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Relevant Costs and Benefits

1. Vernazza Pizza's owner bought his current pizza oven four years ago for $10,000 and it has one more year of life remaining. He is using straight-line depreciation for the oven. He could purchase a new oven for $1,400 but it would last only one year. The owner figures the new oven would save him $1,500 in annual operating expenses compared to operating the old one. Consequently, he has decided against buying the new oven, since doing so would results in a "loss of $500 over the next year.
a. How do you suppose the owner came up with $500 as the loss for the next year if the new pizza oven were purchased? Explain.
b. Criticize the owner's analysis and decision.
c. Prepare a correct analysis of the owner's decision.

2. lamont industries produces chemicals for the swimming pool industry. In one joint process, 10,000 liters of GSX are processed into 7,000 liters of xenolite and 3,000 liters of banolide. The cost of the joint process, including the GSX is $19,000. The firm allocates $13,300 of the joint cost to the xenolite and $5,700 of the cost to the banolide. The 3,000 liters of banolide can be sold at the split-off point for $2,500 or be processed further into a product called kitrocide. The sales value of 3,000 liters of kitrocide is $10,000 and the additional processing cost is $8,100.

Lamont's president has asked your consulting firm to make a recommendation as to whether the banolide should be sold at the split-off point or processed further. Write a letter providing an analysis and a recommendation.

Solution Summary

This solution discusses and illustrates how to compute relevant costs and benefits.