ACCT 2101 final

Which costs will continue even if a company decides to buy?

unavoidable Unavoidable costs are those that will not be eliminated regardless of the decision made. In many cases, the fixed overhead will not change when a company decides to buy rather than make a component. These costs must be considered when making a decision.

You purchased equipment costing $1,000 to use for a lawn-mowing business to earn money for college during the summer. The first week in July, your college roommate asks you to help him paint a house the following week. If you agree, you will have no time to mow. Revenue from mowing would be $1,200. Your roommate has offered you $1,400 to help him paint. Additional mowing costs for the week would be $100, and additional painting costs would be $80. Transportation costs would be $50 for either job. Identify the total amount of any sunk cost(s).

$1,000 Buying the mowing equipment is a past event and is therefore a sunk cost and not relevant to the decision.

Which of the following describes how companies determine the markup percentage given a required rate of return on investment of $12 per unit?

$12/Total unit cost Desired ROI per unit/Total unit cost = Markup percentage

When the net present value (NPV) of a project is positive, its internal rate of return will be

greater than the discount rate. Considering the NPV is positive, the internal rate of return MUST exceed the discount rate.

Intangible benefits associated with potential projects

include enhanced employee loyalty. Intangible benefits include (1) increased quality, (2) improved safety, or (3) enhanced employee loyalty.

Fraser Manufacturing is considering producing two new products. Product 11-A will generate revenues of $84,000, have variable costs of $28,000, and fixed costs of $5,600. Product 22-B will generate revenues of $98,000, have variable costs of $21,000, and fixed costs of $5,600. What is the incremental revenue?

$14,000 Only the revenue is considered when calculating the incremental revenue, therefore, Product A-11 will generate $98,000 and Product B-22 will generate $84,000. Thus, the incremental revenue is $98,000 - $84,000 = $14,000.

Garnet Company's most popular product has a unit variable cost of $40 and a unit sales price of $70.40. Fixed manufacturing costs are $192,000 when the company produces and sells 10,000 units. Garnet has been approached with a one-time opportunity to sell 1,000 more units for $56 each. Because the customer is a foreign wholesaler, these sales will not impact present sales. If Garnet has sufficient capacity, how much will net income change as a result of the special order?

$16,000 increase If there is sufficient capacity, the selling price, less the variable costs will be relevant to choosing whether to accept or reject a special order. Since fixed costs will not be affected, in this case, (the selling price of $56- variable costs $40) x quantity of 1,000= $16,000. The special order can be accepted since it will result in a net profit.

The Plum Division of Fruit Corp. manufactures and sells its decanters for $44.00 per unit. Each decanter sold externally yields a $24.00 contribution margin. Plum's fixed costs per unit are $5.60. The Wine Division wants to purchase 5,000 decanters at $25.60 per unit. Plum can save $2.40 variable cost per unit by selling internally to Wine. If Plum has sufficient capacity to fill Wine's order, what is the minimum transfer price it should accept?

$17.60 Since Plum has excess capacity, the minimum transfer price is:Selling Price - Contribution Margin - Cost Savings:$44.00 - $24.00 - $2.40 = $17.60

Becky manufactures and sells clay pots that retail for $42 each. Becky's total manufacturing cost per pot is $27, consisting of $21 in variable costs and $6 in fixed overhead costs. Becky received an offer from Home Designs, Inc., to purchase 7,500 clay pots for $24 each. Becky has excess capacity to fill the order. By how much will Becky's revenue and expenses increase due to the special-order?

$180,000 increase in revenue; $157,500 increase in expenses The revenues will increase by the selling price of the special-order x the quantity: $24 x 7,500 = $180,000. Expenses will also increase by the additional variable costs for each. $21 x 7,500 = $157,500. The fixed costs will not change, therefore they do not need to be considered in this calculation.

Glade Industries manufactures and bottles energy drinks. Glade has the capacity to produce 3,000,000 units per year. Last year, it produced 2,500,000 units. A grocery chain has placed a special order for 500,000 bottles to be labeled and sold as its house-brand energy drink. Glade's normal selling price is $0.80 per bottle, and the special order is for $360,000 total ($0.72 per bottle). Management estimates the variable cost per bottle to be $0.34 and fixed manufacturing overhead to be $0.22 per bottle. Of the fixed cost assigned to the special order, $2,500 is for special labels, and the remainder would have been incurred without the special order. What is the operating income generated by the special order?

