3 + $5 + $4) = $3 Savings

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8. Mad Cow Company manufactures a part for its production cycle. The costs per unit
for 38,000 units of this part are as follows:

Direct materials $3
Direct labor 5
Variable factory overhead 4
Fixed factory overhead 3
Total costs $15

The fixed factory overhead costs are unavoidable. Assuming no other use of their
facilities, the highest price that Mad Cow Company should be willing to pay for
the part is:

a. $12
b. $15
c. $8
d. $11

$3 + $5 + $4 = $12

9. Tender Company manufactures a part for its production cycle. The costs per unit for
5,000 units of this part are as follows:

Direct materials $3
Direct labor 5
Variable factory overhead 4
Fixed factory overhead 2
Total costs $14

The fixed factory overhead costs are unavoidable. Assume that Tender Company
has been offered 5,000 units of the part from another producer for $15 each. The
facilities currently used to make the part could be rented out to another
manufacturer for $20,000 a year. Tender Company should:

a. make the part to save $1 per unit

b. buy the part to save $3 per unit
c. buy the part to save $1 per unit
d. make the part to save $3 per unit

Buy: (5,000 x $15) + ($2 * 5,000) = $85,000

Make: (5,000 x $14) +$20,000 = $90,000; and
($90,000 - $95,000) / 5,000 units = $1 per unit

10. Reagan Company manufactures a part for its production cycle. The costs per unit for
10,000 units of this part are as follows:

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 Direct materials $20
Direct labor 15
Variable factory overhead 16
Fixed factory overhead 10
Total costs $61

The fixed factory overhead costs are unavoidable. Assuming no other use of their
facilities, the highest price that Reagan Company should be willing to pay for the
part is:

a. $41
b. $35
c. $45
d. $51

11. Burt Company currently produces 10,000 units of a key part at a total cost of
$210,000. Variable costs are $170,000. Of the fixed cost, $10,000 relate specifically
to this part. The remaining fixed costs are unavoidable.
Another manufacturer has offered to supply the part for $190 per unit. The
facilities currently used to manufacture the part could be used to manufacture a
new product with an expected contribution margin of $25,000. Alternately, the
facilities could be rented out at $55,000. _____________ is the opportunity cost
to Burt Company for making the part.

a. ($20,000)
b. $55,000
c. $25,000
d. ($10,000)

12. Three Point Company currently produces 10,000 units of a key part at a total cost of
$512,000. Variable costs are $300,000. Of the fixed cost, $140,000 relate specifically
to this part. The remaining fixed costs are unavoidable.
Another manufacturer has offered to supply the part for $48 per unit. The
facilities currently used to manufacture the part could be used to manufacture a
new product with an expected contribution margin of $55,000. Alternately, the
facilities could be rented out at $63,000. ______________ is the opportunity cost
to Three Point Company to make the part:

a. $63,000
b. $55,000
c. $480,000

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 d. None of these answers is correct.

13. Hoopster Company produces a part that is used in the manufacture of one of its
products. The costs associated with the production of 5,000 units of this part are as
follows:

Direct materials $108,000

Direct labor 156,000
Variable factory overhead 72,000
Fixed factory overhead 168,000
Total costs $504,000

Of the fixed factory overhead costs, $72,000 are avoidable. Knight Company has
offered to sell 5,000 units of the same part to Hoopster for $86.40 per unit.
Assuming there is no other use for the facilities, Hoopster Company should:

a. make the part to save $14.40 per unit

b. buy the part to save $14.40 per unit
c. buy the part to save the company $72,000
d. make the part to save $4.80 per unit

Make : $108,000 + $156,000 + $72,000 + $168,000 = $504,000

Buy : $86.40 x 5,000 units + ($168,000 - 72,000) = $528,000
$504,000 – 528,000 = $(24,000)/ 5,000 units = $4.80 per unit to make the part

14. Crenshaw Company produces a part that is used in the manufacture of one of its
products. The costs associated with the production of 5,000 units of this part are as
follows:

Direct materials $108,000

Direct labor 156,000
Variable factory overhead 72,000
Fixed factory overhead 168,000
Total costs $504,000

