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FC I ? I .4C I F I .F J4,CFC
Aariable overhead FC offices I JK.FC per office J,&F
'ncremental cost 67#5
B There are FC offices that need to be cleaned, and each office requires ? hours
to clean. 9ince ;CH of the =ob could be completed during regular business
hours, /agic /aids will only have to provide extra remuneration for 4CH of
the hours. -urther, employees are paid .FC times their hourly wage of JF for
each overtime hour worked.
8ote that fixed overhead, which is comprised of rent and administrative salaries,
is not relevant as it is very unlikely that the total amount of fixed overhead will
change if /agic /aids accepts the engagement.
/agic /aids incremental costs associated with cleaning the conglomerates FC
offices amount to 67#5.
c. /agic /aids can use the cost number for pricing the local conglomerate0s
request to clean the FC offices. JK,CFCLFC @ J4K per office likely would
represent the minimum price that /agic /aids would charge. This price is
well below /agic /aids normal price of J&C.
The actual price charged will consider other factors. -or instance, the client0s
other options become relevant. 'f this is a one$time deal with no prospect of repeat
business, then /agic /aids might well charge a premium over the normal price.
The prospect of )getting a foot in the door* to bid for future business would push
the price downward. :ong$term implications also matter. 'f the conglomerate
becomes part of /agic /aids client base, then the company likely would wish to
make sure that the price charged in the long term would cover all incremental
costs (measured over the long term!, and not only the incremental costs measured
over the short$term.
6.31
a. +hile set in a service setting, this is a classic example of an organization that
has excess capacity and is attempting to figure out how to price a special
order. 't is like having open seats at a sporting event ( it appears that the
rooms would otherwise remain idle if #rin and Myle do not accept the
customer0s offer.
b. Because the rooms would otherwise remain idle, the lost profit associated with
turning down the customer is D&CC ( (? DC! @ DKC per customer, for a total
of DKC 4 @ "78 0&+ 0&'+ 3'$-&7,+$. 8otice that the standard rate of DEC
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per day is not relevant for computing this amount.
#rin and Myle might be concerned that renting the rooms for a substantial
discount will tarnish the image of their 'nn or adversely affect weekend (or other!
rentals. 't is unlikely that this will occur because )time$based0 pricing is very
common. <otels, airlines, and utility companies all charge more when demand is
expected to be high and less when demand is expected to be low. (Think about the
cost of renting a hotel room in 8ew 6rleans during /ardi .ras versus renting the
same hotel room in mid$7ugust when the temperatures and humidity are high5! 'n
other words, customers naturally expect prices to reflect demand.
7ll things considered, #rin and Myle would be hard pressed not to accept the offer
or to at least make a reasonable counter$offer (e.g., ask for D&FC per person or
require the customers to share a room!. /oreover, #rin and Myle probably should
consider running weekday specials, perhaps reducing the rate to DCC a night
during the week to increase occupancy and maximize contribution margin.
<owever, we also note that such strategies might tarnish the )exclusive* nature of
the facility, depressing #rin0s ability to charge premium rates during the weekend.
7lso, there would be higher wear$and$tear costs in the long run if occupancy were
to increase substantially. #rin0s decision turns on whether she considers this to be
a one$time deal or if this is the start of a new business strategy.
6.32
a. Nen0s decision deals with excess supply ( due to the reduced demand for her
work, Nen finds herself with time to spare.
b. Nen0s variable cost of 0+/7*12 %,+ &51 5&+8 *$ "3 @ DC ?C. <er
payments to the 0+/7*12 $%&. would be "75 @ D&F ?C.
T%'$# 9,1 5*(( $/:, "45 *0 $%, )&,$ %,+ &51 0+/7*12. 8otice that this
estimate is over$stated because it ignores the cost of the additional time it will
take Nen to frame her prints. The additional time has value because Nen could use
it for other activities that she might en=oy more than framing.
c. Nen0s problem is now more complex. By outsourcing the framing, Nen is able
to produce and sell an additional F prints% in turn, these prints generate an
additional contribution margin of DKF ( D&F ( D E @ D4& per print or D4& F
@ D;?C in total. 2ightfully, we should add this amount to the cost of framing
of DCC per print or DCC F @ DFC for F prints, to obtain a total framing
cost of DFC O D;?C @ DKEC. 8ow, we see that Nen prefers to use the framing
shop rather than do her own framing.
