# Chapter 24 Differential Analysis and Product Pricing Study Guide Do You Know?

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1 Chapter 24 Differential Analysis and Product Pricing Study Guide Do You Know? Learning Objective 1: Prepare differential analysis reports for a variety of managerial decisions. How to prepare a differential analysis when deciding to lease or sell equipment? (See exercises 1 3) How to use a differential analysis when deciding to discontinue a segment or product? (See exercises 4 6) How to decide to make or buy components when using a differential analysis? (See exercises 7 9) How to use a differential analysis when deciding to replace equipment? (See exercises 10 12) How to decide whether to process further or sell products using a differential analysis? (See exercises 13 15) When to accept business at a special price using a differential analysis? (See exercises 16 18) Learning Objective 2: Determine the selling price of a product, using the product cost concept. How to use the product cost concept to determine the selling price of a product? (See exercises 19 21) How to determine the target cost for a product? (See exercises 22 24) Learning Objective 3: Compute the relative profitability of products in bottleneck production processes. How to calculate the profitability of products when a production bottleneck exists? (See exercises 25 27) Learning Objective 4: Allocate product costs using activity-based costing. How to allocate factory overhead using activity-based costing? (See exercises 28 30) 1

2 2 Chapter 24 Fill-in-the-Blank Equations 1. = Revenue (Alt. 2) Revenue (Alt. 1) 2. = Costs (Alt. 2) Costs (Alt. 1) 3. = Income (Alt. 2) Income (Alt. 1) 4. Normal selling price = Cost amount per unit + 5. Product cost per unit = Total product cost/ 6. Markup percentage = (Desired profit + )/total product cost 7. Desired profit = Total assets 8. = Expected selling price Desired profit 9. Unit contribution margin per production bottleneck hour = Unit contribution margin/ Exercises 1. Charleston Affair currently has a piece of equipment that is no longer needed. The current book value of the piece of the equipment is \$12,000. The company has the option to lease the equipment for the next three years for \$5,500 each year, or sell the equipment for \$16,000. If leased, the equipment would have no residual value at the end of the lease. The company expects that maintenance and other expenses during the lease would total \$2,000. If sold, Charleston Affair would pay a 5% commission. Prepare a differential analysis to determine if the company should sell (Alternative 1) or lease (Alternative 2) the equipment. 2. Wake Coffee Co. has a piece of equipment no longer needed for production. The company purchased the equipment for \$75,000 and has accumulated depreciation of \$10,000 related to the equipment. Wake Coffee Co. has determined it can either lease the equipment for the next ten years, for yearly revenues of \$9,000, or sell the equipment for \$70,000. If leased, the company expects to incur repairs and other expenses of \$22,000 over the life of the lease. The equipment would also have a \$3,500 salvage value. If sold, the broker requires a 4% broker commission. Prepare a differential analysis to determine if the company should sell (Alternative 1) or lease (Alternative 2) the equipment.

3 Differential Analysis and Product Pricing 3 3. Blair Designs is considering two alternatives for an outdated piece of machinery: leasing the machinery for five years, which would produce revenue of \$8,000 year or selling the machinery for \$38,000. The asset has a current book value of \$25,000. If leased, the company expects to incur \$7,000 of expenses for maintenance and taxes, and the equipment will have a \$4,000 salvage value. If sold, the broker charges a 5% commission fee. Prepare a differential analysis to determine if the company should sell (Alternative 1) or lease (Alternative 2) the machinery. 4. Product B at Charleston Affair generates sales of \$59,000 for 10,000 units. Each unit has variable costs of \$4.50 apiece and total fixed costs of \$18,000. Prepare a differential analysis to determine if Product B should be continued (Alternative 1) or discontinued (Alternative 2) if the fixed costs are unaffected by the decision. 5. Wake Coffee Co. incurs a loss from operations for the Standard Coffee line. Sales revenues for the line total \$72,000, while incurring variable costs of goods sold of \$19,500, variable selling expenses of \$17,400, and fixed costs of \$49,000. Prepare a differential analysis to determine if the Standard Coffee line should be continued (Alternative 1) or discontinued (Alternative 2). Assume the company will incur the fixed costs regardless of the decision. 6. Product BW of Blair Designs generates sales revenue of \$40,000. The product incurs variable costs of goods sold of \$22,000, fixed selling costs of \$22,000, and fixed factory overhead of \$21,000. Use a differential analysis to determine if Product BW should be continued (Alternative 1) or discontinued (Alternative 2). Assume that the company will incur the fixed factory overhead regardless of the decision. 7. Charleston Affair currently makes the King Component, incurring variable costs of \$18 per unit and fixed costs of \$4 per unit. The company has the option to purchase the component for \$20 per unit. Prepare a differential analysis to determine if the company should make (Alternative 1) or buy (Alternative 2) the King Component. Assume that the fixed costs will be incurred in each situation. 8. The Wake Coffee Co. currently produces the Sealable Coffee Bag and incurs the following costs per unit: direct materials, \$2; direct labor, \$3; variable factory overhead, \$2.50; and fixed factory overhead, \$3.50. The company also has the option to purchase the product for \$9.50 per unit. The seller charges a \$1.25 freight fee per unit. Prepare a differential analysis to determine if Wake Coffee Co. should make (Alternative 1) or buy (Alternative 2) the product, assuming that the fixed costs will be incurred regardless of the decision.