Of the fixed factory overhead costs, $72,000 is avoidable. Assuming no other use
of their facilities, the highest price that Crenshaw Company should be willing to
pay for 5,000 units of the part is:

a. $504,000
b. $336,000
c. $432,000
d. $288,000

$108,000 + $156,000 + $72,000 + ($168,000 - $72,000) = $432,000

15. Floyd Company produces a part that is used in the manufacture of one of its products.
The costs associated with the production of 5,000 units of this part are as follows:

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 Direct materials $108,000
Direct labor 156,000
Variable factory overhead 72,000
Fixed factory overhead 168,000
Total costs $504,000

Of the fixed factory overhead costs, $72,000 is avoidable. Assume that Floyd
Company can buy 5,000 units of the part from another producer for $105.60 each.
The facilities currently used to make the part could be rented out to another
manufacturer for $72,000 a year. Floyd Company should:

a. make the part to save $19.20 per unit

b. make the part to save the company $48,000
c. buy the part to save $14.40 per unit
d. buy the part to save the company $72,000

Make: $108,000 + $156,000 + $72,000 + $168,000 +$72,000 = $576,000;

Buy: ($105.60 x 5,000) + ($168,000 - $72,000 ) = $624,000

LEARNING OBJECTIVE 3

3. Sell or Process Further

16. A. Each product may be sold at split-off or processed further and then sold. Joint
processing costs for a year amount to $25,000. Other relevant data are as follows:

Separable
Processing
Sales Value Costs after Sales Value
Product at Split-off Split-off at Completion

P $32,000 $5,000 $40,000

G 16,500 7,500 29,000
A 6,400 8,000 10,000

Once product P is produced, processing it further will cause profits to:

a. increase by $8,000
b. decrease by $5,000
c. decrease by $8,000
d. increase by $3,000

($40,000 - $32,000) - $5,000 = $3,000

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17. Woods Corporation has a joint process that produces three products: P, G, and A.
Each product may be sold at split-off or processed further and then sold. Joint
processing costs for a year amount to $25,000. Other relevant data are as follows:
Separable
Processing
Sales Value Costs after Sales Value
Product at Split-off Split-off at Completion

P $62,000 $5,000 $88,000

G 12,500 6,500 19,000
A 9,400 5,000 12,000

Product G:

a. should be processed further to increase profits by $6,500

b. should be sold at split-off since processing further would only reduce profits
by $6,500
c. should be processed further to increase profits by $19,000
d. can be processed further or sold at split-off; there is no difference in
profit.

($19,000 - $12,500) - $6,500 = $0

18. Els Corporation has a joint process that produces two products: A and B. Each
product may be sold at the split-off point or processed further and then sold. Joint
processing costs for a year amount to $25,000.

Product A can be sold at the split-off point for $32,000. Alternately, product A
can be processed further and sold for $40,000. Additional processing costs are
$5,000.

In deciding whether to sell product A at the split-off point or to process further,

the _____________________ is not relevant.

a. joint processing cost of $25,000

b. sales value at split-off of $32,000
c. sales value at completion of $40,000
d. All of these answers are relevant.

19. Bermuda Triangle Corporation has a joint process which produces three products: X,
Y, and Z. Each product may be sold at split-off or processed further and then sold.

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 Joint processing costs for a year amount to $100,000. Other relevant data are as
follows:

Separable
Processing
Sales Value Costs after Sales Value
Product at Split-off Split-off at Completion

X $128,000 $16,000 $160,000

Y 50,000 26,000 76,000
Z 25,600 20,000 40,000

To maximize profits, Bermuda Triangle Corporation should process

________________ further.

a. product Z only
b. product Y only
c. product X only
d. products X, Y, and Z

X: ($160,000 - $128,000) - $16,000 = $16,000

Y: ($76,000 - $50,000) - $26,000 = $0
Z: ($40,000 - $25,600) - 20,000 = $(5,600)

20. Belize Corporation has a joint process which produces three products: X, Y, and Z.
Each product may be sold at split-off or processed further and then sold. Joint
processing costs for a year amount to $100,000. Other relevant data are as follows:
Separable
Processing
Sales Value Costs after Sales Value
Product at Split-off Split-off at Completion

X $128,000 $16,000 $160,000

Y 50,000 26,000 76,000
Z 25,600 20,000 40,000

In processing Product Z further:

a. profits will decrease by $5,600

b. incremental profits will exceed incremental costs
c. profits will increase by $20,000
d. the additional revenue produced will exceed the additional costs

($40,000 - $25,600) - $20,000 = $(5,600)

