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Cost Analysis for MBA Decision-Making

The document discusses various financial decision-making scenarios faced by companies, including make or buy decisions, dropping or retaining segments, special orders, and sell or further process decisions. It provides specific case studies for Deco Engines, Bed & Bath, Imperial Jewelers, Dorsey Company, and Handy Leather Inc., detailing costs, revenues, and the implications of different choices on profitability. Each section includes required computations and analyses to guide decision-making.

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shayanbarua35
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10 views3 pages

Cost Analysis for MBA Decision-Making

The document discusses various financial decision-making scenarios faced by companies, including make or buy decisions, dropping or retaining segments, special orders, and sell or further process decisions. It provides specific case studies for Deco Engines, Bed & Bath, Imperial Jewelers, Dorsey Company, and Handy Leather Inc., detailing costs, revenues, and the implications of different choices on profitability. Each section includes required computations and analyses to guide decision-making.

Uploaded by

shayanbarua35
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

A) Make or Buy Decision

Deco Engines, Ltd., manufactures a variety of engines for use in heavy equipment. The company has always produced
all of the necessary parts for its engines, including all of the carburetors. An outside supplier has offered to produce
and sell one type of carburetor to Deco Engines, Ltd., for a cost of $35 per unit. To evaluate this offer, Deco Engines,
Ltd., has gathered the following information relating to its own cost of producing the carburetor internally:

Items/Costs Per Unit $ 15,000 Units per Year $


Direct materials 14 210,000
Direct labor 10 150,000
Variable manufacturing overhead 3 45,000
Fixed manufacturing overhead, traceable 6* 90,000
Fixed manufacturing overhead, common 9 135,000
Total cost 42 630,000

* One-third supervisory salary; two-third depreciation of special equipment (no resale value).
Required:
a) Assume that the company has no alternative use for the facilities that are now being used to produce the
carburetors, should the outside supplier’s offer be accepted? Show all computations.
b) Suppose that if the carburetors are purchased, Deco Engines, Ltd., could use the capacity to launch a new product.
The segment margin of the new product would be $150,000 per year. Should Deco Engines, Ltd., accept the offer
to buy the carburetors for $35 per unit? Show all computations.

B) Drop or Retain a Segment


Bed & Bath, a retailing company, has two departments, Hardware and Linens. The company's most recent monthly
contribution format statement follows:

Total Department
Hardware Linens
Sales $4,000,000 $3,000,000 $1,000,000
Variable expenses 1,300,000 900,000 400,000
Contribution Margin 2,700,000 2,100,000 600,000
Fixed expenses 2,200,000 1,400,000 800,000
Net operating income (loss) $500,000 $700,000 $(200,000)

A study indicates that $340,000 of the fixed expenses being charged to Linens are sunk costs that will continue even
if the Linens Department is dropped.
Required:
i) Should Linens be dropped to enhance overall profit of the company? Explain.
ii) In addition, the elimination of the Linens Department will result in a 10% decrease in the sales of the Hardware
Department. If the Linens Department is dropped, what will be the total effect on the net operating income of the
company as a whole?

For the MBA 2nd Semester Tuition Batch


C) Special Order
Imperial Jewelers is considering a special order for 20 handcrafted gold bracelets to be given as gifts to members of
a wedding party. The normal selling price of a gold bracelet is $189.95 and its unit product cost is $149.00 as shown
below:

Direct materials $ 84.00


Direct labor 45.00
Manufacturing overhead 20.00
Unit product cost $149.00

Most of the manufacturing overhead is fixed in nature however; $4.00 of the overhead is variable with respect to the
number of bracelets produced. The customer who is interested in the special bracelet order would like special filigree
applied to the bracelets. This filigree would require additional materials costing $2.00 per bracelet and would also
require acquisition of a special tool costing $250 that would have no other use once the special order is completed.
This order would not affect the company’s regular sales and the order could be fulfilled using the company’s existing
capacity without affecting any other order.
Required:
What effect would accepting this order have on the company’s net operating income if a special price of $154.95 per
bracelet is offered for this order? Should the special order be accepted at this price?