+hat does our answer changeP 3ompared to part QbR, Nen does not have enough
idle time to keep up her current volume of prints and do her own framing. Thus,
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the problem switches from one of excess supply (where we assumed the
opportunity cost of Nen0s time to be DC! to one with excess demand, where we find
the opportunity cost of Nen0s time to be D;?C. The nature of the imbalance drives
Nen0s preferred solution.
N&-,B 7 superior option is to frame some but not all of the prints. 1sing the
notion of allocating time per the contribution margin per unit of the scarce
resource, we could derive this formally.
6.33
a. The following table provides the estimated profit impact at the two prices
consideredB
'tem >rice for valet
parking
DF per
month
DC per
month
2evenue from service
(4CC I DF% ?CC I DC!
D&,CCC D?,CCC
2evenue from new members
(&C I DCC% C I DCC!
&,CCC ,CCC
3ost of new members
(&C I D?F% C I D?F!
KCC ?FC
3ost of valet service
(given!
&,FCC &,FCC
8et profit "8 D,FC
Based on the above estimates alone, Tom and :ynda should offer the valet service
and price it at DC per month (not DF!.
>lease note the tradeoff between price and quantity. 7t a lower price, the feature
has more takers. This tradeoff depends on how much demand (for different
products! changes as price changes. The tradeoff from increasing price is
favorable if we consider the revenue from current members only. <owever, the
effect on new members is unfavorable and large. 7lso taking into consideration
the increases in variable costs due to additional membership, it appears that
asking for DC provides the best tradeoff.
>lease also note that we are not considering any change in the club0s fixed costs
from adding new members. 7s we know from the earlier chapters, <ercules has
been losing members to 7pex, meaning that it has excess capacity in terms of
members.
b. There are several qualitative considerations. -irst, we need to consider the
effect on other members. Aalet parking means reserving a section (usually a
desirable section! of the parking lot. This means that other members would be
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inconvenienced, leading to some lost memberships. 9econd, we have to
consider if the service sets the club on the path of tiers of members, which
feature has both costs and benefits. <owever, this is a move with long$term
consequences for the club0s clientele. Third, Tom and :ynda must consider
that demand for valet parking is not likely even through the day. #ven if they
ad=ust staffing somewhat, it is likely that some patrons will encounter delays
in getting a valet to attend to them. 9uch delays might prompt complaints,
create ill will and otherwise detract from a positive experience (and consume
managerial time!. 6verall, the ),3*$*&1 *$ 1&- 3(,/+ 3'-, particularly because
the monetary benefit is not very large.
6.34
a. Tom and :ynda0s decision turns on alternate uses for the space, or its
opportunity cost. The problem indicates the room is unused during this time.
There is minimal disruption of operations. 'ncreases to direct costs, if any, are
small. Thus, the D;CC offered by /ar=orie would flow directly to profit.
Tualitatively, the service might even attract new membersUfor example, the
expectant women might wish to use the swimming pool or the sauna to relax,
and see <ercules as a one$stop shop. 6verall, T&7 /1) L;1)/ $%&'() /33,.-
-%, &00,+.
b. The change in class timings changes the problem from one of excess supply to
one of excess demand. "uring the peak evening hours, there is considerable
demand for the room (which is why scheduling /ar=orie0s class will displace
existing classes!. Tom and :ynda therefore need to consider the best use of the
space during the evening hours. 1sing it for regular classes benefits the
membership, and prevents loss of members. 1sing it for /ar=orie0s classes
generates additional revenue. But, the opportunity cost is the loss of members,
valued at E I (DCC $ D?F! @ DF&C per month. The net gain from accepting
/ar=orie0s offer is DKCC $ DF&C @ DEC per month.
<owever, qualitative factors are salient in this case. /embers might get upset at
seeing a big part of the club reserved for use by non$members during peak times.
The perception that <ercules is not really a gym for fitness buffs might lead to
long$term erosion of reputation, and consequent loss of membership. 6verall, *-
$,,7$ '15*$, -& +*$8 $'3% +,.'-/-*&1 (&$$,$ 0&+ (,$$ -%/1 "2 .,+ 7&1-%.
c. +e haveB
'ncremental fee due to evening class DCC DKCC$D;CC
'ncremental membership fee lost (DECC! E I DCC
'ncremental variable costs saved D&EC E I D?F
'ncremental profit <"42=
Based on the above, adding the evening class is an unwise move.