$187,500 The special order decision is determined by subtracting the variable costs from the selling price, then multiplying by the number of units. The fixed costs do not need to be considered, since they will not change regardless of acceptance of the special order. The additional cost for the labels is also subtracted to determine if the special order is profitable: [(selling price $0.72 - variable costs $0.34) x order quantity 500,000] - cost of labels $2,500 = $187,500. Because the special order will generate a profit, and since the capacity exists, the order should be accepted.

Maldonado Steel invested in a new project that has an internal rate of return (IRR) of 9%. They expect the project to have annual cash flows of $52,000 for six years. What were the capital expenditures for this project (the PV of an annuity for 6 periods at 9% = 4.48592)?

$233,267.84 An IRR of 9% for a six-year project gives an internal rate of return factor of 4.48592. The initial investment is then calculated as the internal rate of return factor x net annual cash flows OR 4.48592 x $52,000 = $233,267.84.

You are planning to open a local restaurant, and you are considering whether to buy or rent your facility. If you rent the facility, you will pay $2,500 per month in rent plus approximately $1,300 in utilities per month. You will also be required to purchase renters' insurance, which will cost you $350 per month. All maintenance fees on the building and landscaping, however, will be provided by the property owner. If you buy the facility, your mortgage will be $1,800 per month, and utilities will be $1,300 per month. Your property insurance will be $600 per month and your expected maintenance costs are $1,000 per month. What is the relevant cost of purchasing the building?

$3,400 per month The utility costs are not relevant to the decision. If purchasing the building, the costs to be considered are: Mortgage $1,800 Property insurance $600 Maintenance costs $1,000 Total relevant cost= $3,400.

Wind Song Company is researching a new product. The company projects that sales will total $600,000 when 150,000 units are sold. Wind Song's desired profit is $72,000. What is the target cost per unit?

$3.52 $600,000 - $72,000 = $528,000 target costs. $528,000/150,000 = $3.52 target cost per unit.

Urban Kicks is using the cost-plus approach on its new hologram skate shoes and requires a 45% markup on new products. It expects to sell 12,000 pairs annually and estimates costs to be $495,000. Given this information, what is the price per pair of shoes? Round your answer if necessary.

$59.81 First, find the cost per-pair ($495,000/12,000 = $41.25). Then, find the price per-pair by multiplying the cost per-pair by one plus the desired gross margin percentage ($41.25*(1+0.45) = $59.81).

Jasmine Co. has two alternative opportunities. Opportunity A has revenues of $100,000, variable costs of $60,000, and fixed costs of $20,000. Opportunity B has revenues of $120,000, variable costs of $60,000, and fixed costs of $32,000. What is the incremental profit?

$8,000 A: $100,000 revenues-$60,000 variable costs- $20,000 fixed costs = $20,000. B: $120,000 revenues-$60,000 variable costs - $32,000 fixed costs= $28,000. The incremental profit would be $28,000- $20,000= $8,000, if option B was chosen.

JT Engineering wants to buy a machine that costs $158,000, has a 20-year life, and has a $12,000 salvage value. Annual inflows are $66,000 and annual outflows are $41,000. JT requires 14% return, which has an annuity present value factor of 6.6231 and a single future amount present value factor of 0.0728. What is the net present value (NPV) of this purchase to the nearest dollar?

$8,451 First, net annual cash flow must be determined by subtracting outflows from inflows ($66,000 - $41,000 = $25,000). Then, the present value of net cash flow must be determined by multiplying the net annual cash flow by the annuity present value factor ($25,000 x 6.6231 = $165,577.50). Then, the present value of salvage must be determined by multiplying the salvage value by the single future present value factor ($12,000 x 0.0728 = $873.60). Finally, NPV can be determined by adding the present value of salvage and cash flows and then subtracting the capital investment ($165,577.50 + $873.60 - $158,000 = $8,451.10). Rounded to the nearest dollar, NPV of this purchase is $8,451.

Hooper's Hats is introducing a wool fedora with a silk band. Research indicates that 8,500 hats can be sold if the price is $83. Hooper's must invest $87,000 in new equipment to make the hats. If Hooper's requires a minimum rate of return of 27% on all investments, what is the per-hat target cost? Round your answer if necessary.

$80.24 The desired profit for the fedoras is ($87,000 × 0.27) = $23,490. This means each hat must result in ($23,490 / 8,500) = $2.76 of profit. Using the target cost equation, we see that ($83 - $2.76) = $80.24 target cost per hat.