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21. Tangerine Manufacturing Company produces three products using a joint process
which accumulates $25,000 in joint costs. The products, A, B, and C, can be sold at
split-off or processed further and then sold. The production level for each product is
10,000 units. The following unit information is also available:

Separable
Processing
Sales Value Costs after Sales Value
Product at Split-off Split-off at Completion

A $12 $9 $21
B 10 4 17
C 15 6 19

If product A is processed beyond the split-off point, profit will:

a. increase by $210,000
b. increase by $120,000
c. increase by $90,000
d. stay the same

($21 - $12) - $9 = $0

22. Lemon Manufacturing Company produces three products using a joint process
that accumulates $25,000 in joint costs. The products, A, B, and C, can be sold at
split-off or processed further and then sold. The production level for each product
is 10,000 units. The following unit information is also available:

Separable
Processing
Sales Value Costs after Sales Value
Product at Split-off Split-off at Completion

A $12 $9 $21
B 10 4 17
C 15 6 19

Product B:

a. should be processed further to increase profits by $70,000

b. should be sold at split-off to maximize profits
c. should be processed further to increase profits by $3 per unit
d. can be processed further or sold at split-off; it makes no difference.

[($17 - $10) - $4] =$3

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 23. Dumpster Company produces three products using a joint process which accumulates
$25,000 in joint costs. The products, A, B, and C, can be sold at split-off or
processed further and then sold. The production level for each product is 1,000 units.
The following unit information is also available:

Separable
Processing
Sales Value Costs after Sales Value
Product at Split-off Split-off at Completion

A $12 $9 $21
B 10 4 17
C 15 6 19

If Dumpster Company makes the decisions that maximize profit, Dumpster

Company’s net income will be:

a. $47,000
b. $32,000
c. $30,000
d. $15,000

($12 x 1,000) + [($17 - $4) x 1,000] + ($15 x 1,000) - $25,000 = $15,000

LEARNING OBJECTIVE 4

4. Keep or Replace Equipment

24. Samantha Company is considering replacing a machine that is presently used in the
production of its product. The following data are available:

Replacement
Old Machine Machine

Original cost $67,000 $54,000

Useful life in years 13 4
Current age in years 9 0
Book value $32,000 -
Disposal value now $18,000 -
Disposal value in 5 years 0 0
Annual cash operating costs $9,000 $7,000

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 _______________________ is irrelevant.

a. The annual operating cost of the old machine

b. The original cost of the replacement machine
c. The disposal value of the old machine
d. The disposal value in five years

25. Derwood Company is considering replacing a machine that is presently used in the
production of its product. The following data are available:

Replacement
Old Machine Machine

Original cost $99,000 $88,000

Useful life in years 9 6
Current age in years 3 0
Book value $33,000 -
Disposal value now $28,000 -
Disposal value in 5 years 0 0
Annual cash operating costs $17,000 $14,000

___________________________________ is a sunk cost.

a. The annual cash operating costs of the old machine

b. The annual cash operating costs of the replacement machine
c. The disposal value of the old machine
d. The original cost of the old machine

26. Tabitha Company is considering replacing a machine that is presently used in the
production of its product. The following data are available:

Replacement
Old Machine Machine

Original cost $60,000 $35,000

Useful life in years 10 5
Current age in years 5 0
Book value $25,000 -
Disposal value now $8,000 -
Disposal value in 5 years 0 0
Annual cash operating costs $10,000 $4,000

The total relevant costs to consider if the old machine is kept are:

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 a. $60,000
b. $50,000
c. $52,000
d. $30,000

$10,000 x (10 years – 5 years) = $50,000

27. Major Nelson Company is considering replacing a machine that is presently used in
the production of its product. The following data are available:

Replacement
Old Machine Machine

Original cost $57,000 $35,000

Useful life in years 17 5
Current age in years 12 0
Book value $39,000 -
Disposal value now $8,000 -
Disposal value in 5 years 0 0
Annual cash operating costs $7,000 $4,000

The difference in cost between keeping the old machine and replacing the old
machine, ignoring income taxes, is:

a. $22,000 in favor of keeping the old machine

b. $12,000 in favor of keeping the old machine
c. $37,000 in favor of replacing the old machine
d. $22,000 in favor of replacing the old machine

[($7,000 - $4,000) x 5] - $35,000 + $8,000 = $($12,000)