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8otice that the value of the daytime only option is D;CC (as calculated in part QaR.!
The incremental value of the evening class, relative to the daytime class, is a loss
of D4&C, as calculated above. 7dding these two numbers together, leads to DEC,
the value (relative to status quo or doing nothing! for the evening option.
6.35
9imilar to the 9uperior 3ereals problem in the text, the key to this problem is to
realize that the variable costs associated with manufacturing the greeting cards are
sunk ( thus, they are not relevant to "V=W Au0s decision. 7dditionally, "V=W Au0s
fixed costs are non$controllable for the decision, as they are not expected to
change. Thus, the problem is one of revenue maximization.
7t a FCH off sale, "V=W Au0s profit increases by DC.FC I ,FCC @ DKFC.
7t an ECH off sale, "V=W Au0s profit increases by DC.&C I 4,CCC @ DECC.
Thus, "V=W Au maximizes its profit by holding the ECH off sale, even though the
resulting price is below the DC.&? (@ DC.FODC.CE! in variable costs associated
with producing and selling a card. +hat we need to remember is that this is the
variable cost of a card yet to be produced, not a card that has already been
produced.
N&-,> This problem links to a common business practice. 9pecifically, we often
observe stores employing a staggered discounting strategy ( the store starts with,
for example, a &FH discount and increases the discount rate over time (perhaps by
as much as F$&FH a week!. 'n this way, the store attempts to capture as much
consumer surplus (gross revenue! as possible by grouping customer types
according to their willingness to wait and run the risk of having the item selling
out. 9uch a strategy may work quite well for "V=W Au ( i.e., the company could
sell the first ,FCC cards at DC.FC and 4,CCC ( ,FCC @ &,FCC cards at DC.&C. By
employing such a strategy, "V=W Au could earnB
#xpected >rofit @ (DC.FC I ,FCC! O (DC.&C I &,FCC! @ D,&FC.
This amount represents a D4FC (@ D,&FC $ DECC! increase over its best option.
6.36
a. 1nder the gross approach, we include all of the costs connected with each
decision. +e do not worry too much about whether they are controllable or
not. <owever, all of the costs listed in the problem appear to be related to the
trip and are controllable ( costs such as apartment or dormitory rent and
tuition, which are not mentioned in the problem, clearly would not be related
to the decision being made. That said, we could include them under the gross
approach as they would preserve the rank ordering of options.
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1sing the gross approach, we arrive at the following per$person, round$trip cost of
drivingB
'tem "etail Total 3ost
3ost per
>erson
7utomobile$related costs DC.?C per mile I ECC miles
I & segments
D4EC DS;
3ost of refreshments D&C per person per
segment I F persons I &
segments
D&CC D4C
Total 3ost D;EC "136
The following table summarizes the per$person, round$trip cost of flyingB
'tem
"etail Total 3ost
3ost per
>erson
7irline ticket D;S I F persons DE4F D;S
3ost of refreshments DF per person per segment
I F persons I & segments
DFC DC
3ost of travel to and
from airport
D; per person per segment
I F persons I & segments
D;C D&
Total 3ost DSFF "191
't is DS ( D?; @ "55 .,+ .,+$&1 3%,/.,+ -& )+*:, -%/1 -& 0(;. -rom a cost
structure perspective, the bulk of the savings obtain because the auto$related costs
are fixed. The automobile operating costs will be DC.?C per mile, or D4EC in total
for the round$trip, regardless of the number of persons traveling. 9plitting this
cost five ways results in a relatively low cost per person. 'n contrast, the cost of
airfare is variable with respect to the number of persons traveling. There is no
)scale economy* that results.
7lternatively, with the airline trip, the cost is DS for each person traveling,
regardless of the number of people. 'n contrast, the additional cost for person X&
in the auto trip is only D&C each way ( the remainder of the cost is committed
even if only one person is traveling. The scale economy for driving results
because the cost structure contains more fixed and less variable cost (per person!
than the amounts for flying.