The managers at Mango Company recently performed incremental analysis when deciding whether to replace an old delivery truck with a new delivery truck. Which of the following factors were most likely included in their analysis? 1. Cost of new truck. 2. The annual operating cost of the old truck. 3. The estimated annual depreciation expense on the new truck.

1 and 2 only Only costs relevant to the decision need to be considered. Both the new truck's cost and the annual operative cost of the new truck are relevant because they differ between the alternatives.

Sensitivity analysis includes: 1. Using a lower discount rate for more current cash flows and a higher discount rate for more distant cash flows 2. Using only cash flows that are certain to be received

1 only Sensitivity analysis is a way to deal with uncertainty when dealing with decision making and it uses a lower discount rate for a more current cash flow, and a higher discount rate for future cash flows.

Chris Lawrence is contemplating a project with an initial investment of $50,000. Chris also has a discount rate of 8%. If the project has estimated net annual cash flows of $12,000 for the next six years, what is the profitability index for the project?

1.11 The profitability index is calculated by dividing the present value of cash flows by the initial investment. Using the present value of an annuity table, the profitability index is 1.11 [($12,000 x 4.62288) ÷ $50,000].

Riordan Manufacturing is considering an investment in new equipment that will produce equal annual cash flows of $52,000 for 8 years and has a net present value of $94,182. The initial investment is $247,000, the useful life is 8 years, and the equipment's salvage value after 8 years is $26,000. What is the equipment's profitability index? Round your answer to two decimal places.

1.38 The profitability index is calculated by dividing the present value of cash flows by the initial investment. First, calculate the present value of the net cash flows $247,000 + $94,182 = $341,182. Divide this by the initial investment amount to find the profitability index: $341,182 / $247,000 = 1.38.

Managers at Eller Manufacturing are considering purchasing a new refrigerated delivery truck that will produce equal annual cash flows of $36,000 for 6 years. The truck's net present value is $12,780, its cost is $144,000, its useful life is 6 years, and its annual depreciation expense (no salvage value) is $24,000. What is the discount rate used by Eller to evaluate this project? Present Value of an Annuity of 1 Period 8% 9% 10% 11% 12% 15% 6 4.623 4.486 4.355 4.231 4.111 3.784

10% The discount rate used by Eller to evaluate this project is calculated by adding the cost and the NPV divided by the expected equal annual cash flow OR ($144,000 + $12,780) / $36,000 = 4.355.

Poorman Company is contemplating a project with an initial capital investment of $40,000. The expected future annual cash inflows from the project are estimated to be $7,500 for the next 8 years. What is the estimated internal rate of return for the project?

10% The internal rate of return factor is calculated as the capital investment / the annual cash inflows OR $40,000 ÷ $7,500 = 5.33333. By observing the present value of an annuity table and row for year 8, the closest interest rate column is the 10% column which has an estimated internal rate of return factor of 5.33493.

Russ E. breeds and raises horses. He is currently considering purchasing a new property that will cost $2,200,000. The property includes a barn and several horses. Due to the unique nature of the business, the cash flows associated with the property occur at the end of every 6-month interval. Russ estimates that the cash inflows will exceed the cash outflows by $82,000 each 6-month period. Russ estimates he will sell the property in 30 years for $1,690,000. What is the payback period of the new property? Round your answer to one decimal place.

13.4 years The payback period method identifies the time period required to recover an investment.Payback period = net investment / annual cash flow. $2,200,000 / ($82,000 x 2) = 13.4 years.

Which of the following will be included when calculating a project's profitability index? 1. Intangible benefits 2. Salvage value of equipment

2 only The profitability index is calculated by dividing the present value of cash flows by the initial investment. The present value of the equipment's salvage value is also included as part of the NPV of the cash flows. Intangible benefits are not part of this calculation.

Seaview Company is considering purchasing a small hotel on the Oregon coast. The hotel would require an initial investment of $5,000,000. The hotel will generate quarterly cash inflows of $350,000, and the hotel will have a $450,000 residual value at the end of 15 years (at which time Seaview plans to sell the hotel). What is the hotel's payback period? Round your answer to one decimal place.

3.6 years The payback period method identifies the time period required to recover an investment. Payback period = net investment / annual cash flow. $5,000,000 / ($350,000 x 4) = 3.6 years.

Rona is working to determine the material loading percentage for the following situation. The overhead costs for the company come to $38,400, and the other overhead amounts to $16,000. In total, the cost for parts and materials is $320,000. The company also has a desired profit margin of 15%. What is the overall material loading percentage?

