Chapter 25: Q25-17RQ (page 1406)
Explain why a segment with an operating loss can cause the company to have a decrease in total operating income if the segment is dropped.
Answer
Dropping a segment may lead to a decrease in total operating income if such a segment has a positive contribution margin.
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Question: Explain the difference between price-takers and price-setters.
Cool Systems manufactures an optical switch that it uses in its final product. The switch has the following manufacturing costs per unit:
Direct materials \(5.00
Direct labor 3.00
Variable overhead 6.00
Fixed overhead 7.00
Manufacturing product cost \)21.00
Another company has offered to sell Cool Systems the switch for $15.00 per unit. If Cool Systems buys the switch from the outside supplier, the idle manufacturing facilities cannot be used for any other purpose, yet none of the fixed costs are avoidable.
Prepare an outsourcing analysis to determine whether Cool Systems should make or buy the switch.
Johnson Builders builds 1,500-square-foot starter tract homes in the fast-growing suburbs of Atlanta. Land and labor are cheap, and competition among developers is fierce. The homes are a standard model, with any upgrades added by the buyer after the sale. Johnson Builders’s costs per developed sublot are as follows:
Land \(50,000
Construction 123,000
Landscaping 9,000
Variable selling costs 8,000
Johnson Builders would like to earn a profit of 14% of the variable cost of each home sold. Similar homes offered by competing builders sell for \)207,000 each. Assume the company has no fixed costs.
Requirements
1. Which approach to pricing should Johnson Builders emphasize? Why?
2. Will Johnson Builders be able to achieve its target profit levels?
3. Bathrooms and kitchens are typically the most important selling features of a home. Johnson Builders could differentiate the homes by upgrading the bathrooms and kitchens. The upgrades would cost \(16,000 per home but would enable Johnson Builders to increase the sales prices by \)28,000 per home.
(Kitchen and bathroom upgrades typically add about 175% of their cost to the value of any home.) If Johnson Builders makes the upgrades, what will the new cost-plus price per home be? Should the company differentiate its product in this manner?
What makes information irrelevant to decision making?
Elm Petroleum has spent \(204,000 to refine 61,000 gallons of petroleum distillate, which can be sold for \)6.30 per gallon. Alternatively, Elm can process the distillate further and produce 58,000 gallons of cleaner fluid. The additional processing will cost \(1.80 per gallon of distillate. The cleaner fluid can be sold for \)9.10 per gallon. To sell the cleaner fluid, Elm must pay a sales commission of \(0.10 per gallon and a transportation charge of \)0.16 per gallon.
Requirements
1. Diagram Elm’s decision alternatives, using Exhibit 25-18 as a guide.
2. Identify the sunk cost. Is the sunk cost relevant to Elm’s decision?
3. Should Elm sell the petroleum distillate or process it into cleaner fluid? Show the expected net revenue difference between the two alternatives.
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