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Study Guides For 3 Exams ACG 201
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Megan Hannah Barr
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This 9 page Study Guide was uploaded by Megan Hannah Barr on Wednesday September 7, 2016. The Study Guide belongs to ACG 201 at University of North Carolina - Wilmington taught by John J Bean in Spring 2016. Since its upload, it has received 7 views. For similar materials see Managerial Accounting in Accounting at University of North Carolina - Wilmington.
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Chapter 5 Cost Volume Profit Relationships Cost Volume Profit Analysis- help managers understand the interrelation among cost, volume, and profit by focusing their attention on the interactions among the prices of products, volume of activity. Per unit total variable costs, total fixed costs, and mix of products sold. It is a vital tool used in many business decisions such as deciding what products to manufacture or sell, what pricing policy to follow, what marketing strategy to employ, and what type of productive facilities to acquire. Contribution Margin- the amount remaining from sales revenue after variable expenses have been deducted CM is used first to cover fixed expenses; any remaining CM contributes to net operating. Total Per Unit CM Ratio If 400 units are sold a month, the company will be operating at break-even Sales (500 bikes) $250,000 $500 100% When CM equals fixed expenses, we are at break even Less: Variable Expenses 150,000 300 60% Contribution Margin 100,000 200 40% The CM Ratio of 40% means that for each dollar increase in sales the company will Less: Fixed Expenses 80,000 provide 40cents in CM Net Operating Income $20,000 CM Ratio = CM per unit OR Total CM CVP Equation: Profit = (Sales – Variable Expenses) – Fixed Expenses P per unit Total Sales Profit = (P x Q – V x Q) – Fixed Expenses OR Profit = Unit CM x Q – Fixed Expenses ***To determine break-even set profits equal to $0/solve for Q V= Variable expense per unit P- Price per unit Q- Quantity Sold Unit CM = P – V Contribution Margin Ratio- Use this ratio to compute changes in CM and net operating income resulting from changes in sales volume **EX. If Racing increased its sales volume to 500 bikes, what would management expect profit or net operating income to be? Profit = (CM Ratio x Sales) – Fixed Expenses Profit = (40% x $250,000) - $80,000 = 100,000-80,000 = $20,000 Variable Expense Ratio Change in Regular Sale Price (wholesaler example) Increase in CM (units x price) $3,000(how much racing wants to increase profits) / 150 bikes = $20 Increase in variable expenses Variable cost per bike = $300 Net income Selling Price required to make $3,000 profit = $320 The Formula Method Unit sales to attain their target profit = Target profit + Fixed Expenses / CM per unit Unit sales to break even = Fixed expenses / CM per unit The Equation Method Profit = CM Ratio x Sales – Fixed expenses Margin of Safety- The excess of budgeted (or actual) sales over the break-even volume of sales MOS = Total sales – Break even sales Percentage = Margin of safety / Sales Cost structure and Profit stability – Refers to the relative proportion of fixed costs in an organization. Managers often have some latitude in determining it. An advantage of a high fixed cost structure is that income will be higher in good years compared to companies with lower proportions of fixed costs A disadvantage of a high fixed cost structure is that income will be lower in bad years compared to companies with lower proportions of fixed costs Operating Leverage- a measure of how sensitive net operating income is to percentage changes in sales. Measures how change in sales will affect profits Degree of operating leverage = Contribution margin / Net operating income Example. A degree operating