32% To find the overall material loading percentage add the overhead costs and the other overhead costs, then divide that number by the total cost for materials and parts. That percentage should be added to the desired profit margin to arrive at the overall loading percentage.In this case, that would be: $38,400 + $16,000 = $54,400. $54,400 / $320,000 = 17%. 17% + 15% = 32%.

A project requires an investment of $125,000 and will generate operating cash flows of $30,000 per year. What is the payback period of this project?

4.17 years The payback period method identifies the time period required to recover an investment. For even cash flows, payback period = $125,000 ÷ $30,000 = 4.17 years.

Which of the following is information that is irrelevant to a decision about retaining or replacing equipment?

A book value of $40,000 on an eight-year-old piece of equipment. The book value of the old equipment is a sunk cost and therefore not relevant to the decision. Because the book value of the old equipment will not change regardless of a decision made, it does not need to be considered when deciding whether to retain or replace the equipment.

What is a potential disadvantage to using the annual rate of return method for determining the desirability of a project rather than the net present value (NPV) or internal rate of return (IRR) methods?

Annual rate of return does not consider the time value of money. Unlike the NPV or IRR methods, the annual rate of return method does not take into account the time value of money when determining the desirability of a project.

Cove Company decided to replace an old machine with a new machine. Which of the following was most likely included in the incremental analysis performed by the company's managers?

Book value of old machine: No Current disposal price of old machine: Yes The book value of the old machine is considered a sunk cost. This cost cannot be recouped regardless of what decision is made. The current disposal price (expected proceeds) of the old machine differs between the alternatives, therefore it is relevant to the decision-making process.

Which of the following methods uses discounted cash flow techniques? 1. The internal rate of return method 2. The net present value method

Both 1 and 2 Both the internal rate of return and the net present value methods take into account time value of money by discounting future cash flows.

JT Engineering is considering two new projects. After using the net present value (NPV) method to determine the acceptability of the projects, Project A comes back with an NPV of $5,200 and Project B comes back with an NPV of $0. Based on this information, which of the following correctly describes the acceptability of these projects?

Both projects are acceptable, but Project A is more attractive. When making a selection between project A and B, the higher the positive net present value, the more attractive the investment. Therefore, Project A would be a more attractive investment.

CS Enterprises has a machine that originally cost $250,000. Its current book value is $75,000 and its remaining useful life is two years. CS is considering a replacement that costs $212,000 and has a two-year useful life. The new machine will decrease variable costs from $84,000 to $73,000. If the old machine has a scrap value of $3,000, what should CS do? Why?

CS should retain the old machine because the company will sustain a $187,000 decrease in net income if it purchases the new machine. Relevant costs must be considered when deciding whether to keep or replace a machine. Variable costs are the only costs currently associated with retaining the old machine and are 2 years x $84,000 = $168,000. Variable costs, purchase costs, and scrap value of the old machine are associated with the purchase of the new machine and are ([2 years x $73,000] + $212,000 + [-$3,000]) = $355,000. This amounts to a $187,000 decrease in net income ($168,000 - $355,000 = -$187,000). Thus, CS should retain the current machine.

Which of the following scenarios is an example of a behavioral decision-making error?

CT Tech purchases a $600,000 machine and six months later a new, more efficient machine becomes available. Management does not purchase the machine because it doesn't think another purchase is warranted. Behavioral decision-making errors occur when inappropriate, non-quantitative factors are considered.

Morgan wants to have a new roof built. She has contacted three companies. All companies have very similar prices in terms of labor and materials. Company 1 offered a material loading percentage of 68%. Company 2 offered a percentage of 54%. And Company 3 offered a percentage of 38%. Which one should Morgan choose?

Company 3, because if the labor and materials are the same for all three, then she needs to find the company with the lowest material loading percentage in order to get the most affordable price. If the labor and material charges are the same for all three companies, finding the lowest material loading percentage will ensure a lower total price for labor and materials.

Darling Dollhouses sells unassembled dollhouses, but it is considering selling assembled dollhouses instead. Currently, the firm charges $120 for each unassembled house it sells. Darling estimates the fixed production costs for assembling one dollhouse will be $9 and the variable costs will be $5. Based on these figures,

Darling should only switch to producing assembled dollhouses if it anticipates selling them for more than $134. Assembling the dollhouses will add $9 in fixed production costs + $5 in variable costs= $14 to the total costs associated with each house. Thus, if Darling wants the assembled houses to have a greater net income per unit than the unassembled houses, it must sell the assembled houses for more than $120 + $14 = or $134 per unit.