N&-,: This problem also highlights the subtle distinction between the timing of
cash flow and cost. The immediate cash outflow connected with flying will equal
the number computed above. <owever, the current cash outflow connected with
driving is likely lower. This is because the DC.?C cost per mile includes an
allowance for depreciation, repairs, insurance and so on. These costs eventually
will be paid out in cash (e.g., when you actually pay for repairs! but the timing
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need not coincide with the duration of the trip. 8aturally, costs related to gas
(which are included in the DC.?C per mile rate! will lead to immediate cash
outflows.
b. The key here is to realize that the per$person cost of flying will not change
even though the group0s size has changed. The entire cost of flying is variable
with respect to the number of persons traveling. Thus, the total cost will
change, but the per$person cost (DS! will be the same regardless of group
size. This can readily be seen in the following tableB
'tem "etail Total 3ost
3ost per
>erson
7irline ticket D;S I & persons D??E D;S
3ost of refreshments DF per person per segment
I & persons I & segments
D&C DC
3ost of travel to and
from airport
D; per person per segment
I & persons I & segments
D&4 D&
Total 3ost D?E& "191
The per$person cost of driving, however, will change. <ere, the fixed costs of
driving will be spread over two rather than five people. 'n essence, the per$person
cost of driving will increase substantially because the total cost of driving does
not decrease much (it only decreases by the round trip cost of refreshments for ?
people!. The following table provides the revised computationsB
'tem "etail Total 3ost
3ost per
>erson
7utomobile$related costs DC.?C per mile I ECC miles
I & segments
D4EC D&4C
3ost of refreshments D&C per person per
segment I & persons I &
segments
DEC D4C
Total 3ost DF;C "28
't is now cheaper to fly than to drive. The logic essentially is the same as in part
QaR. -rom a cost structure perspective, the cost of driving is essentially fixed ( in
other words, it will be DC.?C per mile, or D4EC in total for the round$trip,
regardless of the number of persons traveling. 9plitting this cost only two ways,
rather than five ways, results in a relatively high cost per person. 'n contrast to
part QaR, you are not taking advantage of the potential scale economies associated
with driving.
N&-,: 'nstructors also can relate the above discussion to the rationale for a
monopoly, as discussed in students0 economics courses. +hat is the scale
economy associated with a cable company or an electric utilityP
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c. There are numerous other factors that might come into play regarding this
decision, including the following threeB
-rom an en=oyment perspective, the trip is potentially a great deal more
fun, if you drive together rather than fly separately (i.e., road trip5!.
#ach method offers differing types of flexibility. "riving allows the group
to plan around the weather, while internet$only tickets come with
numerous restrictions and change penalties. "riving also provides you
with available transportation at home over winter break. <owever, unlike
flying, driving also requires that you and your friends coordinate your
schedules.
-rom a safety perspective, statistics show that flying is safer than driving.
'ndeed, many parents might worry about five college students taking a
long road$trip over the winter months.
d. +e characterize this problem as one of excess demand. /oney is the resource
in short supply. Then, because the )revenue* is the same for both options, we
wish to find the option that uses the smallest amount of the scarce resource, or
equivalently, has the lowest cost.
6.37
a. :et us begin by calculating relative sales values.
.ravelB S,CCC tons I C.E I D?C D&;,CCC
9andB S,CCC tons I C.& I D4C DK&,CCC
Total D&EE,CCC
Thus, KFH of the =oint cost (@D&;,CCCLD&EE,CCC! would be allocated to gravel
and the &FH to sand. +e have the cost allocated as C.KF I D&&F,CCC @ D;E,KFC
and C.&F I D&&F,CCC @ DF;,&FC.
7lternatively, we can calculate the rate per sales D at the split off as
D&&F,CCCLD&EE,CCC @ DC.KE&F. +e then allocate D&;,CCC I DC.KE&F @
"168#75 to gravel and DK&,CCCI C.KE&F @ "56#25 to sand.
b. +e know that only incremental revenues and costs are important for this
decision. :et us therefore calculate the net gain from processing the sand
further.
Aalue of sandbox quality SCC tons I D;C D44,CCC
:ost value at split off S,CCC tons I C.& I D4C DK&,CCC
8et gain in revenue DK&,CCC
3ost of additional processing given (DE,CCC !
8et value "54#
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Thus, M;,+$ $%&'() .+&3,$$ -%, $/1) /- $.(*- &00 *1-& $/1)?&4 @'/(*-; $/1)
?,3/'$, *- *13+,/$,$ .+&0*- ?; "126#
1
A "72# B "54#.
