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# Relevant Cost

You just started a summer internship with the successful management consulting firm of Kirk, Spock, and McCoy. Your first day on the job was a busy one, as the following problems were presented to you.

Required: Supply the requested comments in each of the following independent situations.

1. FastQ Company, a specialist in printing, has established 500 convenience copying centers throughout the country. In order to upgrade its services, the company is considering three new models of laser copying machines for use I producing high-quality copies. These high quality copies would be added to the growing list of products offered in the FastQ shops. The selling price to the customer for each laser copy would be the same, no matter which machine is installed in the shop. The three models of laser copying machines under consideration are 1024s, a small-volume model; 1024m, a medium-volume model; and 1024G, a large-volume model. The annual rental costs and the operating costs vary with the size of each machine. The machine capacities and costs are as follows:

Copier Model 1024S 1024M 1024G
Annual capacity (copies) 100,000 350,000 800,000
Costs:
Annual machine rental 8,000 11,000 20,000
Direct Material and direct labor .02 .02 .02
Variable overhead costs .12 .07 .03

a. Calculate the volume level in copies where FastQ Company would be indifferent to acquiring either the small-volume model laser copier, 1024, or the medium-volume model laser copier, 1024M.

b. The management of FastQ Company is able to estimate the number of copies to be sold at each establishment. Present a decision rule that would enable FastQ Company to select the most profitable machine without having to make a separate cost calculation for each establishment. (Hint: To specify a decision rule, determine the volume at which FastQ would be indifferent between the medium and large copiers.)

2. Alderon Enterprises is evaluating a special order it has received for a ceramic fixture to be used in aircraft engines. Aeron has recently been operating at less than full capacity, so the firm's management will accept the order if the price offered exceeds the costs that will be incurred in producing it. You have been asked for advice on how to determine the cost of two raw materials that would be required to produce the order.

a. The special order will require 800 gallons of endor, a highly perishable material that is purchased as needed. Alderon currently has 1,200 gallons of endor on hand, since the material is used in virtually all of the company's products. The last time endor was purchased, Alderon paid \$5.00 per gallon. However, the average price paid for the endor in stock was only \$4.75. The market price for endor is quite volatile, with the current price at \$5.50. If the special order is accepted, Alderon will have to place a new order next week to replace the 800 gallons of endor used. By then the price is expected to reach \$5.75 per gallon.

Using the cost terminology, comment on each of the cost figures mentioned in preceding discussion. What is the real cost of endor if the special order is produced?

b. The special order also would require 1,500 kilograms of tatooine, a material not normally required in any of Alderon's regular products. The company does happen to have 2,000 kilograms of tatooine on hand, since it formerly manufactured a ceramic product that used the material. Alderon recently received an offer of \$14,000 from solo Industries for its entire supply of tatooine. However, Solo Industries is not interested in buying any quantity less than Alderon's entire 2,000-kilogram stock. Alderon's management is unenthusiastic about Solo's offer, since Alderon paid \$20,000 for the tatooine. Moreover, if the tatooine were purchased at today's market price, it would cost \$11.00 per kilogram. Due to the volatility of the tatooine, Alderon will need to get rid of its entire supply one way of another. If the material is not used in production or sold, Alderon will have to pay \$1,000 for each 500 kilograms that is transported away and disposed of in a hazardous waste disposal site.

Using the cost terminology, comment on each of the cost figures mentioned in the
Preceding discussion. What is the real cost of tatooine to be used in the special order?

3. A local PBS station has decided to produce a TV series on state-of-the art manufacturing. The director of the TV series, Justin Tyme, is currently attempting to analyze some of the projected costs for the series. Tyme intends to take a TV production crew on location to shoot various manufacturing scenes as they occur. If the four-week series is shown in the 8:00-9:00 PM prime-time slot, the station will have to cancel a wildlife show that is currently scheduled. Management projects a 10 percent viewing audience for the wildlife how, and each 1 percent is expected to bring in donations of \$10,000. In contrast, the manufacturing show is expected to be watched by 15 percent of the viewing audience. However, each 1 percent of the viewership will likely generate only \$5,000 in donations. If the wildlife show is canceled, it can be sold to network television for \$25,000.

Using the cost terminology, comment on each of the financial amounts mentioned in the preceding discussion. What are the relative merits of the two shows regarding the projected revenue to the station?

#### Solution Preview

You just started a summer internship with the successful management consulting firm of Kirk, Spock, and McCoy. Your first day on the job was a busy one, as the following problems were presented to you.

Required: Supply the requested comments in each of the following independent situations.

1. FastQ Company, a specialist in printing, has established 500 convenience copying centers throughout the country. In order to upgrade its services, the company is considering three new models of laser copying machines for use I producing high-quality copies. These high quality copies would be added to the growing list of products offered in the FastQ shops. The selling price to the customer for each laser copy would be the same, no matter which machine is installed in the shop. The three models of laser copying machines under consideration are 1024s, a small-volume model; 1024m, a medium-volume model; and 1024G, a large-volume model. The annual rental costs and the operating costs vary with the size of each machine. The machine capacities and costs are as follows:

Copier Model 1024S 1024M 1024G
Annual capacity (copies) 100,000 350,000 800,000
Costs:
Annual machine rental 8,000 11,000 20,000
Direct Material and direct labor .02 .02 .02
Variable overhead costs .12 .07 .03

a. Calculate the volume level in copies where FastQ Company would be indifferent to acquiring either the small-volume model laser copier, 1024, or the medium-volume model laser copier, 1024M.

At the point of indifference the costs would be equal. The total cost would be the fixed cost + (direct material and labor) X volume.
For 1024 S the total cost would be 8,000 + (.02+.12) X volume
For 1024M the total cost would be 11,000 + (.02+.07) X volume
We can write
8,000+0.14 X volume = 11,000 + 0.09 X volume
Volume = ...

#### Solution Summary

The solution has various problems relating to relevant costs.

\$2.19