4 4 Chapter Blair Designs currently produces a Subcomponent, incurring variable direct costs of \$4.25 per unit, variable factory overhead of \$2.25 per unit, and fixed factory overhead of \$5.00 per unit. The company could also buy the Subcomponent for \$7.50 from an outside provider, which would also charge a freight fee of \$2.00 per unit. Prepare a differential analysis to determine if Blair Designs should make (Alternative 1) or buy (Alternative 2) the Subcomponent, assuming that fixed factory overhead will be incurred if the product is made or sold. 10. Charleston Affair is considering replacing an outdated piece of machinery. Use the information below for the old piece of machinery and new machinery to prepare a differential analysis to determine if Charleston Affair should continue (Alternative 1) or replace (Alternative 2) the old machine. Old machine: Estimated annual variable manufacturing costs \$18,000 Estimated selling price \$10,000 Estimated residual value \$6,500 Estimated remaining useful life 7 years New machine: Purchase price \$110,000 Estimated annual variable manufacturing costs \$5,000 Estimated residual value 1,500 Estimated useful life 7 years 11. Wake Coffee Co. has an outdated piece of machinery that the company is considering replacing. Use the information below for the two pieces of machinery. Prepare a differential analysis to determine if the company should continue with the old piece of machinery (Alternative 1) or replace the piece of machinery (Alternative 2). Old machine Estimated annual variable manufacturing costs \$15,000 Estimated selling price \$3,200 Estimated remaining useful life 5 years New machine Purchase price \$42,000 Estimated annual variable manufacturing costs \$6,000 Estimated residual value 0 Estimated useful life 5 years

5 Differential Analysis and Product Pricing Blair Designs has an old piece of equipment that management is considering replacing. Use the information below for the piece of equipment and its replacement to prepare a differential analysis to determine if the company should continue with the old piece of equipment (Alternative 1) or replace the piece of equipment (Alternative 2). Old equipment Estimated annual variable manufacturing costs \$11,500 Estimated selling price \$3,200 Estimated remaining useful life 10 years New equipment Purchase price \$50,000 Estimated annual variable manufacturing costs \$5,000 Estimated residual value \$5,000 Estimated useful life 10 years 13. Charleston Affair produces Product K for \$8 per pound, which can be sold for \$15 per pound or processed into Product M, which sells for \$30 per pound. Each pound requires an additional \$12 to process into Product M. Prepare a differential analysis to determine if the company should sell Product K (Alternative 1) or process further into Product M (Alternative 2). 14. Wake Coffee Co. processes Standard Coffee in batches of 5,000 pounds, which sell for \$8 per pound and cost \$10,000 to produce. The company can process the Standard Coffee into Deluxe Coffee for additional costs of \$6,000 per 5,000 pound batch. Each batch of Deluxe Coffee produces 3,000 pounds, which sell for \$15 per pound. Prepare a differential analysis to determine if Wake Coffee Co. should sell Standard Coffee (Alternative 1) or process further into Deluxe Coffee (Alternative 2). 15. Blair Designs produces 4,000 yards of Solid Fabric per batch, which sells for \$5 per yard. Each batch of Solid Fabric produced incurs \$12,000 of costs. The company can incur an additional \$3,000 in costs to process the batch of Simple Fabric into 2,400 yards of Patterned Fabric, which sells for \$12 per yard. Prepare a differential analysis to determine if the company should sell Solid Fabric (Alternative 1) or process further into Patterned Fabric (Alternative 2). 16. Charleston Affair received a special purchase order for 5,000 units at a purchase price of \$10 per unit, which are normally sold at \$12 each. Each unit requires \$6 of variable manufacturing costs. Each purchase order incurs processing costs of \$2,000. Prepare a differential analysis to determine if the company should reject (Alternative 1) or accept (Alternative 2) the order, assuming there is sufficient capacity.