8oteB The important point to note is that the =oint cost, or how it is allocated, is
not relevant for the decision in QbR. That =oint cost is sunk for this decision. These
allocations are usually done only for the purpose of valuing inventory.
6.38
/ihir has two optionsB (! run the promotion or (&! do not run the promotion.
6ption (!, or not running the promotion, is the status quo. +e can then answer
the question regarding whether /ihir should run the promotion by calculating the
incremental costs and revenues associated with running the promotion. Based on
the information provided, the incremental revenues and costs areB
"ecreased ticket sales (&CC tickets Y D?.SF per ticket! (DKSC!
'ncreased profit from concession standB
8umber of customers &FC @ FCH of FCC
7verage revenue D;.CC per patron
'ncreased concessions sales (&FC patrons Y D;.CC per patron! D,FCC
7verage cost DC.SC @ C.F D;.CC
'ncreased concessions cost (&FC patrons Y DC.SC per patron (D&&F!
8et profit D,&KF
Aalue of promotion D4EF
/ihir should run the promotion as weekly profit is expected to increase by D4EF.
N&-,B This problem is one of excess supply as /ihir has available seats during the
matinee shows.
6.39
a. 6ne approach is to construct a profit model for the laser tag arena, a profit
model for the video arcade, and a profit model for :azer:ite as a whole. This
problem, though, lends itself nicely to employing an incremental approach.
Because we know the status quo, we can figure out controllable costs and
revenues.
-rom .reg0s perspective, we can delineate the following incremental benefits and
costsB
'ncrease in contribution margin from customers attracted by after$school special @
FCC I (DF.CC ( D?.CC! @ D,CCC
"ecrease in contribution margin from losing customers paying normal price @ ?CC
I (DK.FC ( D?.CC! @ D,?FC
D&;,CCC @ Aalue of sandbox quality minus further processing costs @ D44,CCC $ DE,CCC.
Balakrishnan, /anagerial 7ccounting e -62 '89T213T62 19# 68:,
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'ncremental fixed costs @ DFC
The overall effect is to ),3+,/$, -%, (/$,+ -/2 /+,1/ .+&0*-/?*(*-; ?; "5 .,+
5,,8 @ D,CCC ( D,?FC ( DFC.
Thus, from .reg0s standpoint the after$school special probably is not such a hot
idea. The annual profit of the laser tag arena will decrease by DFCC I F& weeks @
"26#.
8oteB 't is also possible to solve the problem by computing the profit under two
options. That is, we could employ the gross approach. 1nder this approach, the
profit reported decreases from D?,ECC per week to D?,?CC per week.
b. -rom :azer:ite0s perspective, we also need to consider the effect of the after$
school special on the video arcade. The effect on the video arcade can be
calculated as followsB
'ncremental profitarcade @ (net increase in laser tag customers I .KF! I Q;.CC ( (.C
I ;.CC!R
@ (&CC I .KF! I (;.CC ( .;C! @ "81 *13+,/$, .,+ 5,,8.
Thus, L/C,+L*-, /$ / 5%&(, *13+,/$,$ 5,,8(; .+&0*-$ ?; "31 .,+ 5,,8 @ DEC
( DFCC, or approximately D?C I F& weeks @ "16#12 .,+ ;,/+. 3onsequently, the
after$school special is a profitable move for :azer:ite as a whole.
The key point of this exercise is to emphasize that we cannot look at each product
in isolation (e.g., laser tag sales only! when the business model has considerable
product interdependencies. /oreover, numerous laser tag operations attempt to
lure customers in with the hopes that they will spend considerable sums of money
on video games and other ancillary activities. 6ther examples of this behavior
include software firms giving away the reader (e.g., 7dobe 7crobat! in the hope
of making money selling the writing software. This idea of a loss leader, covered
in microeconomics, often occurs in casinos (cheap food and free drinks! and
supermarkets (low milk prices! or restaurants (kids eat free!.
N&-,> .reg0s compensation arrangement appears to be misaligned with the
company0s goals. To this end, :azer:ite probably is better off if .reg0s
compensation is linked to overall company profitability. 'n this way, .reg will not
believe that he is competing for customers with the video arcade.
Balakrishnan, /anagerial 7ccounting e -62 '89T213T62 19# 68:,
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6.4
a. Based on the problem data, .erry has two optionsB (! 3ontinue with the
current arrangement of using the upstairs space for music lessons, or (&!