leverage of 5 with a 10% increase in sales will result in a 50% increase in profits. Chapter 7 Activity-based Costing: a tool to aid decision making ABC- designed to provide managers with cost information for strategic and other decisions that potentially affect capacity, and therefore affect “fixed” as well as variable costs. **Used as a supplement for, rather than replacement to, a company’s primary costing system ABC differs from traditional costing systems in three ways: 1. Nonmanufacturing and manufacturing costs may be assigned to products, but only on a cause and effect basis. Ex. ABC systems can assign sales commissions, shipping costs, and warranty repair costs to specific products. 2. Some manufacturing costs may be excluded from product costs, this is because ABC only assigns a cost to a product decisions concerning that product will cause changes in the cost. Excludes: Organizational-sustaining costs and the cost of unused or idle capacity 3. Numerous overhead product are used, each of which is allocated to products and other cost objects using its own unique measure of activity - ABC cost pools are created to correspond to the activities performed in an organization that cause the consumption of overhead resources -Therefore the total number of ABC cost pools will definitely exceed one and is likely to exceed the number of departments within a company, since more than one activity is often performed within each department. Relying exclusively on these bases to assign overhead costs to products has come under increased scrutiny since, economy-wide, direct labor/overhead costs have been moving in opposite direction and the variety of products produced by companies has increased. Activity measure- an allocation base in ABC system Transaction driver – simple count of the number of times an activity occurs. EX number of bills sent out to customers Duration driver – measure of the amount of time needed for an activity. EX. Time spent preparing individual bills for customers Manufacturing companies typically combine their activities into five classifications 1. Unit-Level – Performed each time a unit is produced. EX. Providing power to run processing equipment 2. Batch-Level – Performed each time a batch is handled or processed. EX Setting up equipment and shipping customer orders 3. Product-Level – Relate to specific customers and must be carried out regardless EX. Designing or advertising a product 4. Customer-Level – Relate to specific customers and are not tied to any specific product Ex. Sales calls and catalog mailings 5. Organizational-Sustaining – Carried out regardless of any of the above activities. EX. Heating a factory and cleaning executive offices Characteristics of a successful ABC system -Strong top management -Link to evaluations and rewards -Cross-functional involvement **Notice these pools equal costs on the income statement **Notice 100% of factory building lease is allocated to the “other” activity. Baxter has a single production facility that it does not plan to to contract or expand, the lease is an unavoidable organizational-sustaining cost. Use ABC to compute product and customer margins Preparing a product management report 1. Gather each product’s sales and direct cost data 2. Incorporate the previously computed activity-based cost assignments of each product 3. Deduct each product’s direct and indirect costs from sales Preparing a customer margin analysis 1. Gather sales and direct cost data 2. Incorporate previously computed ABC assignments 3. Compute customer margin by deducting all direct and indirect costs from sales Product margin using traditional systems 1. Gather each product’s sales and direct cost data 2. Compute plant-wide overhead rate 3. Allocate manufacturing overhead to each product 4. Actually compute product margins Differences between ABC and Traditional 1. Traditional