Why is the effect of a machine's book value on current and future earnings the same whether a company chooses to retain it or replace it?

In either scenario, the book value is recorded as a loss or expense. The book value of the asset will need to be removed from the books if the asset is replaced. If it is retained, then depreciation will be reported annually until the value is at -0-. Thus, the net effect on current and future earnings would be the same. The book value of the equipment is a sunk cost, since it cannot be recouped regardless of the decision made.

When considering whether to retain or replace current equipment, how does the book value of the current equipment impact the decision?

It does not impact the decision because it is a sunk cost. The book value of the old equipment is a sunk cost and therefore not relevant to the decision.

Ahrens Tech makes motherboards for the computers it produces. Costs for producing 25,000 motherboards are shown in the chart. Ahrens can purchase the motherboards from an outside firm for $9.50 apiece. Will Ahrens save money or incur additional costs by purchasing the motherboards? Make Buy DM $115,000 $0 DL $35,000 $0 VMC $62,000 $0 FMC $46,000 S27,000

It will incur $6,500 in additional costs. Ahrens spends $258,000 making motherboards ($115,000 + $35,000 + $62,000 + $46,000). It will spend $264,500 (($9.50 X 25,000) + $27,000) purchasing motherboards. Thus, Ahrens will lose $6,500 ($258,000 - $264,500) if it purchases the motherboards.

Inca Industries is considering two new machines. Machine A will generate revenues of $160,000, have variable costs of $55,000, and fixed costs of $8,000. Machine B will generate revenues of $140,000, have variable costs of $40,000, and fixed costs of $8,000. Which machine should be selected and why?

Machine A because incremental profit will be $5,000 higher. Fixed costs do not differ between the two options, so the $8,000 in fixed costs are not relevant to the decision. Option A: $160,000 revenue - $55,000 variable costs= $105,000 and Option B: $140,000 revenue- $40,000 variable costs=$100,000. Option A generates an additional $5,000 ($105,000-$100,000), so it is a better option.

Which term describes when an outsourcing decision refers to the components of a manufacturing product?

Make-or-buy decision A make or buy decision takes into account all relevant costs.

Given a required rate of return on investment of $12 per unit, what does the equation $12/Total unit cost provide?

Markup percentage. Desired ROI per unit/Total unit cost = Markup percentage

Home Safety Appliances is considering a project that would increase the efficiency and safety of their assembly line. The initial investment will be $350,000. They believe annual cash inflows will be $67,000 and annual cash outflows will be $32,000. The project will last 15 years with a discount factor of 8%. They also believe that intangible benefits will effectively increase cash inflows by $12,000 annually and decrease cash outflows by $3,000 annually. What is the difference in net present value (NPV) of the project when intangible benefits are or are not included?

NPV is $128,392.20 higher when intangibles are included. Using the present value of an annuity table, the discount factor for 15 years at 8% is 8.55948. To calculate NPV when intangibles are not included: annual cash flows = $67,000 - $32,000 = $35,000. The present value of the cash flows is $35,000 x 8.55948 = $299,581.80. Subtracting the initial investment gives an NPV of $299,581.80 - $350,000 = -$50,418.20. To calculate NPV when intangibles are included: annual cash flows = $67,000 - $32,000 + $12,000 + $3,000 = $50,000. The present value of the cash flows is $50,000 x 8.55948 = $427,974. Subtracting the initial investment gives an NPV of ($427,974 - $350,000) = $77,974. The difference between the net present value when intangible benefits are included compared to when they are not is $77,974.00 + $50,418.20 = $128,392.20.

In computing net present value or the profitability index, managers can deal with uncertainty by 1. Using a lower discount rate for more distant cash flows 2. Using a higher discount rate for less risky projects

Neither 1 nor 2 The profitability index takes into account both the size of the original investment and the discounted cash flows. But it does not use a lower discount rate for distant cash flows, or a higher discount rate for less risky projects.