28. Tony Company is considering replacing a machine that is presently used in the
production of its product. The following data are available:

Replacement
Old Machine Machine

Original cost $295,000 $188,000

Useful life in years 11 5
Current age in years 6 0
Book value $130,000 -
Disposal value now $52,000 -
Disposal value in 5 years 0 0
Annual cash operating costs $39,000 $24,000

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 ____________________________ is irrelevant.

a. The original cost of the replacement machine

b. The disposal value of the old machine
c. The book value of the old machine
d. The annual operating cost of the old machine

29. Jeannie Company is considering replacing a machine that is presently used in the
production of its product. The following data are available:

Replacement
Old Machine Machine

Original cost $333,000 $222,000

Useful life in years 6 5
Current age in years 1 0
Book value $198,000 -
Disposal value now $132,000 -
Disposal value in 5 years 0 0
Annual cash operating costs $45,000 $34,000

__________________________ is a sunk cost.

a. The disposal value of the old machine

b. The original cost of the old machine
c. The annual cash operating costs of the old machine
d. The annual cash operating costs of the replacement machine

30. In a decision to keep or replace existing equipment, ____________ is a false

statement.

a. the disposal value of the old equipment is irrelevant

b. the book value of the old equipment is irrelevant
c. the cost of the new equipment is relevant
d. depreciation on the new equipment is relevant

LEARNING OBJECTIVE 5

5. Eliminate Unprofitable Segment or Product

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31. _______________ will not continue if an ongoing operation is changed or
deleted.

a. Avoidable costs
b. Common costs
c. Sunk costs
d. Differential costs

32. _______________ are costs that continue even if an operation is halted.

a. Common costs
b. Sunk costs
c. Unavoidable costs
c. Variable costs

33. Riverside Industries has three product lines, A, B, and C. The following
information is available:
A B C

Sales $100,000 $90,000 $44,000

Variable costs 76,000 48,000 35,000
Contribution margin $24,000 $42,000 $9,000
Fixed costs:
Avoidable 9,000 18,000 3,000
Unavoidable 6,000 9,000 7,700
Operating income $9,000 $15,000 $(1,700)

Riverside Industries is thinking of dropping product line C because it is reporting

a loss. Assuming Riverside drops line C and does not replace it, the operating
income will:

a. increase by $2,400
b. increase by $600
c. decrease by $6,000
d. decrease by $9,000

$3,000 - $9,000 = $(6,000)

34. Citrus Industries has three product lines, A, B, and C. The following information
is available:
A B C

Sales $60,000 $90,000 $24,000

Variable costs 36,000 48,000 20,000
Contribution margin $24,000 $42,000 $4,000
Fixed costs:
Avoidable 9,000 18,000 3,000
Unavoidable 6,000 9,000 2,400

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 Operating income $9,000 $15,000 $(1,400)

Assuming Citrus Industries can increase the selling price of product C to $30,000,
all other information remaining constant, operating income will:

a. increase $3,600
b. decrease $3,600
c. decrease $6,000
d. increase $6,000

$30,000 - $24,000 = $6,000

35. The most recent income statement for the Strongsville Branch of the July
Company is presented below.

Sales $57,000
Variable costs 31,500
Contribution margin $25,500
Fixed costs:
Avoidable 13,500
Unavoidable 18,000
Operating income $(6,000)

The July Company is thinking of eliminating the Strongsville Branch because it is

showing a loss. If the Strongsville Branch is eliminated, July’s operating income
will:

a. increase $6,000
b. decrease $12,000
c. decrease $31,500
d. not change

$13,500 - $25,500 = $(12,000)

36. The most recent income statement for the Parma Branch of the Dinero Company
is presented below.

Sales $57,000
Variable costs 31,500
Contribution margin $25,500
Fixed costs:

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 Avoidable 13,500
Unavoidable 18,000
Operating income $(6,000)

If the Parma Branch is eliminated and the space is rented for $24,000, operating
income will be:

a. increased by $24,000
b. decreased by $30,000
c. increased by $12,000
d. decreased by $12,000

($31,500 + $13,500 - $57,000) + $24,000 = $12,000

37. _____________ are relevant in deciding whether to add or delete a product or

service.
a. Avoidable costs
b. Common costs
c. Unavoidable costs
d. All of these answers are correct.

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