costing allocates all manufacturing overhead to products. ABC costing only assigns manufacturing overhead costs consumed by products 2. Traditional costing allocates all manufacturing overhead costs using a volume-related allocation base. ABC costing uses non- volume related allocation bases 3. Traditional costing disregards selling and administrative expenses because they are assumed to be period expenses. ABC costing directly traces shipping costs to products and includes nonmanufacturing overhead costs caused by products in the activity cost pools that are assigned to products Most companies do not use ABC for external reporting: -External reports are less detailed than internal -May be difficult to make changes to the company’s accounting system -ABC does not conform to GAAP -Auditors may be suspect of the subjective allocation process based on interviews with employees ABC Limitations -Substantial resources required to implement and maintain -Resistance to unfamiliar numbers and reports 747 -Desire to fully allocate all costs to products DifferencesBetweenABCand -Potential misinterpretation of unfamiliar numbers Traditional Product Costs -Does not conform with GAAP S rueS atrts L o nfegs L i P orduct margins – traditio$ 69, 0000, 0$ 21, 0000, 0 Chapter 10 Standard costs and variances P orduct margins – ABC 83, 7020, 0 ( 1,132,000) C ahngein reportedmargins $ 14, 7020, 0$ ( 3,232,000) Variance analysis cycle 1. Prepare a standard cost performance report 2. Analyze variances between actual results and what should have happened The traditional cost The traditional cost system overcosts the system undercosts the SureStarts and reports LongLifes and reports 3. These variances raise questions like why did this occur, and why is this variance larger a lower product a higher product than last period? margin for this product. margin for this product. 4. The significant variances are investigated to discover root causes 5. Corrective actions are taken 6. Next periods operations are carried out and process is repeated. Quantity and price standards -The purchasing manager is responsible for raw material purchase prices and the production manager is responsible for the quantity of raw materials used -The buying and using activities occur at different times. Raw material purchases may be held in inventory for a period of time before use in production 1014 1038 1021 1024 AGeneral Model for Variance Analysis MaterialsVariances: Labor Variances Summary Materials Variances Summary Usingthe Factored Equations StandardHours Actual Hours Actual Hours Standard Quantity Actual Quantity Actual Quantity Materials quantity variance × × × × × × MQV = (AQ × SP) – (SQ × SP) Standard Rate Standard Rate Actual Rate Standard Price Standard Price Actual Price (1) (2) (3) = SP(AQ – SQ) 2,400 hours 2,500 hours 2,500 hours StandardQuantity AcofInput,ntity AcofInput,tity 200 kgs. 210 kgs. 210 kgs. kg (210 kgs – (0.1 kg/parka 2,000 × × × AllatStandardPriceutputatStandardPrice atActualPrice × × = $5.00/kg (210 kgs – 200 kgs) $10.00 per hour $10.00 per hour $10.50 per hour (SQ ×SP) (AQ×SP) (AQ×AP) $5.00 per kg. $5.00 per kg. = $5.00/kg (10 kgs) = $50 U = $24,000 = $25,000 = $26,250 = $1,000 = $1,050 = $1,029 QuantityVariance PriceVariance Materials price variance (2)– (1) (3)– (2) MPV = (AQ × AP) – (AQ × SP) Quantity variance Price variance = AQ(AP – SP) Efficiency variance Rate variance $50 unfavorable $21 favorable = 210 kgs ($4.90/kg – $5.00/kg) $1,000 unfavorable $1,250 unfavorable SpendingVariance = 210 kgs (– $0.10/kg) = $21 F (3)– (1) 1063 1065 1062 1064 Materials Variances―An Important Materials Variances―An Important Materials Variances―An Important Materials Variances―An Important Subtlety Subtlety Subtlety Subtlety Glacier Peak Outfitters has the following direct Standard Quantity Actual Quantity Actual Quantity Actual Quantity × × × × materials standard for the fiberfill in its mountain Standard Price StandardPrice Standard Price Actual Price parka. 