Each day, Presto Pasta incurs total costs of $22,000 to process raw ingredients into spaghetti. The firm can then sell the spaghetti as is for total daily revenue of $84,000. Alternatively, Presto can partially cook the pasta, package it with tomato sauce, and sell it as an instant frozen meal. The additional costs for making the frozen meals are $50,000 per day and total daily revenues from the meals are $139,000. Given these figures,

Presto should sell the frozen meals. Total daily net income from the plain spaghetti is sales of $84,000 - variable costs of $22,000 = $62,000, while that from the frozen meals is sales of $139,000 - variable costs $22,000 - additional costs of $50,000 = $67,000. Thus, net income is higher with the frozen meals.

What would you call firms in an industry where there are so many competitors selling similar products that each firm sells at the market price?

Price takers. Price takers cannot set the price of their product because the supply and demand by customers (market forces) set the price due to many competitors selling the same product. On the other hand, price makers and price setters refer to companies who can set their product's price rather than relying on market forces. Monopolists are companies who have no competition, and therefore they can set their product's pricing.

Halifax Manufacturing is considering producing two new products. Product 11-A will generate revenues of $112,000, have variable costs of $38,500, and fixed costs of $5,600. Product 22-B will generate revenues of $98,000, have variable costs of $28,000, and fixed costs of $5,600. Which product should be selected and why?

Product 11-A because incremental profit will be $3,500 higher. Because the fixed costs do not differ between the two options, they are not relevant to the decision. Option 11-A would bring in revenue of $112,000 and incur variable costs of $38,500= $73,500. Option 22-B would produce revenue of $98,000 with variable costs of $28,000= $70,000. Option A generates a higher incremental profit, thus should be chosen.

Buckel Co. has two new products. They have equal sales and sell for the same price, and both have incurred the same costs and have the same rate of return on investment. The desired profit for the products is the same, but Product A is earning less than the desired profit, while Product B is earning more than the desired profit. What can you assume about these products?

Product A is exceeding its target cost, while Product B is incurring less than its target cost. Target cost is set based on market price and desired profit. If a company can produce its product at the target cost, it will earn its desired profit. If a company produces its product below the target cost, it will earn more than its desired profit. If a company produces its product above the target cost, it will earn less than its desired profit.

__________ is a pricing strategy that starts with the market price.

Target costing Target costing starts with the market price to determine the price a company can charge for its product. The other options given are based on non-market factors. Breakeven costing calculates the amount a company must sell the product for to cover the product's cost without any profit amount. Cost plus allows for the product's cost to be covered plus an amount for a profit. Fixed costing is a set amount without considering the market pricing.

GreenCut Lawnmowers makes three models of push mower: the Standard, the Premium, and the Pro. Condensed income statement data related to the three models are as follows: Standard Premium Pro Sales $499,000 $320,000 $450,000 VC 68,000 69,000 72,000 Cont. Margin 431,000 251,000 378,000 FC 245,000 264,000 271,000 Net Income $186,000 $(13,000) $107,000 GreenCut is considering discontinuing the Premium mower; if it does so, 35% of the fixed costs previously allocated to the Premium will now be allocated to the Standard, while another 30% will be allocated to the Pro. Given these figures, what will happen if GreenCut stops manufacturing the Premium?

The firm's net income will drop by $158,600. If GreenCut eliminates the Premium, its total sales will drop to $1,269,000 - $320,000 = $949,000, and its total variable costs will drop to $209,000 - $69,000 = $140,000, which means its overall contribution margin will be $949,000 - $140,000 = $809,000. The firm's fixed costs will also drop by 35% x $264,000 = $92,400, bringing them to $780,000 - $92,400 = $687,600. Thus, the firm's net income will be $809,000 - $687,600 = $121,400, which is $158,600 lower than its current level. It is better to keep the Premium, since eliminating it will lower the overall net income of the company.

JT Engineering wants to purchase a $360,000 machine. The machine will last eight years, be paid off in five years, and has no salvage value. Annual revenues are $190,000, annual expenses are $105,000, and the required rate of return is 15%. Using the annual rate of return method, the purchase is acceptable for JT. What was the determining factor in this decision?

The machine's annual rate of return met or exceeded the required rate. If the project is acceptable based on the annual rate of return method, it means that the machine's annual rate of return met or exceeded the required rate.

The Battery Division of Moto Motorcycles manufactures 200,000 motorcycle batteries each year and has enough capacity to manufacture up to 30,000 more. The division's variable cost per battery is $40, and it sells the finished batteries to customers for $88 each. Moto's management wants the Battery Division to sell 25,000 batteries to the Parts Division at a transfer price based on the variable cost per battery. Currently, the Parts Division purchases its batteries from an outside vendor at a cost of $52 each. Assuming the two divisions proceed with the transfer using this cost-based price, which of the following statements is accurate?

