Relevant Costing Problems
Air Frisco owns a single jet aircraft and operates between San Francisco and the Fiji Islands. Flights leave San Francisco on Mondays and Thursdays and depart from Fiji on Wednesdays and Saturdays. Air Frisco cannot offer any more flights between San Francisco and Fiji. Only tourist-class seats are available on its planes. An analyst has collected the following information:
Seating capacity per plane 360 passengers
Average number of passengers per flight 200 passengers
Flights per week 4 flights
Flights per year 208 flights
Average one-way fare $500
Variable fuel costs $14,000 per flight
Food and beverage service costs $20 per passenger
(no charge to passenger)
Commission to travel agents paid by Air Frisco 8% of fare
(all tickets are booked by travel agents)
Fixed annual lease costs allocated to each flight $53,000 per flight
Fixed ground services (maintenance, check in,
baggage handling) costs allocated to each flight $7,000 per flight
Fixed flight crew salaries allocated to each flight $4,000 per flight
For simplicity, assume that fuel costs are unaffected by the actual number of passengers on a flight.
1. Calculate the operating income that Air Frisco earns on each one-way flight between San Francisco and Fiji.
2. The Market Research Department of Air Frisco indicates that lowering the average one-way fare to $480 will increase the average number of passengers per flight to 212. Should Air Frisco lower its fare? Show your calculations.
3. Travel International, a tour operator, approaches Air Frisco on the possibility of chartering (renting out) its jet aircraft twice each month, first to take Travel International's tourists from San Francisco to Fiji and then to bring the tourists back from Fiji to San Francisco. If Air Frisco accepts Travel International's offer, Air Frisco will be able to offer only 184 (208 - 24) of its own flights each year. The terms of the charter are as follows: (a) For each one-way flight, Travel International will pay Air Frisco $75,000 to charter the plane and to use its flight crew and ground service staff; (b) Travel International will pay for fuel costs; and (c) Travel International will pay for all food costs. On purely financial considerations, should Air Frisco accept Travel International's offer? Show your calculations. What other factors should Air Frisco consider in deciding whether or not to charter its plane to Travel International?
Summarize your findings in a report which answers the above questions.
Pecos Printers, Inc.
Pecos Printers, Inc. is a small manufacturing firm in Houston, Texas that manufactures color ink jet printers for the small business market. It has just launched the PP 7500. Read the following article from the Los Angeles Times for background on printers in this market. click here
A 50% markup is standard in this industry so that Pecos must sell to distributors below $400 per printer to keep the retail price below the industry top of $600 ($400 * 150% = $600). Paul Pecos, the founder and CEO of Pecos Printers, wants to keep the price to distributors as low as possible so he has carefully engineered his manufacturing process to be as efficient as possible.
The model PP 7500 is an exceptionally desirable model with the following features:
? A monthly capacity of 10,000 copies
? A print speed of 10 copies per minute for black and white and 5 copies per minute for color.
? A lifetime capacity of 120,000 copies.
? The ability to accept readily available HP ink cartridges.
Lester Ledger, the Pecos Controller has developed the following cost sheet for the model 7500:
Cost Category Cost per Unit
Direct Materials (variable) $125
Direct Labor (variable) 50
Overhead (Variable) 30
Overhead (Fixed)* 45
Total Unit Costs $250
*This is determined on a per unit basis as followed. Lester assumes that the annual fixed overhead costs for this product will be $450,000 and that approximately 10,000 Model 7500's will be produced during the current year. Pecos has the capacity to produce 20,000 units per year without increasing fixed costs.
Paul has determined that approximately 20% of the total manufacturing costs are necessary for a decent profit. Therefore, the minimum wholesale cost for this model is $300 ($250 * 120%) and the resulting minimum retail price is $450 ($300 * 150%).
Based on these data, Paul has developed the following pricing rule for his sales staff: Accept any offer from distributors of $300 or more and reject any offer below $300.
The sales staff is on salary with no commission paid for any sale. The salesmen negotiate with distributors who make firm offers which the Pecos salesmen then either accept or reject. Last month the three salesmen reported the following offers and results:
Offer (per unit) Number of Units Accepted?
Offer No. 1 $310 200 Yes
Offer No. 2 $305 150 Yes
Offer No. 3 $295 300 No
Offer No. 1 $305 50 Yes
Offer No. 2 $200 250 No
Offer No. 3 $300 100 Yes
Offer No. 4 $330 75 Yes
Offer No. 1 $305 250 Yes
Offer No. 2 $245 400 No
Offer No. 3 $325 100 Yes
In addition, Ms. Glenda Goodperson, the office assistant manager received an offer from a new distributor for 700 units at $290. She felt this would be advantageous for Pecos and accepted the offer. When Paul Pecos found out about this transaction, he was furious that Ms. Goodperson had violated his decision rule and fired her on the spot. He then cancelled the order with the new distributor.
Overall, Paul was satisfied with the month's sales results. His sales staff had sold 925 units which translated to an annual rate of over 11,000 units. This was 10% above his estimate of 10,000 annual sales.
1. Evaluate Paul Pecos' decision rule.
2. Evaluate Paul Pecos' reaction to Ms. Goodperson's sale.
3. Prepare a contribution margin income statement for the month with two columns: in the first column, show the results following Paul's decision rule. In the second column, show what the results would have been if you chose to revise the decision rule and your revised decision rule had been followed. For simplicity sake, ignore non-manufacturing costs and taxes.
4. Do you have any other recommendations for Paul to improve his operations?
The solution has two relevant cost problems - Air Frisco and Pecos Printers