200 kgs. 200 kgs. 210 kgs. 210 kgs. 0.1kg. offiberfill per parkaat$5.00per kg. × × × × $5.00 per kg. $5.00 per kg. $5.00 per kg. $4.90 per kg. Thequantity variance Last month 210 kgs. of fiberfill were purchased at a = $1,000 = $1,000 = $1,050 = $1,029 is computedonly on cost of $1,029. Glacier used 200 kgs. to make thequantity used. 2,000 parkas. The pricevarianceis Quantity variance Price variance $0 $21 favorable computed on the entire quantity purchased. Potential Problems with Standard Cost -Emphasizing standards may exclude other important objectives / Emphasis on negative may impact moral -Favorable variances may be misinterpreted / Continuous improvements may be more important than meeting standards -Invalid assumptions about the relationship between labor cost and output / Standard cost reports may not be timely Chapter 11 ROI = Net Operating Income Margin = Net Operating Income Turnover = Sales . ROI = Margin x Turnover Average Operating Assets Sales Average Operating Assets -In the absence of a scorecard, management may not know how to increase ROI -Managers often inherit many committed costs over which they have no control -Managers evaluated on ROI may reject profitable opportunities Residual Income = Net Operating Income – (Average Operating Assets x Minimum Required Rate of Return) *Residual income encourages managers to make profitable investments that would be rejected by managers using ROI 1138 1135 Delivery Performance Measures Zephyr, Inc. - Continued Theresidualincomenumbers suggestthattheWholesaleDivisionoutperformed Order Production Goods theRetail Divisionbecauseits residualincomeis $10,000higher. However,the Received Started Shipped RetailDivisionearnedanROIof30%comparedtoanROIof22%forthe WholesaleDivision. TheWholesaleDivision’s residualincomeis largerthanthe RetailDivisionsimplybecauseitis abiggerdivision. Process Time + Inspection Time R teail Wh loesale Wait Time + Move Time + Queue Time Op reatin gassets $ 1 0000, 0$ 10, 0000, 0 Req iuredrateo rfetu r n× 2 0 % 2 0 % Throughput Time Minmiu mreq iuredretu r n$ 2 00,0 0$ 2 0000, 0 Delivery Cycle Time R teail Wh loesale Actu lain oc e $ 3 00,0 0$ 2 2000, 0 Manufacturing Valueadded time Minmiu mreq iuredretu r n (20,000) (200,000) Cycle = Efficiency Manufacturing cycle time Resid aul in oc e $ 1 00,0 0$ 2 00 ,0 0 Throughput time = Process Time + Inspection Time + Move Time + Queue Time Manufacturing Cycle Efficiency (MCE) = Value Time Added (Process Time) / Throughput Time Delivery Cycle Time = Wait Time + Throughput Time Chapter 12 Relevant Cost – A cost that differs between alternatives (Sunk costs and future costs that do not differ between alternatives are NOT relevant costs) Relevant Benefit – A Benefit that differs between alternatives 1. Eliminate costs and benefits that do not differ between alternatives 2. Use remaining costs (differential, or avoidable) that differ between alternatives to make a decision Adding/Dropping segments. A company should only drop a segment if its profits will increase When a limited resource of some type restricts the company’s ability to satisfy demand, the company is said to have a constraint The machine or overall output is called the bottleneck – it is the constraint It is often possible for a manager to increase the capacity of a bottleneck, which is called relaxing (or elevating) the constraint, in numerous ways such as: 1. Working overtime on the bottleneck. 2. Subcontracting some of the processing that would be done at the bottleneck. 3. Investing in additional machines at the bottleneck. 4. Shifting workers from non-bottleneck processes to the bottleneck. 5. Focusing business process improvement efforts on the bottleneck. 