The transfer will be profitable for the Parts Division and for Moto as a whole. Because the Battery Division has enough extra capacity to manufacture the 25,000 batteries, it does not lose any money per battery sold. In comparison, the Parts Division saves $52 - $40 = $12 per battery purchased. Thus, the overall savings to Moto as a whole are 25,000 × $12 = $300,000.

Walters Studios and Stanley Publishing both have new projects that require an initial investment of $320,000 and will have annual cash inflows of $42,000. If Walters expects their project to last 16 years and Stanley expects their project to last 14 years, which one has the higher internal rate of return?

Walters Studios The internal rate of return factor is calculated as the initial investment divided by annual cash flows OR ($320,000) / ($42,000). These values are the same for both companies, so their internal rate of return factor will be the same ($320,000 / $42,000) = 7.61905. For 16 periods, this gives an IRR between 10% and 11%. For 14 periods, this gives a value between 9% and 10%. Therefore, Walters Studios will have the higher IRR.

The Epic Company sells suit jackets and buttons. The button division can produce 200,000 buttons per year and sells 160,000 buttons externally for $0.30 each. The buttons produce a contribution margin of $0.16 per button. The suit jacket division needs 40,000 buttons this year and currently pays $0.18 per button to purchase the buttons externally. Should the button division sell the buttons to the suit division? Why or why not?

Yes, Epic Company will save $0.04 per button. Variable cost = $0.30 - $0.16 = $0.14 Savings = External Price - Variable Cost = $0.18 - $0.14 = $0.04

One of the quantitative factors associated with make-or-buy is that it may

free up resources used by a company. Quantitative factors involve numbers and calculations. Qualitative factors do not involve numbers but other potential outcomes of a decision.

Incremental revenues

are relevant. Relevant costs are those that differ between two different decisions.

Fairfield Industries is considering whether to retain or replace a piece of equipment with a $63,000 book value and a scrap value of $14,000. After much discussion, Fairfield decides to replace the equipment. How should Fairfield treat the old machine's scrap value?

as a relevant cost The scrap value is a relevant cost because it differs between the alternatives. The book value is not relevant, as it is a sunk cost and cannot be recouped regardless of which decision is made.

Recognizing the time value of money is an important characteristic of

both the internal rate of return and the net present value methods. Both the internal rate of return and the net present value methods take into account time value of money by discounting future cash flows.

In ________ transfer pricing, some markup may be added to the product's cost to calculate a transfer price.

cost-based Cost-based pricing bases the transfer price on the production cost, plus it may also allow for an additional amount to be added to it. Target cost, negotiated cost, and market-based pricing do not allow for a markup to be added to the product's cost but use other costing techniques. Target costing uses a set price without consideration of costs, negotiated pricing uses a price the two divisions have agreed upon, and the market sets market-based pricing.

To calculate a project's profitability index, you must

divide the present value of the project's net cash flows by the amount of the initial investment. The profitability index takes into account both the size of the original investment and the discounted cash flows. The profitability index is calculated by dividing the present value of net cash flows that occur after the initial investment by the amount of the initial investment.

A firm saved $22,000 in fixed costs by eliminating one of its unprofitable product lines. By dropping the product line, the firm also saw its total company-wide contribution margin drop by $18,500. These figures indicate that the firm has seen its net income

increase by $3,500 due to the product discontinuation. The firm saved $22,000 in expenses by eliminating the product, however it also experienced an $18,500 drop in contribution margin. Since $22,000 - $18,500 = $3,500, the net result is a $3,500 increase in net income. Dropping the product would result in an increase in the net income of the company of $3,500.

A negotiated price is one that

is agreed to by both the buying and selling division. A negotiated price is the price agreed to by both the seller and the buyer. Typically negotiated prices are used when the sale is a company sale, i.e., one division in the company sells to another division in the same company.

For projects with normal cash flows, if a project clears the screening process on the basis of positive net present value,

it will also clear the screening process on the basis of its internal rate of return. Considering the NPV is positive, the internal rate of return MUST exceed the discount rate.

