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Chapter 02
The Nature of Costs
Multiple Choice Questions
1. | Opportunity Costs:
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2. | John invested $12,000 in the stock of Hyper Cyber Eight years later, Hyper Cybers shares reached $125,000, but John held onto the shares in the belief that their price would double in the next five years. Unfortunately, Hyper Cyber did not double. Rather the market value of Johns shares today is $4,000. If the shares were sold and the proceeds invested in another investment, they would likely earn 5% per annum. Which of the following terms and values is correct?
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3. | Which of the following can be an opportunity cost?
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4. | Davos Inc. makes fiberglass ski-boards in Switzerland. Identify the correct matching of terms.
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5. | Pamela in Bamplona makes bull-repellent scent according to a traditional Spanish recipe, which normally sells at 9 (Euros) per unit. Normal production volume is 10,000 ounces per month. Average cost is 5 per ounce, of which 2 is direct material and 1 is variable conversion cost. This product is seasonal. After July, demand for this product drops to 6,000 ounces monthly. In November, Umberto offers to buy 1,500 ounces for 6,000.
If Pamela accepts the order, she must design a special label for Umberto at a cost of 500. Each label will cost 25 cents to make and apply. Pamela should:
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6. | Pamela in Bamplona makes bull-repellent scent according to a traditional Spanish recipe, which normally sells at 9 (Euros) per unit. Normal production volume is 10,000 ounces per month. Average cost is 5 per ounce, of which 2 is direct material and 1 is variable conversion cost. This product is seasonal. After July, demand for this product drops to 6,000 ounces monthly. In November, Umberto offers to buy 1,500 ounces for 6,000.
Now assume that the order is received in July, peak season. If Pamela accepts the order, she will turn away regular customers who order 500 ounces. Pamela should:
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7. | Francois French manufactures cheese, which he normally sells at 20/kg, on which sales commission of 5% is paid. Plant capacity is 7,500 kg/month. Income tax is levied at 30%.
The number of kilograms to sell to break-even is:
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8. | Francois French manufactures cheese, which he normally sells at 20/kg, on which sales commission of 5% is paid. Plant capacity is 7,500 kg/month. Income tax is levied at 30%.
If sales are 5,000 kgs, which of the following is true?
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9. | Francois French manufactures cheese, which he normally sells at 20/kg, on which sales commission of 5% is paid. Plant capacity is 7,500 kg/month. Income tax is levied at 30%.
Francois French wants to increase after-tax profits to 35,000. Assuming sufficient demand, which strategy achieves this goal?
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10. | The Mojave Water Agency (MWA) sets water policy and water rates for a desert area that faces a severe water shortage. It has 200,000 customers who are charged $100 per month for the first 20,000 cubic feet (cu.ft) and 1 cent per cu.ft thereafter. The average customer bill is $200 per month. It costs the agency cent per cu.ft to monitor and bill for usage. The MWA wants to cut costs by replacing metered billing with a flat fee which would be added to each property owners real estate tax bill. Which is true?
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11. | Hardley sells mamburgers. He faces fixed costs of $18,000 per month and variable production and marketing costs of $2 per mamburger. Market research has developed the following demand schedule. Which price/volume combination should Yardley choose?
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12. | Berties Burritos, a fast food enterprise, wants to understand his cost structure. He collected data, which appears below, to analyze costs using the high-low method.
Which is true?
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Essay Questions
13. | Fixed, Variable, and Average Costs
Midstate University is trying to decide whether to allow 100 more students into the university. Tuition is $5,000 per year. The controller has determined the following schedule of costs to educate students:
The current enrollment is 4,200 students. The president of the university has calculated the cost per student in the following manner: $30,600,000/4,200 students = $7286 per student. The president was wondering why the university should accept more students if the tuition is only $5,000. Required: a. What is wrong with the presidents calculation?
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14. | The Elements of Cost Volume Profit
The M Companys variable costs are 75% of the sales price per unit and their fixed costs are $240,000. If the company earned $60,000 before taxes in selling 150,000 units, what was the sales price per unit?
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15. | Opportunity Costs
The First Church has been asked to operate a homeless shelter in part of the church. To operate a homeless shelter the church must hire a full time employee for $1,200/month to manage the shelter. In addition, the church would have to purchase $400 of supplies/month for the people using the shelter. The space that would be used by the shelter is rented for wedding parties. The church averages about 5 wedding parties a month that pay rent of $200 per party. Utilities are normally $1,000 per month. With the homeless shelter, the utilities will increase to $1,300 per month.