6. Reducing defective units processed through the bottleneck. Joint Products- two or more products produced from a common input Split off Point- the point in the manufacturing process where each joint product can be recognized as a separate product Joint costs are irrelevant in decisions. Therefore, these costs should not be allocated to end products for decision-making purposes. With respect to sell or process further decisions, it is profitable to continue processing a joint product after the split-off point so long as the incremental revenue from such processing exceeds the incremental processing costs incurred after the split-off point. 1243 1248 1249 1256 Utilization of a Constrained Resource: The Make or Buy Decision Special Orders Special Orders J et, Inc . An Example P er C ontribution Income Statement If Jet acceptsthespecial order, theincremental U nit C sot of 20,000 U nits R evenue (5 0, 0 0× $ 2)0 $ 1 0 00 ,0 0 revenuewill exceed theincremental costs. In Ensign Companyproducestwo productsand B yu M kae V ariable costs: otherwords, netoperatingincomewill increase selected dataareshown below: O tuside purchase price $ 52 $ 050, 000 iDrect materi al s $ 2 00,0 0 by$6,000. Thissuggeststhat Jetshouldaccept iDrect l abor 5 0, 0 0 theorder. P orduct D riect materials (20,000$un9ts) 1 8 00 0, 0 $8 variable cos 1 2 D riect labor 5 1 0 00 0, 0 Manufacturi ng overhead 1 00,0 0 V ariable overhead 1 2 00,0 0 Marketi ng costs 5 0, 0 0 In rcease in reven u (e3,000 ×$10) $3 00,0 0 S lelingpriceper unit $ 0 6 $ 0 5 D epreciation of equip. 3 - T oalt variab el co sts 4 00,0 0 In rcease in co tss (3,000 ×$8 variab el co ts42, 000 L ses variabelexp ne ess p reu nt3 6 3 5 S upervisor's salary 2 4 00,0 0 C ontribution margin 6 00,0 0 G neeral factory overhead 1 0 - In rcease in n etin oc me $ 6 0, 0 0 C notributionmarginperunit $ 2 4 $ 1 5 T oaltco ts $ 3 0 $ 3 4 00 0, $ 5 0 00 0, 0 F xi ed co sts: C rurentdemandper week(units) 20, 0 0 22, 0 0 Manufacturi ng overhead $ 2 80,0 0 Marketi ng costs 2 00,0 0 C notributionmarginratio 4 0 % 3 0 % Shouldwemakeorbuy part4A? T oalt fixed co sts 4 80,0 0 Note: This answerassumes thatthefxedcosts are P orcessingtimerequired Given thatthetotal avoidablecosts areless than thecostof N et operating income $ 1 20,0 0 unavoidableandthatvariablemarketingcosts mustbe nomachine A1 per unit 10. 0mn.i 05. 0mn.i buyingthepart,Essexshouldcontinuetomakethepart. incurredonthespecial order. 1266 1267 1285 1262 Utilization of a Constrained Resource Utilization of a Constrained Resource Sell or Process Further Utilization of a Constrained Resource Let’ sseehowthisplan wouldwork. Accordingto theplan, wewill produce DataaboutSawmill’sjointproductsincludes: Thekeyisthecontribution margin perunitof the constrained resource. Alolting Our Constrained Resource (Machine A )1 2,200 unitsof Product 2 and 1,300 of Product 1. Our contribution margin looks Per L og P orduct L umb er Sawd ust 1 2 W eekly demand for Product 2 , 2020 u ntsi likethis. Sales valu eat th esp ilt-o ffp o$n t1 4 0 $ 4 0 C ontribution margin per unit $ 4 2 $ 5 1 T mie req ureid p reu nt i × 05. 0mni. T mi e req ureid to p or d ue o÷ n u1 0. 0m ni. ÷0 5. 0m ni. T oalttime req ureid to make Pro d ut 1c Pro d ut 2c Sales valu eafter fu trh er p or ecss2 7 0 5 0 C ontribution margin per minute $ 2 4 $ 3 0 P orduct 2 11, 0 0mni. Allo acted jo ni tp or du tcco tss 1 7 6 2 4 Pro d utioc nan dsales (u ntsi) , 3010 , 2020 Co nribt uiot nmarg ni p er u nt i $ 2 4 $ 1 5 Co tso ffu trh er p or ecssin g 5 0 2 0 Ensign should emphasize Product2because it T oalttime availabel 24, 0 0mni. T oaltco nribt uiot nmarg ni $ 3 12,0 0 $ 3 30,0 0 generates a contribution margin of $30per minute T mie u esd to make Pro d tu2c 11, 0 0mni. T mie availabelfo rPro d tu1c 13, 0 0mni. of the constrainedresource relative to $24per minute for Product1. T mie req ureid p reu nt i ÷ 10. 