6 6 Chapter Wake Coffee Co. normally sells finished goods for \$8.50 per unit. The company received a special order to sell 4,000 units for \$4.50 each. The variable manufacturing costs per unit is \$3, and the company will incur an additional \$2.50 per unit to rush the order. Prepare a differential analysis to determine if the company should reject (Alternative 1) or accept (Alternative 2) the order, assuming there is sufficient capacity to produce the goods. 18. Blair Designs sells its finished goods in batches of 2,000 units for \$4 per unit. The company has received a special order for three batches for a total selling price of \$10,000. Each unit incurs variable manufacturing costs of \$1.50 per unit and each batch incurs variable costs of \$200. Prepare a differential analysis to determine whether Blair Designs should reject (Alternative 1) or accept (Alternative 2) the order, assuming there is sufficient capacity to produce the goods. 19. Charleston Affair uses the product cost concept to price its goods. The company plans to release a new product in the upcoming month. Use the information shown below to determine: a. Product cost per unit b. Desired profit c. Markup percentage d. Markup per unit e. Normal selling price per unit Total product cost \$49,000 Total selling and administrative expenses \$32,100 Total assets \$120,000 Estimated units produced and sold 14,000 Desired rate of return on assets 10%

7 Differential Analysis and Product Pricing Wake Coffee Co. uses the product cost concept to price its goods. With the information shown, calculate each of the following for a new good: a. Product cost per unit b. Desired profit c. Markup percentage (round to the nearest percentage) d. Markup per unit e. Normal selling price per unit Total product cost \$24,800 Total selling and administrative expenses \$10,200 Total assets \$95,000 Estimated units produced and sold 6,200 Desired rate of return on assets 12% 21. Blair Designs plans the release of a new product in the upcoming year. Use the product cost concept and the information below to determine the following: a. Product cost per unit b. Desired profit c. Markup percentage (round to the nearest percentage) d. Markup per unit (round to the nearest cent) e. Normal selling price per unit Total product cost \$32,000 Total selling and administrative expenses \$8,000 Total assets \$140,000 Estimated units produced and sold 25,000 Desired rate of return on assets 15% 22. Charleston Affair currently sells 1,000 units of Product Z for \$64.50 and expects the price to rise by 12% in the upcoming year. The balance sheet shows total assets of \$200,000, and management has set a required rate of return of 15% on the assets. Use the target costing method to determine the total target cost the company should achieve. 23. Wake Coffee Co. expects for the price of Standard Coffee to be \$12 per pound in 2016 and sell 2,000 pounds. The company owns \$52,000 in assets, with a required rate of return on the assets of 12%. Determine the total target cost the company should achieve using the target costing method.

8 8 Chapter Blair Designs has a desired profit of \$40 per unit of Product T in the upcoming year. Product T currently sells for \$72 a unit, but the price is expected to increase 20% in the upcoming year. Use target costing to determine the target cost per unit the company should achieve. 25. All products at Charleston Affair must pass through a sealing treatment. When operating at full capacity, the treatment is considered a production bottleneck. Use the information below to determine the most profitable product when using bottleneck resources. Product X Product Y Product Z Unit selling price \$9 \$12 \$18 Unit variable cost Sealing treatment hours per unit All finished goods at Wake Coffee Co. must pass through a sanitizing wash, which is a production bottleneck when operating at full capacity. Use the information below to determine the most profitable product when using bottleneck resources. Standard Deluxe French Roast Unit selling price \$100 \$150 \$200 Unit variable cost Sanitizing wash hours per unit When operating at full capacity at Blair Designs, the stitching process is considered to be a production bottleneck. Use the information below to determine which product is most profitable when using bottleneck resources. Round answers to the nearest cent. Solid Patterned Print Unit selling price \$150 \$210 \$240 Unit variable cost Stitching process hours per unit

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