Incremental Analysis Problems 111320

ACCEPT OR REJECT A SPECIAL ORDER
PROBLEM 1
Raine Company produces a light fixture with the following unit costs:
Direct materials P 100
Direct labor 50
Variable overhead 150
Fixed overhead 100
The production capacity is 300,000 units per year. Because of a depressed housing market, the
company expects to produce only 180,000 fixtures for the coming year. The company also has
fixed selling costs totalling P25M per year and variable selling costs of P50 per unit sold. The
fixtures normally sells for P600.
At the beginning of the year, a customer from a geographic region outside the area normally
served by the company offered to buy 100,000 fixtures for P350 each. The customer also
offered to pay all transportation costs.
Required:
1. Based on a quantitative analysis, should the company accept the order?
2. What qualitative factors might impact the decision? Assume that no other orders are
expected beyond the regular business and the special order.
PROBLEM 2
Steve Gates, manager of an electronics division, was considering an offer by Pat Soliven,
manager of a sister division. Pat’s division was operating below capacity and had just been
given an opportunity to produce 8,000 units of one of its products for a customer in a market
not normally served. The opportunity involves a product that uses an electric component
produced by Steve’s division. Each unit that Pat’s division produces requires two of the
components. However, the price that the customer is willing to pay is well below the price that
is usually charged. To make a reasonable profit on the order, Pat needs a price concession from
Steve’s division. Pat had offered to pay full manufacturing cost for the parts. So Steve would
know that everything was above board, Pat supplied the following unit cost and price
information concerning the special order, excluding the cost of the electrical components:
Selling price P 1,600
Less costs:
Direct materials 850
Direct labor 350
Fixed overhead 150
The normal selling price of the electrical components is P115 per unit. Its full manufacturing
cost is P92.50 (P52.50 variable and P40 fixed). Pat argued that paying P115 per component
would wipe out the operating profit and result in her division showing a loss. Steve was
interested in the offer because his division was also operating below capacity. (The order would
not use all the excess capacity.)
Required:
1. Should Steve accept the order at a selling price of P92.50 per unit? By how much will
his division’s profits be changed if the order is accepted? By how much will the profits
of Pat’s division change if Steve agrees to supply the part at full cost?
2. Suppose that Steve offers to supply the component at P100. In offering this price, Steve
says that it is a firm offer, not subject to negotiation. Should Pat accept this price and
produce the special order? If pat accepts the price, what is the change in profits for
Steve’s division?
3. Assume that Steve’s division is operating at full capacity and that Steve refuses to supply
the part for less than the full price. Should Pat still accept the special order? Explain.
MAKE OR BUY DECISIONS

PROBLEM 1
Buckingham Company is currently manufacturing Part Q108, producing 35,000 units annually.
The part is used in the production of several products made by Buckingham. The cost per unit
for Q108 is as follows:
Direct materials P300
Direct labor 100
Fixed overhead 175
Of the total fixed overhead assigned to Q108, P3,850,000 is direct fixed overhead (the lease of
production machinery and salary of a production line supervisor) – neither of which will be
needed if the line is dropped. The remaining fixed overhead is common fixed overhead. An
outside supplier has offered to sell the part to Buckingham for P550. There is no alternative use
for the facilities currently used to produce the part.
Required:
1. Should Buckingham Company make or buy Q108?
2. What is the most that Buckingham would be willing to pay an outside supplier?
3. If Buckingham buys the part, by how much will income increase or decrease?
4. Assuming all of the fixed overhead is common fixed overhead. Should Buckingham
Company make or buy Q108? If Buckingham buys the part, what is the effect to net
income?
PROBLEM 2
Hetrick Dentistry Services operates in a large metropolitan area. Currently, Hetrick has its own
dental laboratory to produce porcelain and gold crowns. The unit costs to produce the crowns
are as follows:
Porcelain Gold
Raw materials P 3,500 P 6,500
Direct labor 1,350 1,350
Variable overhead 400 400
Fixed overhead 1,100 1,100
Fixed overhead is detailed as follows:

Salary (supervisor) P1,300,000
Depreciation 250,000
Rent (lab facility) 1,600,000
Overhead is applied on the basis of direct labor hours. These rates were computed by using
5,500 direct labor hours.
A local dental laboratory has offered to supply Hetrick all the crown it needs. Its price is P6,250
for porcelain crwons and P7,500 for gold crowns; however, the offer is conditional on supplying
both types of crowns – it will not supply just one type for the price indicated. If the offer is
accepted, the equipment used by Hetrick’s laboratory would be scarpped (it is old and has no
market value) and the lab facility would be closed. Hetrick uses 2,000 porcelain crowns and 600
gold crowns per year.
Required:
1. Should Hetrick continue to make its own crowns, or should they be purchased from the
external supplier? What is the peso effect of purchasing?
2. What qualitative factors should Hetrick consider in making this decision?
3. Suppose that the lab facility is owned rather than rented and that the P1.6M is
depreciation rather than rent. What effect does this have on the analysis in Req. 1?
4. Refer to the original data. Assume that the volume of crowns is 4,200 porcelain and 600
gold. Should Hetrick make or buy the crowns? Explain the outcome.
KEEP OR DROP DECISIONS

PROBLEM 1
Fun Time Company produces three lines of greeting cards: scented, musical, and regular.
Segmented income statement for the past year are as follows:
Scented Musical Regular Total
Sales 500,0 750,0 1,250,0 2,500,0
00 00 00 00
Less: Variable Expenses 350,0 600,0 625,0 1,575,0
00 00 00 00
Contribution margin 150,0 150,0 625,0 925,0
00 00 00 00
Less- Direct fixed expenses 200,0 250,0 150,0 600,0
00 00 00 00
Segment margin (50,0 (100,00 475,0 325,0
00) 0) 00 00
Less: Common fixed expenses 375,0
00
Operating income (loss) (50,0
00)
Kathy Bernardo, president of FunTime, is concerned about the financial performance of her firm
and is seriously considering dropping both the scented and musical product lines. However,
before making a final decision, she consults Jim Chidwick, Fun Time’s vice president for
marketing.
Required:
1. Jim believes that by increasing advertising by P50,000 (P12,500 for Scented and
P37,500 for Musical), sales of those two lines would increase by 30%. If you were Kathy,
how would you react to this information?
2. Jim warns Kathy that eliminating the scented and musical lines would lower the sales of
the regular line by 20%. Given this information, would it be profitable to eliminate the
scented and musical lines?
3. Suppose that eliminating either line reduces sales of the regular cards by 10%. Would a
combination of increased advertising (the option described in req. 1) and eliminating
one of the lines would be benificial? Identify the best combination for the firm.
SELL OR PROCESS FURTHER DECISIONS

Shenista Inc. produces four products (Alpha, Beta, Gmma, and Delta) from a common input. The
joint costs for a typical quarter follow:
Direct materials P 4,750,000

Direct labor 2,150,000
Overhead 4,250,000
The revenue from each product are as follows: Alpha, P5M; Beta, P4,650,000; Gamma, P1.5M;
and Delta P2M.
Management is considering processing Delta beyond the split-off point, which would increase
the sales value of Delta to P3,750,000. However, to process Delta further means that the
company must rent some special equipment that costs P770,000 per quarter. Additional
materials and labor also needed will cost P425,000 per quarter.
Required:
1. What is the operating profit earned by the four products for one quarter?
2. Should the division process Delta further or sell it at split-off point? What is the effect of
the decision on quarterly operating profits?

Incremental Analysis Problems 111320

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ACCEPT OR REJECT A SPECIAL ORDER

MAKE OR BUY DECISIONS

Fixed overhead is detailed as follows:

KEEP OR DROP DECISIONS

SELL OR PROCESS FURTHER DECISIONS

Direct materials P 4,750,000

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