D) Sell or Further Process


Dorsey Company manufactures three products from a common input in a joint processing operation. Joint processing
costs up to the split-off point total $350,000 per quarter. The company allocates these costs to the joint products on
the basis of their relative split-off point.
Unit selling prices and total output at the split-off point are as follows:

Product Selling Price Quarterly Output


A $16 per pound 15,000 pounds
B $ 8 per pound 20,000 pounds
C $25 per gallon 4,000 gallons

Each product can be processed further after the split-off point. Additional processing requires no special facilities.
The additional processing costs (per quarter) and unit selling prices after further processing are given below:

Product Additional Processing Costs Selling Price


A $63,000 $20 per pound
B $80,000 $ 9 per pound
C $36,000 $32 per gallon

Required:
Which product or products should be sold at the split-off point and which product or products should be processed
further? Show computations.

For the MBA 2nd Semester Tuition Batch


Practice: Further Processing Decision
Handy Leather Inc. processes several products from processing 1 ton of raw leather. Material and processing cost
total is Taka 90,000 per ton, and one third of which is allocated to product ‘A.’ 20% parts of product ‘A’ are produced
from each ton of leather. The units can be sold at the split off point for 250 each, or processed further at an additional
variable cost of 50 per unit. The further processing also requires additional fixed cost of Taka 7,500. The final product
can be sold at Taka 350 per unit.
Required: Should product ‘A’ be processed further or sold at split off point? Show all calculations.

For the MBA 2nd Semester Tuition Batch

Common questions

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Unit cost at split-off point is Taka 30,000 ($90,000/3). Selling at split-off nets Taka 50,000. Further processing costs Taka 60 and requires Taka 7,500 fixed, giving Taka 67,500 total with additional revenue of Taka 70,000. The gain is Taka 2,500. Process further only if capacity exists .

Dropping Linens causes the loss of its contribution margin ($600,000) and fixed costs still incur $340,000. Plus, a 10% reduction in Hardware sales ($3,000,000) means a $300,000 revenue loss, reducing its contribution by $210,000 (70% margin). Net Operating Income drops by $540,000 total, decreasing profitability and suggesting retaining Linens .

Conduct a Comprehensive Cost-Volume-Profit (CVP) Analysis combined with Constraint Analysis to determine contribution margin impacts, understand fixed cost behavior via step-fixed and allocated costs, and measure opportunity cost. This ensures accurate profitability estimation and resource utilization .

The cost without special tooling and filigree per bracelet is $149. With added costs, it becomes $155 ($149 + $2 filigree cost + $250/20 unit tool cost). Selling at $154.95 results in a net loss of $0.05 per bracelet. Total loss is $1 (20 * $0.05 loss). Therefore, the order should not be accepted at this price unless strategic gains warrant .

Consider the $150,000 segment margin gain from the new product versus the $30,000 incremental cost saving from buying carburetors. Include capacity constraints, strategic fit of the new product, market conditions, fixed cost absorption, and indirect effects on brand reputation. Revenue from the new line must exceed marginal and indirect costs to justify .

Deco Engines, Ltd., should calculate the relevant costs of producing the carburetors internally versus purchasing them. The internal production cost per unit includes: Direct materials ($14), Direct labor ($10), and Variable manufacturing overhead ($3), totaling $27 per unit. Fixed manufacturing overhead ($6) is not avoidable unless there's value in alternative use. There's a $3 per unit savings if bought externally without alternative use. Therefore, purchasing from the supplier would save $3 per unit ($30,000 total). Without an alternative, they should accept the offer .

Dropping the Linens Department eliminates its $1,000,000 sales and $600,000 contribution margin, but $340,000 of its fixed expenses remain. Removing it means $200,000 loss reduces to a $540,000 net loss impact due to remaining fixed costs. Dropping the Linens Department is not recommended as it worsens Net Operating Income by $340,000 .

Product A yields $240,000 increase after processing ($60,000 net gain); Product B shows a $20,000 net loss if processed; Product C gains $52,000 from further processing. A and C should process further for a gain, while B should sell at split-off due to loss .

The basic unit cost is $149; with $6 extra, it's $155.95. Selling at $154.95 causes a $1 loss per bracelet. To breakeven, raise the price to at least $155.95 or reduce costs, without affecting capacity. Any initial investment is covered at this pricing .

By purchasing the carburetors, Deco Engines can produce a new product that yields a segment margin of $150,000. Internally, the avoided costs are the variable expenses plus the fixed supervisor's salary. The cost of buying externally is $35 per unit. The difference between making or buying ($35 - $27 = $8 saved per unit) multiplies to a $120,000/year advantage. Combined with the new product’s segment margin, accepting the offer would lead to a $150,000 increase in annual income, assuming no alternative use of the fixed overhead .

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