Question

Problems

Allred Inc. is trying to decide whether to purchase Machine A or Machine B. Below are the associated costs. Which are relevant?

	Machine A	Machine B	Relevant or Not Relevant?
Cost of Machine	$46,000	$50,000
Setup Costs	$5,000	$5,000
Costs incurred for research of the machine	$400	$600
Annual operating costs for the machine	$6,000	$5,000

Outsourcing Decision

Animals United currently outsources pet beds for their product line.The beds are purchased for $30 each.The company is considering making the beds instead and have looked at the costs involved.They are:

Unit-level material cost$7

Unit-level labor cost$3

Unit-level overhead cost$2

Batch-level cost (100 per batch)$150

Product-level supervisor salary$20,000

Allocated facility level cost$16,000

Assume the company has demand for 500 beds.If they decide to make the beds, what are the total relevant costs?

              

Should Animals United buy or make the beds?

Special Order Decision

Integrated Masters Inc. is currently operating at 50% capacity and manufacturing 50,000 units of a patented electronic component.The cost structure of the component is as follows:

Raw Materials	$1.50 per unit
Direct Labor	$1.50 per unit
Variable Overhead	$2.00 per unit
Fixed Overhead	$100,000 per year

An Italian firm has offered to purchase 30,000 units at a price of $6 per unit.The normal selling price per unit is $8.This special order will not impact any of Integrated Master’s current business.The company has computed its cost per unit as $7 so it is reluctant to accept this offer.

Should Integrated Masters accept this Special Order?Show the calculation that helps you develop your answer.

Asset Replacement Decision

Roadrunner Freight Company owns a truck that cost $42,000.Currently, the truck’s book value is $24,000 and its expected remaining useful life is four years.Roadrunner has the opportunity to purchase for $31,200 a replacement truck that is extremely fuel efficient.Fuel cost for the old truck is expected to be $6,000 per year more than fuel cost for the new truck.The old truck is paid for but, in spite of being in good condition, can be sold for only $14,400.

Should Roadrunner replace the old truck with the new fuel-efficient model, or should it continue to use the old truck until it wears out?Include your calculations with your answer.

Answer 1

Relevant cost is the cost which differs among alternative courses of action. Also, sunk costs i.e. those costs already incurred are irrelevant costs.

Hence, the classification will be as follows:

	Machine A	Machine B	Relevant or Not Relevant?
Cost of Machine	$46,000	$50,000	Relevant
Setup Costs	$5,000	$5,000	Not Relevant
Costs incurred for research of the machine	$400	$600	Irrelevant, Sunk cost
Annual operating costs for the machine	$6,000	$5,000	Relevant

Outsourcing Decision

Total relevant Cost will be as follows:

Material Cost 500*7	3,500
Labor Cost 500*3	1,500
Overhead Cost 500*2	1,000
Batch level cost 5*150	750
Product level supervisor salary	20,000
Total relevant cost	26,750

Since the cost of making 26,750/500 = $53.5 is higher than the purchase cost $30, Animals United should buy the beds

Special Order Decision

Total relevant Cost per unit will be as follows:

Raw Materials	$1.50
Direct Labor	$1.50
Variable Overhead	$2.00
Total relevant cost	$5.00

Since relevant cost is less than the offered price per unit, Integrated Masters should accept this Special Order. It will provide additional income of $1 per unit.

Note: Fixed Overheads will remain the same irrespective of decision since there is excess capacity. Hence, these are irrelevant for decision making.