Question

A firm uses activity-based costing and has the following activity rates: $100 per machine hours, $500 per batch start, $5 per order.

The firm has two several products, including the following two.

Product 1: $100,000 revenue, $50,000 direct costs, 250 machine hours, 25 batch starts, 500 orders

Product 2: $95,000 revenue, $40,000 direct costs, 40 machine hours, 16 batch starts, 400 orders

Which of the following process improvements is the MOST profitable?

	a.	Reduce both product’s batch starts by 25%.
	b.	Reduce Product 1’s direct costs by 12.5%.
	c.	Reduce Product 2’s orders by 50%.
	d.	Reduce machine hour activity rate cost by 25%.

Answer 1

Current Profiablity
	Product 1	Product 2
Revenue	100000	95000
Direct Costs	50000	40000
Machine Hour Costs	25000	4000
Batch Starts Costs	12500	8000
Order Costs	2500	2000
Profit	10000	41000	51000
Reduce Batch products start by 25%
Revenue	100000	95000
Direct Costs	50000	40000
Machine Hour Costs	25000	4000
Batch Starts Costs	9375	6000
Order Costs	2500	2000
Profit	13125	43000	56125
Reduce Product 1st Direct Costs by 25%
Revenue	100000	95000
Direct Costs	37500	40000
Machine Hour Costs	25000	4000
Batch Starts Costs	12500	8000
Order Costs	2500	2000
Profit	22500	41000	63500
Reduce Product 2s Order By 50%
Revenue	100000	95000
Direct Costs	50000	40000
Machine Hour Costs	25000	4000
Batch Starts Costs	12500	8000
Order Costs	1250	1000
Profit	11250	42000	53250
Reduce Machine Hour Activity Rate by 25%
	Product 1	Product 2
Revenue	100000	95000
Direct Costs	50000	40000
Machine Hour Costs	18750	3000
Batch Starts Costs	12500	8000
Order Costs	2500	2000
Profit	16250	42000	58250

Most Profitable Option is Reduce 1st Products Direct cost by 25%