0mni. The total contribution margin for Ensign is $64,200. P orduction ofP orduct 1 13, 0 0u ntsi 128 1213 1288 127 Sell or Process Further IdentifyingRelevant Costs IdentifyingRelevant Costs IdentifyingRelevant Costs Auot mo bleiCo tss(b saedo n10,000milesd ivrenp reyear) A nalysis of Sell or Process Further Cynthia, a Boston student, is considering visiting her friend in New York. An naluCo Co tsp re Fromafnancial standpoint, Cynthiawould bebetter P er Log She can drive or take the train. By car, it is 230 miles to her friend’s o Ff xiedIteMlei offtaking thetrain to visither friend. Someof the apartment. She is trying to decide which alternative is less expensive straig h-lint ed $e e28, 0 0 $02. 8 0 non-fnancial factors may infuenceher fnal decision. Lumber S awdust and has gathered the following information: 2 Co tso gf saoinl e 01. 0 0 4 Mainetn na ecan drep iarsrn 13, 8 0ic00. 6 5 S ales value after further proces$ing2 7 0 $ 5 0 Auot mo bleiCo tss(b saedo n10,000milesd ivren p reyear5 Parkin gfeesatsch ol o 3 6 0 00. 3 6 RelevantFinancialCostofDriving S ales value at the split-off point 1 4 0 4 0 An naluCoCo tsp re 6 T oaltaverag eco ts $ 06. 1 9 Gaso ie(460@ $0.100p er mile) $ 4 60 .0 I ncrementaler venue 1 3 0 1 0 1 An nalustraig h-lint e$ pe28, 0 0 $02. 8 0r Main etn na ec(460@ $0.065p remile) 2 99 .0 C ost of further processing 5 0 2 0 2 Co tso gf saoinl e 01. 0 0 Red cutio nin resale (460@ $0.026p rem1 19 .6 P orfit (loss) from further proce$sing8 0 $ ( 10) 3 An naluco tso afu otin usa13, 8 0 d01. 3 8s So me Ad ditio nal Inof mratio n Parkin gin New Yo kr(2d yas @ $25p red5 00 .0 4 Main etn na ecan drep iars 00. 6 5 7 Red cutio nin resale valu eo cfa$ 00. 2 6e o wf ear T toal $1 3876. 5 Parkin gfeesatsch ol o 3 6 0 00. 3 6 8 Ro nu -dtiptrain fare $ 1 0 4 6 T oaltaverag eco ts $ 06. 1 9 9 Ben feitso rfelaxin go ntraintrip ? ?? ? The lumber should be processed 1 0 Co tso fp uttin gd go in ken en$ wh4 0i g on e R leevantFinancial C sotof Taking the Train further and the sawdust should be $45 per month × 8 months 0per gallon ÷27MPG 1 1 Ben feito hf vain gcar in New Yo ? ?? ? R uond-trip ticket $ 1 0040. 1 2 Hassle o pf rakin gcar in New Yo ? ?? ? sold at the splitoff point. $24,000 cost – $10,000 salvage value ÷ 5 years 1 3 Per d ay co tso pf rakin gcar i$New2 5 kr Chapter 13 – Capital Budgeting Screening decisions- Does a proposed project meet some preset standard of acceptance? Preference decisions- Selecting from among several competing courses of action **A Dollar today is worth more than a dollar a year from now, therefore projects that offer earlier returns are more desirable. The Net Present Value Method Calculate the present value of cash inflows, and the present value of cash outflows, subtract the present value of outflows from the present value of inflows Positive- Acceptable because it promises a return greater than the required rate of return Zero- Acceptable because it promises a return equal to the required rate of return Negative- Not acceptable because it promises a return less than the required rate of return *Net present value emphasizes cash flows and not accounting net income (because accounting income is based on accruals that ignore timing of cash flows) The initial investment in working capital is a cash outflow, at the beginning of the project for items such as inventory. It is recaptured at the end of the project when working capital is no longer needed. AKA Working capital is released at the end of the project to be used elsewhere Simplifying assumptions - All cash flows other than the initial investment occur at the end of the periods - All cash flows generated by an investment project are immediately reinvested at a rate of return equal to the discount rate Choosing a discount rate The firm’s cost of capital is usually regarded as the minimum required rate of return. Cost of capital is the average rate of return the company must pay to it’s long term creditors and