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16. | Fixed and Variable Costs:
The university athletic department has been asked to host a professional basketball game at the campus sports center. The athletic director must estimate the opportunity cost of holding the event at the sports center. The only other event scheduled for the sports center that evening is a fencing match that would not have generated any additional costs or revenues. The fencing match can be held at the local high school, but the rental cost of the high school gym would be $200. The athletic director estimates that the professional basketball game will require 20 hours of labor to prepare the building. Clean-up depends on the number of spectators. The athletic director estimates the time of clean-up to be 2 minutes per spectator. The labor would be hired especially for the basketball game and would cost $16 per hour. Utilities will be $500 greater if the basketball game is held at the sports center. All other costs would be covered by the professional basketball team. Required: a. What is the variable cost of having one more spectator?
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17. | Opportunity Cost of Attracting Industry
The Itagi Computer Company from Japan is looking to build a factory for making Wi-Fi routers in the United States. The company is concerned about the safety and well-being of its employees and wants to locate in a community with good schools. The company also wants the factory to be profitable and is looking for subsidies from potential communities. Encouraging new business to create jobs for citizens is important for communities, especially communities with high unemployment. Required: a. Do the headlines accurately describe the deal with Itagi?
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18. | Cost, Volume, Profit Analysis
With the possibility of the US Congress relaxing timber cutting restrictions, a local lumber company is considering an expansion of its facilities. The company believes it can sell lumber for $0.18/board foot. A board foot is a measure of lumber. The tax rate for the company is 30 percent. The company has the following two opportunities: Build Factory A with annual fixed costs of $20 million and variable costs of $0.10/board foot. This factory has an annual capacity of 500 million board feet. Required: a. What is the break-even point in board feet for Factory A?
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19. | Cost, Volume, Profit Analysis
Leslie Mittelberg is considering the wholesaling of a leather handbag from Kenya. She must travel to Kenya to check on quality and transportation. The trip will cost $3,000. The cost of the handbag is $10 and shipping to the United States can occur through the postal system for $2 per handbag or through a freight company which will ship a container that can hold up to a 1,000 handbags at a cost of $1,000. The freight company will charge $1,000 even if less than 1,000 handbags are shipped. Leslie will try to sell the handbags to retailers for $20. Assume there are no other costs and benefits. Required: a. What is the break-even point shipping through the postal system?
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20. | Multiple Product Cost Volume Profit
A company sells three products as shown below:
These three products all always sold in fixed proportions. In other words, Product X always accounts for 24% of total sales (60,000/250,000), Product Y always accounts for 56% of total sales (140,000/250,000), and Product Z always accounts for 20% of total sales (50,000/250,000). Required: a. How many units of each product need to be sold to break-even?
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21. | Make or Buy
A company needs 10,000 units of a component used in producing one of its products. The latest internal accounting reports show that the per unit manufacturing cost to be $150.00, variable manufacturing costs of $110.00 and fixed manufacturing cost of $40. The company recently received an offer from another manufacturer to produce the component for $144.00. If it buys the component on the outside 40% of the fixed manufacturing cost can be avoided. Required: a. If the company buys the component from the outside supplier at $144.00, what is the impact on income?
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22. | Cost, Volume, Profit Analysis
Easy Go Company manufactures a line of electric garden tools that are sold in general hardware stores. The companys controller, Amy Tait, has just received the sales forecast for the coming year for Easy Gos three products: weeders, hedge clippers, and leaf blowers. Easy Go has experienced considerable variations in sales volumes and variable costs over the past two years, and Harlow believes the forecast should be carefully evaluated from a cost-volume-profit viewpoint. The preliminary budget information for the next year is presented below.
For the next year, Easy Gos fixed factory overhead is budgeted at $2 million, and the companys fixed selling and administrative expenses are forecast to be $600,000. Easy Go has a tax rate of 40 percent. Required: a. Determine Easy Go Co.s budgeted net income for next year.
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23. | Break-even and Cost-Volume-Profit with Taxes
DisKing Company sells used DVDs on line. The projected after-tax net income for the current year is $120,000 based on a sales volume of 200,000 DVDs. DisKing has been selling the disks at $16 each. The variable costs consist of the $10 unit purchase price of the disks and a handling cost of $2 per disk. DisKings annual fixed costs are $600,000 and DisKing is subject to a 40 percent income tax rate. Required: a. Calculate DisKing Companys break-even point for the current year in number of DVDs.
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24. | Cost-Volume-Profit of a Make/Buy Decision
Telly Industries is a multiproduct company that currently manufactures 30,000 units of Part MR24 each month. The facilities now being used to produce Part MR24 have a fixed monthly cost of $150,000 and a capacity to produce 84,000 units per month. If Telly were to buy Part MR24 from an outside supplier, the facilities would be idle, but its fixed costs would continue at 40 percent of its present amount. The variable production costs of Part MR24 are $11 per unit. Required: a. If Telly Industries continues to use 30,000 units of Part MR24 each month, it would realize a net benefit by purchasing Part MR24 from an outside supplier only if the suppliers unit price is less than how much?