Colin's Caps makes baseball hats. The company is deciding whether to buy the hats from a company that will produce them for $5 per hat. Colin's variable costs are $2 per unit and its annual fixed costs are $75,000. The company makes 20,000 hats per year. If the hats are bought, all variable costs and 60% of annual fixed costs will be eliminated. Which is better for Colin, making or buying the hats?

making the hats, because it will result in a $15,000 savings for the company All relevant costs need to be considered when choosing between make or buy. Since the production costs to make (20,000 units x $2) = +$75,000 in fixed costs = $115,000. The total costs to buy (20,000 units x $5) + ($75,000 x 40%) in fixed costs = $130,000. So, the buy cost of $130,000 - the make cost of $115,000 shows a savings of $15,000 to make the hats.

Target costing starts with the ________ price.

market Target costing does not start with the maximum, minimum, or variable cost; it starts with the market price. Companies look at the market to determine the selling price of their product. The total cost plus profit must be equal to the market selling price.

The most unbiased transfer price is a ________ price.

market-based Market-based pricing is set by supply and demand factors in the market, which is the most unbiased approach. The negotiating divisions determine a negotiated price; therefore, it may be biased towards the division's price who has the best negotiation skills. Using cost-based transfer pricing may not be a price that others would be willing to pay. An imposed price is not connected to the product's actual cost, thus, creating a biased price.

The most unbiased transfer price is the

market-based transfer price. Market-based pricing is set by supply and demand factors in the market, which is the most unbiased approach. The negotiating divisions determine a negotiated price; therefore, it may be biased towards the division's price who has the best negotiation skills. Using cost as the transfer price or cost-plus-based transfer pricing may not be a price that others would be willing to pay.

The transfer price that is agreed to by both the buying and the selling division is the

negotiated transfer price. A negotiated price is the price agreed upon by both the seller and the buyer. If a market-based transfer price is used, the market price is charged to the division receiving the product. The other options are a cost-based transfer price, which uses the division's production cost of the product, or a cost-plus-based transfer price, which uses the division's production cost plus a profit amount added to it.

Chandler, Inc., would like to buy one of the light fixtures it produces. The cost to buy the fixture is $15 per unit. The cost to make the fixture is $13 per unit. If the company buys, it can rent out the factory space it is no longer using for $75,000 annually. In this situation, the $75,000 is a(n)

opportunity cost. If the company buys the product, the excess capacity can be used to generate additional revenue. Foregoing this is referred to as an opportunity cost.

When a company is analyzing a make-or-buy process, resources are freed up so they can be put to another use. The alternative use is considered to be a(n)

opportunity cost. Opportunity costs are a consideration in a make or buy decisions. If the area previously used to make, can be used for an alternative purpose, that must be considered in the decision-making process.

In the long run, a company must price its product or service at the

product's production cost plus a reasonable profit. When a company prices a product, the company must cover its manufacturing cost and add for a reasonable profit. The value of the product or service to the customer is not used because each customer has different values for a product or service. A firm's targeted markup plus the cost to deliver the product isn't used because the product cost must, at a minimum, cover the product's manufacturing cost.

Both the internal rate of return and the net present value methods

recognize the time value of money. Both the internal rate of return and the net present value methods take into account time value of money by discounting future cash flows.

Which type of cost occurs only with the implementation of a particular alternative?

relevant Costs that do not differ between options are not relevant to a decision. Costs that do differ between two options are relevant and need to be considered. For example, rent expense, is a relevant cost in a decision whether to continue occupancy of a building or to purchase or lease a new building.

A qualitative issue to consider with respect to make-or-buy is

supplier reliability. Qualitative issues do not involve costs or revenues. In this case, it is important to consider vendor reliability in addition to costs, as a lower priced option might not be the best choice if the vendor might deliver the material in 2 days or 10 days. It might be worth paying a bit more to have a reliable delivery schedule.

When the price of a product is set by market forces, a company is said to be a price

taker Price takers cannot set their product's price because the market forces (supply and demand by customers) set the price due to many competitors selling the same product. On the other hand, price makers and price setters refer to companies who can set their product's price rather than relying on market forces.

Industrial Products Inc. is trying to decide whether to build a new manufacturing plant or a new warehouse. Both facilities require the same initial investment and are expected to generate the same annual cash flows and intangible benefits. However, when calculating the net present values (NPVs) of the projects, Industrial uses a lower discount rate for the warehouse than for the manufacturing plant. This tells us that

the warehouse will have a higher NPV than the plant because Industrial believes the warehouse presents a lower degree of risk. A higher discount rate will result in a lower NPV. A higher discount rate is used for riskier projects. Thus, the warehouse will have a higher NPV than the plant because Industrial believes the warehouse presents a lower degree of risk.