3onverting the upstairs space to retail space. 6ption (! is the status quo, and
evaluating option (&! relative to the status quo yieldsB
'tem "etail Total
2evenue from new space FC square feet I DF,CCC per
square foot
DKFC,CCC
Aariable costs from new space DKFC,CCC I KFH variable costs DF;&,FCC
3ontribution margin from retail
space
DKFC,CCC I &FH contribution
per D of revenue DEK,FCC
$ 2evenue from cubicle rentals ; cubicles I 4C rentals per
week I FC weeks per year I DF
per rental
;C,CCC
$ 3ost of additional sales persons & I FC,CCC CC,CCC
$ 7dditional fixed costs DC,CCC ( DK,FCC &,FCC
I13+,/$, *1 .+&0*- "25#
6ur calculations reveal that .erry0s profit will increase by D&F,CCC if he decides
to convert the upstairs to retail space. 'n arriving at this solution, notice that the
contribution margin from the existing retail space is not included because it is
assumed to be the same with and without the remodel. 7dditionally, the cost of
existing sales persons is also constant in the decision to remodel as are the
downstairs fixed costs of DS&,FCC (@ DCC,CCC ( DK,FCC!.
b. 6ftentimes, decision makers need to consider the implicit assumptions
contained in the numerical computations. The following assumptions seem
particularly importantB
The lessons must surely generate a lot of goodwill and traffic through the
store. They also help .erry keep himself in the )loop* of the music
business in the city. 3losing the cubicles likely will trigger a loss in sales.
't is unlikely that the new space will have the same sales per square foot.
'ndeed, closing the cubicles may lower the sales in the existing space as
well.
The above computations also ignore the one$time cost of the remodel.
.erry0s decision has to incorporate whether the remodel will cost DF,CCC,
DF,CCC, or DFC,CCC. The latter involves a much riskier gamble.
Balakrishnan, /anagerial 7ccounting e -62 '89T213T62 19# 68:,
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6.41
a. The key is to realize that Nustin has ,43,$$ ),7/1) as the pumps currently use
all available capacity. Thus, taking the order requires Nustin to give up some
pumps. 7t FCC valves x ? hours per valve, the valve order will consume ,FCC
hours. "ividing the total C,CCC hours available by the total production of
&,FCC pumps, Nustin calculates that it takes 4 hours to produce a pump. 7t this
rate, ,FCC hours can be used to make ?KF pumps. Nustin divides the D&F,CCC
in monthly contribution by &,FCC pumps to calculate that each pump yields
DFC in contribution margin. Thus, we haveB
3ontribution from Aalves FCC valves I D?C per valve DF,CCC
:essB :ost contribution from pumps ?KF pumps I DFC per pump E,KFC
N,- 3%/12, *1 .+&0*- <"3#75 =
Nustin will lose D?,KFC if it takes the order. The fixed costs of DKF,CCC (3/ of
D&F,CCC ( profit of DFC,CCC! are not relevant for this decision.
Alternate approach
+e could also solve the problem by examining the contribution per labor hour.
#ach pump yields a contribution of DFC L 4 hours @ D&.FC per labor hour. 'n turn,
each valve yields a contribution of only D?CL? hours @ DC per labor hour.
7ccepting the valve order diverts resources toward less profitable uses. Because
,FCC hours would be diverted, the loss is ,FCC hours I (D&.FC ( DC.CC! per
hour @ D?,KFC.
b. >rofit will be unchanged if valves also contributed DE,KFC to profit. Thus, the
price per valve should be DE,KFCLFCC valves @ "37.5 .,+ :/(:,.
7lternately, profit will be unchanged if valves also contribute D&.FC per labor
hour. 7s each valve consumes three hours, the minimum price is D&.FC x ? hours
@ D?K.FC per valve.
c. There are many potential qualitative factors. -irst, Nustin0s management has
been trying to diversify into valves. This order might give them an
opportunity to test out their production methods and establish their reputation
for quality valves. The order might also help them learn the process and reap
the cost gains from such learning. 9econd, the order might be the precursor to
a larger order at better prices. Third, this might be an order from a large
customer (for pumps!, prompting Nustin to accommodate the order even it
means losing money. 't is difficult to estimate the monetary value of these
considerations. 8evertheless, managers routinely make such tradeoffs
everyday.