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25. | Opportunity Cost of Purchase Discounts and Lost Sales
Spring Company manufactures hard drives for computer manufacturers. At the beginning of this year Spring began shipping a much-improved hard drive, Model W899. The W899 was an immediate success and accounted for $5 million in revenues for Spring this year. Required: a. Define opportunity cost and explain why opportunity costs are not usually recorded.
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26. | Make/Buy and the Opportunity Cost of Freed Capacity
Zelean Manufacturing uses 10 units of part KJ37 each month in the production of radar equipment. The cost to manufacture one unit of KJ37 is presented in the accompanying table.
Materials handling represents the direct variable costs of the receiving department and is applied to direct materials and purchased components on the basis of their cost. This is a separate charge in addition to manufacturing overhead. Zeleans annual manufacturing overhead budget is one-third variable and two-third fixed. Scott Supply, one of Zeleans reliable vendors, has offered to supply part KJ37 at a unit price of $15,000. The fixed cost of producing KJ37 is the cost of a special piece of testing equipment that ensures the quality of each part manufactured. This testing equipment is under a long-term, noncancelable lease. If Zelean were to purchase part KJ37, materials handling costs would not be incurred. Required: a. If Zelean purchases the KJ37 units from Scott, the capacity Zelean was using to manufacture these parts would be idle. Should Zelean purchase the parts from Scott? Make explicit any key assumptions.
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27. | Price gouging or increased opportunity cost?
After the Iraqi invasion of Kuwait in August 1990, the world price of crude oil doubled to more than $30 per barrel in anticipation of reduced supply. Immediately, the oil companies raised the retail price on refined oil products even though these products were produced from oil purchased at the earlier, lower prices. The media charged the oil companies with profiteering and price gouging, and politicians promised immediate investigations. Required: Critically evaluate the charge that the oil companies profited from the Iraqi invasion. What advice would you offer the oil companies?
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28. | Break-even analysis with multiple products
You are a new consultant with the Boston Group and have been sent to advise the executives of Penury Company. The company recently acquired product line L from an out-of-state concern and now plans to produce it, along with its old standby K, under one roof in a newly renovated facility. Management is quite proud of the acquisition, contending that the larger size and related cost savings will make the company far more profitable. The planned results of a months operations, based on managements best estimates of the maximum product demanded at todays selling prices are:
Required: a. Based on historical operations, K alone incurred fixed expenses of $40,000, and L alone incurred fixed expenses of $20,000. Find the break-even point in sales dollars and units for each product separately.
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29. | Average versus Variable Cost
Measer Enterprises produces energy-efficient light bulbs and operates in a highly competitive market in which the bulbs are sold for $4.50 each. Because of the nature of the production technology, the firm can produce only between 10,000 and 13,000 units per month, in fixed increments of 1,000 units. Measer has the following cost structure:
Required: At what output level should the firm operate?
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30. | Break-even Analysis
The MedView brochure said, Only 45 scans per month to cover the monthly equipment rental of $18,000. The footnote at the bottom of the brochure read: *Assumes a reimbursable fee of $475 per scan. Required: a. What variable cost per scan is MedView assuming in calculating the 45-scans-per-month amount?
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31. | Break-even Analysis
Exotic Roses, owned by Margarita Rameriz, provides a variety of rare rose bushes to local nurseries that sell Ramerizs roses to the end consumer (landscapers and retail customers). Rameriz grows the roses from cuttings that she has specifically cultivated for their unusual characteristics (color, size, heartiness, and resistance to disease). Margaritas roses are in great demand as evidenced by the wholesale price she charges nurseries, $15 per potted plant. Exotic Roses has the following cost structure (variable costs are per potted plant):
Required: a. How many potted rose plants must Exotic Roses sell each year to break even?
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32. | Break-even Analysis
You are evaluating ways to expand an optometry practice and its earnings capacity. Optometrists perform eye exams, prescribe corrective lenses (eyeglasses and contact lenses), and sell corrective lenses. One way to expand the practice is to hire an additional optometrist. The annual cost of the optometrist, including salary, benefits, and payroll taxes, is $63,000. You estimate that this individual can conduct two exams per hour at an average price to the patient of $45 per exam. The new optometrist will work 40-hour weeks for 48 weeks per year. However, because of scheduling conflicts, patient no-shows, training, and other downtime, the new optometrist will not be able to conduct, bill, and collect 100 percent of his or her available examination time.
Required: In terms of the percentage of available time, what is the minimum level of examinations the new optometrist must perform to recover all the incremental costs of being hired?
Chapter 07 Cost Allocation: Theory
Multiple Choice Questions
Essay Questions
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