Decision Making, Incremental Analysis

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Chapter 7

PROBLEM 7-1 Decision Making and Ethics (LO 1, Ethics)

Joan Paxton, VP of marketing for Supertone Recording Equipment, has developed a marketing plan for presentation to the company’s president. The plan calls for television ads, something the company has never used. As part of her presentation, she will indicate the impact of the TV ads on company profit as follows:

Incremental sales from increased exposure		$9,000,000
Less:
Incremental cost of goods sold	$3,900,000
Cost of TV ads	2,500,000	6,400,000
Incremental profit		$2,600,000

While Joan is quite confident in the cost of the ads and the incremental cost of goods sold if sales are $9,000,000, she is quite uncertain about the sales increase. In fact, she believes that her estimate is on the high side. However, she also believes that if she puts in a more conservative estimate, such as $7,000,000, the president will not go along with the TV ads even though they still generate substantial profits at $7,000,000 of incremental sales.

Required

Is it unethical of Joan to bias her estimate of incremental sales on the high side, given that she believes the ultimate outcome is in the best interest of the company?

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PROBLEM 7-2 Incremental Analysis of Outsourcing Decision (LO 1, 2, 4)

Oakland College is considering outsourcing grounds maintenance. In this regard, Oakland has received a bid from Highline Grounds Maintenance for $295,000 per year. Highline states that its bid will cover all services and planting materials required to “keep Oakland’s grounds in a condition comparable to prior years.” Oakland’s cost for grounds maintenance in the preceding year were $302,000 as follows:

Salary of three full-time gardeners	$195,000
Plant materials	80,000
Fertilizer	7,000
Fuel	8,000
Depreciation of tractor, mowers, and other miscellaneous equipment	12,000
Total	$302,000

If Oakland College outsources maintenance, it will be able to sell equipment for $30,000, and the three gardeners will be laid off.

Required

a.    Analyze the one-year financial impact of outsourcing grounds maintenance.

b.    How will savings in the second year differ from those in year 1?

c.    Discuss qualitative factors that should be considered in the decision.

PROBLEM 7-5 Keep-or-Buy Decision, Sunk Costs (LO 1, 2, 4)

Susan Crossing purchased a used Ford Focus for $8,000. Since purchasing the car, she has spent the following amounts on parts and labor:

New stereo system	$1,500
New paint job	2,500
New tires	900
New muffler	250
Total	$5,150

Unfortunately, the car needs a few major repairs now; among other things, the brake rotors and pads must be replaced, and the radiator has sprung a leak. (A new radiator is needed.) The repairs are estimated to cost $2,500.

Susan has looked around at other used cars and has found a used Honda Civic for $8,500 that is in very good condition and is approximately the same age as the Ford Focus. Susan can sell the Ford Focus “as is: for $6,500.

Required

a.    In trying to dcide whether to repair the Ford Focus or buy the Honda Civic, Susan is upset because she has already spent $13,150 on the Focus. The car seems like it costs too much to sell at such a large loss. How would you react to her dilemma?

b.    Assuming that Susan would be equally happy with either the Ford Focus or the Honda Civic, should she buy the Civic or repair the Focus? Explain your answer.

c.    Are there any qualitative factors that might enter into this decision? Explain.

PROBLEM 7-9 Dropping a Product Line (LO 1, 2, 4)

Pantheon Gaming, a computer enhancement company, has three product lines: audio enhancers, video enhancers, and connection-speed accelerators. Common costs are allocated based on relative sales. A product line income statement follows:

Pantheon Gaming
Income Statement
For the year ended December 31, 2011
	Audio	Video	Accelerators	Total
Sales	1,045,000	2,255,000	2,200,000	5,500,000
Less cost of goods sold	575,000	1,240,000	1,870,000	3,685,000
Gross margin	470,000	1,015,000	330,000	1,815,000
Less other variable costs	53,000	69,000	20,000	142,000
Contribution margin	417,000	946,000	310,000	1,673,000
Less direct salaries	155,000	175,000	65,000	395,000
Less common fixed costs:
Rent	11,970	25,830	25,200	63,000
Utilities	4,370	9,430	9,200	23,000
Depreciation	5,890	12,710	12,400	31,000
Other administrative costs	79,230	170,970	166,800	417,000
Net income	160,540	552,060	31,400	744,000

Since the profit for accelerator devices is relatively low, the company is considering dropping this product line.

Required

a. Determine the impact on profit of dropping accelerator products.

b. Discuss the potential qualitative effects of discontinuing the sale of accelerator products.

PROBLEM 7-17 Appendix. Batch Size Decision and Constraints (LO A1)

At Dalton Playground Equipment, the powder-coating process is a bottleneck. Typically, it takes approximately two hours to switch between jobs. The time spent cleaning nozzles and paint tasks and recalibrating equipment. Currently the company runs relatively small batch sizes through the process but is considering increasing them to reduce setup time.

With small batch sizes, powder coating can process approximately 2,000 nits per 8-hour shift, and products have an average contribution margin of $50. With large batch sizes, powder coating can process approximately 2,300 units per 8-hour shift.

Required

1. Calculate the additional profit associated with running larger batch sizes through powder-coating process.
2. What potential problems are created by larger batch sizes?