stockholders Internal Rate of Return IROR is the ROR promised by an investment project over its useful life. It is computed by finding the discount rate that will cause the net present value of a project to be zero. It works very well if a project’s cash flows are identical every year. If not, a trial and error process must be used to find IROR If IROR is greater than or equal to the minimum required rate of return then the project is acceptable If IROR is less than the minimum required rate of return then the project should be rejected Present Value Factor for IROR = Investment required / annual net cash flows 1314 1318 1313 1315 Recovery of the Original Investment Recovery of the Original Investment The Net Present Value Method Recovery of the Original Investment ( 1) ( 2) ( 3) (4) (5) Presen t • Carver Hospital is considering the purchase of Valu eo f R ceovery of U rnecovered Lester Company has been offered a five year contract an attachment for its Xray machine. to provide component parts for a large manufacturer. Amo nu ot f 1 0 % Cash I nvestment I nvestment I nvestment at I etm Y aer(s) CashFol wF cato r F ol ws O tustanding R teurn on d uinr gth e the end ofthe Co ts $3, 170 Intiial in evstmen (to tufNo w) ( 3,170) 10. 0 0 ( 3,170) d uinrgth e C sah I nvestment y ear y ear C sot and revenue information Y aer y ear I nfl ow ( 1)1 0 % ( 2)- (3) ( 1)- (4) C sot of special equipment $160, 000 Lfei 4y aers An un lacashinlof ws 14- $ 10, 0 0 31. 7 0$ 31, 7 0 Salvag vealu e z reo Netp ersen vtalu e $ -0 - 1 $ 31, 7 0$ 10, 0 0$ 3 1 7$ 6 8 3$ 24, 8 7 W roking capital required 1 0 00 0, 0 In rceaseinan unlacashinlof sw $1, 000 2 24, 8 7 10, 0 0 2 4 9 7 5 1 17, 3 6 R leining equipment in 3years 3 00,0 0 3 17, 3 6 10, 0 0 1 7 3 8 2 7 9 0 9 S lavage value of equipment in 5 years 50, 0 0 P re se n tV a lu e o f$1 4 9 0 9 10, 0 0 9 1 9 0 9 0 P e rio ds 1 0 % 1 2 % 1 4 % A nnual cash revenue and costs: No investments are to be made unless they 1 0 .9 0 9 0 .8 9 3 0 .8 7 7 Presentvalue T oaltin evstmen treco evred $ 31, 7 0 aSles revenue from parts 7 5 00 0, 0 2 1 .7 3 6 1 .6 9 0 1 .6 4 7 oCst of parts sold 4 0 00 0, 0 have an annual return of at least 10%. 3 2 .4 8 7 2 .4 0 2 2 .3 2 2 of an annuity 4 3 .1 7 0 3 .0 3 7 2 .9 1 4 of$1table This implies thatthecash infows aresufcientto recoverthe$3,170 aSlaries, shipping, etc. 2 7 00 0, 0 5 3 .7 9 1 3 .6 0 5 3 .4 3 3 initial investment(thereforedepreciation is unnecessary)and to Will we be allowed to invest in the attachment? provideexactly a10%return on theinvestment. 1325 1341 1342 1320 The Net Present Value Method The Total-Cost Approach The Total-Cost Approach The Net Present Value Method Cash 1 0 % P ersent Y ears F ol ws F acto r V laue White Company has two alternatives: Investment inequipment N wo $(160,000) 1 0. 0 0$ ( 160,000) If White installs a new washer . . . Annual netcash infowfromoperations W roking capital needed N wo ( 100,000) 1 0. 0 0 ( 100,000) 1. remodel an old car wash or, Co ts $ 030, 000 A nnual net cash inflows 1 5- 8 00,0 0 3 7. 9 1 3 0 23 8, 0 2. remove the old car wash and install a new one. S laes revenue $7 5 00 0, 0 R leining ofequipment 3 ( 30,000) 0 7. 5 1 ( 22,530) Pro du tcive life 1 0y ears C sot of parts sold 4(00, 000) S lavage value ofequip. 5 5 0, 0 0 0 6. 2 1 3 1, 0 5 The company uses a discount rate of 10%. Salvag evalu e S laaries, shipping, etc. ( 270,000) W roking capital released 5 1 0 00 0, 0 0 6. 2 1 6 21,0 0 $ , 0070 A nnual net cash inflows $ 8 00,0 0 N tepresent value $ 8 59,5 5 Rep alce b r uh ses N we C ra Old Car W sah W sah atth een do f6 years $ 05, 000 Salvag eo fo dl eq uip . $ 04, 000 Acceptthecontractbecausetheprojecthas a An n lureaven use $ 9 00,0 0 $ 7 00,0 0 positivenetpresentvalue. An n lucaash o praetin gco tss 3 00,0 0 2 50,0 0 An n lunatecash in lof ws $ 6 00,0 0 $ 4 50,0 0 Let’s look at the present value of this alternative. 