Question 1. Anticipating unusually high sales for July, Radios, Inc. a producer of small two-way radios, plans to produce 20,000 radios, using all available capacity. Radios anticipating costs for the radios for July as follows:
Unit Manufacturing Costs
Variable Direct labor Materials Cost $1.20
Variable Labor $2.50
Variable Overhead $0.10
Fixed Overhead $0.85
Total Manufacturing Costs per unit $4.65
Unit Marketing Costs
Variable $0.90
Fixed $2.20
Total marketing Costs per unit $3.10
$7.75
Selling price per unit $15.00
On June 30, Radios received a contract offer from Communication Devices (a radio manufacturer) to supply 10,000 radios for delivery by July 31. In place of the standard sales price of $15.00 per radio, the Communication Devices offer would reimburse Radios’ share of both variable and fixed manufacturing costs (that is, $4.65 per product) plus a fixed fee of $5,000. Variable marketing costs would be zero for this order. None of the fixed costs would be affected by this order. Radios would lose 10,000 units of sales to regular customers in July, but this order would not affect sales in any subsequent months. Prepare a differential analysis comparing the status quo for July with the alternative case in which Radios accepts the special order. Write a brief report to Radios’ management explaining why the company should or should not accept the special order.
Question 2. Cisco’s Sportswear makes jerseys for athletic teams. The junior league group has offered to buy 80 jerseys for the teams in its league for $14 per jersey. The normal team price for such jerseys is $20. Cisco’s purchases the plain jerseys for $12 per jersey and then sews a name and number to each jersey at a variable cost of $3 per jersey. Cisco’s makes about 2,000 jersey’s per year and has a capacity limit of 4,000 jerseys. The annual fixed cost of equipment used in the sewing process is $5,000, and other fixed costs allocated to jerseys are $2,000, bringing the total costs allocated to each jersey to $3.50. Compute the amount by which the operating profit of Cisco’s would change if the special order were accepted. Should Cisco’s accept the special order?
Question 3. Victoria Hair Salon styles hair in three operation-washing, cutting/setting, and drying-and charges $15 per styling. (Each styling is one “unit”.) Victoria styles hair on a walk-in basis and does not take appointments; customers who face a wait walk across the street to another salon. Victoria’s owners find it has a cutting/setting bottleneck on Saturdays due to a limited number of stylists. The bottleneck exists for a total eight hours each Saturday. Pertinent information as follows:
Washing Cutting/Setting Drying
Hourly capacity 30 units 12 units 15 units
Saturday capacity 240 units 96 units 120 units
Actual Saturday production 96 units 96 units 96 units
Fixed operating costs per Sat. $10 $75 $100
Each hair styling has variable costs of $5. Victoria’s output is constrained by the 96 units of cutting/setting capacity. Two options exist hat can relieve the bottleneck at the cutting/setting operation. Consider the differential costs associated with each of the following options to determine the impact on throughout.
Option A. Victoria can increase bottleneck output by hiring one nonstylist employee to prepare customers for the cutting/setting by washing and combing their hair. This would increase the cutting/setting capacity to 110 each Saturday. The cost for this additional employee is $64 per Saturday.
Option B. Victoria could hire another stylist for each Saturday, increasing the cutting/setting capacity to 108 each Saturday and costing an additional $120 per Saturday. (Note that the drying operation has a capacity of 120). Should Victoria’s owner go ahead with either of the two options? Why or why not?
Question 4. Ralston Products is considering a project that requires an initial investment of 2,200,000, and that will generate the following cash inflows for the next five years:
Year Cash inflow at end of year
1 $300,000
2 400,000
3 800,000
4 800,000
5 600,000
Calculate the net present value of this project if Ralston’s cost of capital is
a. 12 percent
b. 20 percent
Question 5. The Southern Rail Lines (SRL) is considering replacing its power jack tamper, used to maintain track and roadbed, with a new automatic-raising power tamper. SRL spent $18,000 five years ago for the present power jack tamper and estimated it to havea total life of 12 years. If SRL keeps the old tamper, it must overhaul the tamper two years from now at a cost of $5,000. SRL can sell the old tamper for $2,500 now; the tamper will be worthless seven year from now.
A new automatic-rasing tamper costs $23,000 delivered and has an estimated physical life of 12 years. SRL anticipates, however, that because of developments in maintenance machines, it should retire the new machine at the end of the 7th year for $5,000. Furthermore, the new machine will require an overhaul costing $10,000 at the end of the fourth year. The new equipment will reduce wages and fringe benefits by $4,000 per year.
Track maintenance work is seasonal, so SRL normally uses the equipment only from May 1 through October 31 of each year. SRL transfers track maintenance employees to other work but pays them at the same rate for the rest of the year. The new machine will require $1,000 per year of maintenance, whereas the old machine requires $1,200 per year. Fuel consumption for the two machines is identical. SRL’s cost of capital is 12 percent per year, and because of operating losses, SRL pays no income tax. Should SRL purchase the new machine?
Question 6. What is the internal rate of return on the following projects, each of which requires a $20,000 cash outlay now and returns the cash flow indicated?
a. $10,426.72 at the end of Years 1 and 2.
b. $3,196.40 at the end of Years 1 through 10.
c. $3,429.28 at the end of Years 1 through 13.
d. $3,939.00 at the end of Years 1 through 15.
e. $8,397.84 at the end of Years 3 through 7.
f. $3,618.80 at the end of Years 2 through 10.
g. $37,508.98 at the end of year 5 only.
Question 7. A manager’s favorite project requires an after-tax cash outflow on January 1 of $10,000 and promises to return $2,500 of after-tax cash inflows at the end of each of the next five years. The after-tax cost of capital is 10 percent per year.
a. Use the net present value method to decide whether this favorite project is a good investment.
b. How much would the projected cash inflow for the end of Year 5 have to increase for the project to be acceptable?
c. How much would the projected cash inflow for the end of Year 5 have to increase for the project to have a net present value of $200?