Balakrishnan, /anagerial 7ccounting e -62 '89T213T62 19# 68:,
;$E
6.42
a. The )traditional* allocation of a sales person0s &F hours would lead to the
following revenue per month for a typical sales territoryB
C'$-&7,+
T;., D &0
C'$-&7,+$
T*7,
.,+ V*$*-
T&-/(
T*7,
E
T*7,
L,0-
EE
R,:,1',
.,+ V*$*-
T&-/(
R,:,1',
:arge C F hours FC hours KF hours D4F,CCC D4FC,CCC
/edium &F & hours FC hours &F hours D?C,CCC DKFC,CCC
9mall &F hour &F hours C DF,CCC D?KF,CCC
Total Revenue
"1#575#
Z @ (X of customers! (Time per visit!.
ZZ @ &F hours ( cumulative total time.
Thus, the typical sales person generates monthly revenue of "1#575#.
b. The key to Trey0s success is to realize that time is a scarce resource. 9ince
sales persons cannot visit all potential customers, the revenue$maximizing
strategy prioritizes customers by their revenue per hour of time (spent in
visits!. 7s shown below, this ranking changes the traditional ordering of
customersB
C'$-&7,+
T;.,
T*7,
.,+ V*$*-
R,:,1',
.,+ V*$*-
R,:,1', .,+
H&'+ &0 T*7,
:arge F.C hours D4F,CCC DS,CCC
/edium &.C hours D?C,CCC DF,CCC
9mall .C hours DF,CCC DF,CCC
Thus, medium and small customers should get top priority because they generate
DF,CCC in revenue per hour of time spent whereas large customers generate only
DS,CCC in revenue per hour of time spent.
9uch an allocation leads to the following revenue per monthB
C'$-&7,+
T;., D &0
C'$-&7,+$
T*7,
.,+ V*$*-
T&-/(
T*7,
E
T*7,
L,0-
EE
R,:,1',
.,+ V*$*-
T&-/(
R,:,1',
/edium &F & hours FC hours KF hours D?C,CCC DKFC,CCC
9mall FC hour FC hours &F hours DF,CCC DKFC,CCC
:arge F
Z
F hours &F hours C D4F,CCC D&&F,CCC
Total Revenue
"1#725#
Z @ (X of customers! (Time per visit!.
ZZ @ &F hours ( cumulative total time.
Balakrishnan, /anagerial 7ccounting e -62 '89T213T62 19# 68:,
;$S
Thus, we see why Trey is 9uper9ound0s top sales person ( he generates revenue
of "1#725#, or D,K&F,CCC ( D,FKF,CCC @ DFC,CCC more than other sales
persons. /oreover, Trey optimally allocates his time across 9uper9ound0s
customer base.
8oteB "oes prioritizing by sales per visit hour maximize not only revenue but also
company profitP The answer is )it depends* ( such a strategy also maximizes
profit only if the contribution margin ratio is the same for all three customer types.
'f different customer groups order a different mix of products (resulting in
different contribution margin ratios!, the firm needs to prioritize customers by
their contribution per visit hour to maximize profit.
8ote (advanced!B 'nstructors could also use this problem to underscore the agency
conflict and choice of performance measures. -or instance, the provided solution
of maximizing revenue might be optimal from the sales person0s perspective if
their incentives are based on revenue. <owever, the effort allocation might not be
optimal from the firm0s perspective. The store can manage this discrepancy by
compensating the sales person based on contribution margin. <owever, there is
more room for dispute in measuring contribution margin, which reduces its value
as a performance measure. -ormally, while contribution margin aligns incentive
more (is more congruent!, it also is harder to measure (has greater noise! than
revenue.
6.43
a. The following table summarizes the quantitative analysis, or the net monetary
benefit associated with accepting the assignment (compared to the status quo
of not accepting the assignment!B
I-,7 D,-/*( A7&'1-
-ee from new assignment .iven DFC,CCC
$ 7dditional tuition cost .iven E,CCC
$ 9alary given up due to
delayed graduation
DC,CCC per month
I 4 months
4C,CCC
8et benefit to accepting offer "2#
-rom a purely financial perspective, 3hristine should accept the assignment. 'n
this context, notice thatB
3hristine0s savings prior to entering the /B7 program and the amount of
her loan are not relevant as they do not differ between her two decisions.
The D&,CCC a month in living expenses (e.g., rent, utilities, and groceries!
is not relevant as 3hristine will incur this cost regardless of her decision.
That is, 3hristine expects to spend D&,CCC a month in living expenses
regardless of whether she is working or in college.
Balakrishnan, /anagerial 7ccounting e -62 '89T213T62 19# 68:,
;$&C
b. The net QimmediateR monetary benefit associated with accepting the assignment
is somewhat small and likely is not large enough for 3hristine to accept the
assignment. 3onsequently, 3hristine0s decision likely will hinge on qualitative
considerations. 9ome qualitative considerations includeB
"oes 3hristine desire to return to her old employer upon graduatingP 'f so,
the prospects for doing so certainly increase if she accepts the assignment.
+ill the assignment help 3hristine land a better =ob by, for example,
demonstrating how her /B7 degree has allowed her to go solo on
pro=ectsP
+ill this assignment provide a nice change of pace from the grind of
schoolworkP
+ill accepting the assignment unduly disrupt 3hristine0s /B7 studiesP
3hristine may worry about getting off track andLor being able to even take
the same classes next trimester (i.e., some classes are only offered
periodically! andLor graduating with her cohort (classmates and friends she
developed in the first & trimesters!.
7ll in all, 3hristine0s decision is not clear cut. <er presumed friendly relationship
with her ex$employer, the reputation value of being known as a team player, and
her desire to be a partner in a consulting firm might propel 3hristine toward
accepting the assignment.
6.44
a. 3harlie0s decision deals with ,43,$$ ),7/1). There are competing demands
for 3harlie0s time this evening, as he could either attend the Mnick0s game or
have dinner with the important client. 3harlie cannot perform both activities
this evening, giving rise to his dilemma.
b. The price paid for the two tickets is sunk and is not relevant to 3harlie0s
decision. The D;CC is spent regardless of whether 3harlie attends the game or
has dinner with the client. /oreover, 3harlie faces the same tradeoff if he had
found the tickets on the street or if he had paid D&,CCC for the tickets.
N&-,B 'n such decisions, many people do consider the price paid for the
tickets, in seeming contradiction to the idea that a sunk cost is not relevant.
One explanation could be that the price paid is a good measure of the
minimum opportunity cost of attending the game. (3harlie must expect to get
at least D;CC worth of =oy from the game. +hy else would he pay that much
for the ticketsP!. -rom a psychological perspective, having a readily available
estimate of the lower bound for a qualitative cost may cause people to focus
on the number as the opportunity cost.
Balakrishnan, /anagerial 7ccounting e -62 '89T213T62 19# 68:,
;$&
c. 1nless 3harlie can sell the tickets under the )dinner with the client* option,
his decision hinges on qualitative factors. 3harlie needs to weigh the lost
en=oyment from not being able to attend the Mnicks game against the cost of
upsetting the client if 3harlie chooses to go to the game (and not have dinner
with the client!. Both of these factors are qualitative ( the en=oyment from the
game is a function of 3harlie0s interest in sports, who he is going with, the
Mnicks0 chances of winning the series, and so on. 9imilarly, the cost of
upsetting the client depends on the client0s personality, the volume of
business, the client0s options, and so on. #ssentially, 3harlie has to
sub=ectively determine which option has the greater utility per hour. 3harlie
has a difficult decision to make.
PROFLEMS
6.45
a. 'n this problem, it perhaps is easiest to construct an entire income statement
for >ete0s >ets assuming he drops the birds and fish line and compare overall
profit to that reported in the problem text.
The following table computes the profit associated with the choice to discontinue
selling birds and fish, and use the space to expand dog and cat offerings.
D&2$ C/-$ T&-/(
2evenue
&EF
&
>rice per suite ( corporate D&C.CC D&C.CC
>rice per suite ( individual DFC.CC DFC.CC
2evenuesB
9uites ( corporate D&K,CCC DE,CCC
9uites ( individual F&,;FC 4&,KFC
3onvention center F,CCC F,CCC
-ood, telephone, G movies 4,4CC
?
&4,CCC
Total revenues DCS,CFC D;&,KFC
Aariable 3ostsB
-ood, laundry, supplies, etc. DK,&EC D&E,ECC
:abor (kitchen help, maids! &C,;C
4
FC,4CC
C&1-+*?'-*&1 7/+2*1 DK,;C DE?,FFC
7dditional -ixed 3ostsB
Build runway D?,CCC
QP+&0*-R "71#61 "8#55