1345 1346 1343 1344 The Total-Cost Approach The Total-Cost Approach The Total-Cost Approach The Total-Cost Approach Both projects yieldapositive Remo del th eOld Wash er In tsall th eNew Wash re IfWhiteremodels theexisting Cash 1 0 % netpresentvalue. Cash 1 0 % Y ear F ol ws F acto rPresen Vt alu e N te Y ear F ol ws F acto rPresen Vt alu e washer... In tiial in evstmen t No w $(175,000) 10. 0 0 $ (175,000) In tiial in evstmen t No w $(300,000) 1 0. 0 0 $ ( 300,000) P ersent Rep alce b ur hs se 6 ( 50,000) 0 5. 6 4 ( 28,200) Rep alce b ur hs es 6 (80,000) 05. 6 4 (45,120) V luae Remo dl ceo tss $ 1 70 50,0 An nu al n etcash in lfo1 1- 0 4 50,0 0 61. 4 5 2 7562, 5 An nalun tecash iwslof 1 1- 0 6 00,0 0 6 1. 4 5 3 6 780, 0 Repalce b ur hs seat Netp ersen tvalu e $ 5 64,0 5 In evstinn we wash er $ 8 32,0 2 Salvag eo of dl eq up iNo wt 4 00,0 0 1 0. 0 0 4 00,0 0 Remo dl eexistin gwash re 5 64,0 5 Salvag eo nwe eq up imen 1 0 7 0, 0 0 0 3. 8 6 2 7, 0 2 th een do 6f years 8 00,0 0 Netp ersen vtalu e $ 8 32,0 2 If weremodel theexistingwasher, we Infavo ro nf ew wash re $ 2 67,9 7 will produceapositivenetpresent If weinstall thenewwasher,the Let’s lookatthepresent However, investing in the new washer will investmentwill yieldapositivenet valueof $56,405. value produce a higher net present value than presentvalueof$83,202. remodeling the old washer. ofthis secondalternative. 1353 1348 1354 1355 Least Cost Decisions The Incremental-Cost Approach Least Cost Decisions Least Cost Decisions Hereis informationaboutthetrucks ... Bu yth eNew T ur ck C sah 1 0 % P ersent Cash 1 0 % Presen t Home Furniture should purchase the new truck. Y aer Fol ws F cato r V laue Ol d Tr uck Y ear F ol ws F acto r Valu e Incrementalinvestment N wo $(125, 000)1. 000 $(125, 000) Pu crh ase p irce No w $ (21, 000)1. 000 $ 2(1, 000) Incrementalcostofbrushes 6 $ 3 00,0 0 05. 6 4 6, 9120 O evrhaul cost now $ 45, 0 0 An nu al o peratin gco tss 1 5- (6,000) 3 7. 9 1 22(, 746) N tepresent value of costs Increased netcash inflows1 1- 0 1 50,0 0 61. 4 5 2, 1975 A nnual operating costs 1 00,0 0 Salvag evalu eo fo dl tru No w 9 0, 0 0 1 0. 0 0 , 0090 sasoci ated wi th purchase S lavageofold equipment N wo 4 00,0 0 10. 0 0 0, 0400 Salvag evalu eo fn ew tru ck 5 3 0, 0 0 0 6. 2 1 , 8613 S lavageofnewequipment 1 0 70, 0 0 03. 8 6 , 7022 S lavage value in 5years 2 5 0 32(, 883) fonew truck $( 32,883) N tepresentvalue $ 62, 797 S lavage value now 90, 0 0 Net p ersen tvalu e N tepresent value of costs Keep th eOld T ur ck sasoci ated wi th overhaul i ng N w eTruck Cash 1 0 % Presen t xei sti ng truck ( 42,255) We getthe same answer under either the Y ear F ol ws F acto r Valu e total-costor incremental-costapproach. Pu crh sae p irce $ 2 10,0 0 Overh au lco ts No w $ (4, 500) 1. 000 $ 4,(500) N tepresent value in favor of uprchasi ng the new truck $ 9 3, 7 2 An n luoapraetin gco tss 60, 0 0 An nu al o peratin gco tss1 5- (10,000) 3 7. 9 1 37(, 910) Salvag evalu eo fo dl tru c5 2 5 0 0 6. 2 1 55 1 Salvag evalu ein 5years 30, 0 0 Netp ersen tvalu e 42(, 255) 1360 1359 Uncertain Cash Flows –An Example Uncertain Cash Flows –An Example v Assumethatall of thecashfows relatedto an investmentinasupertankerhavebeen N tepresentvalue to be offs$10, 4000,= $ 1 00,0000, 0 P ersentvalue factor 01. 0 4 estimated, exceptforits salvagevaluein 20 years. v Using adiscountrateof 12%, managementhas This equationcanbeusedto determinethat determined thatthenetpresentvalueof all the ifthesalvagevalueofthesupertankeris at cash fows, exceptthesalvagevalueis a least$10,000,000,thenetpresentvalueofthe negative$1.04million. investmentwouldbepositiveandtherefore acceptable. Howlargewould the salvagevalueneedto be to makethis investmentattractive? Manufacturing Costs Direct Materials - become an integral part of the finished product Direct (Touch) Labor - labor cost that can be easily traced to a product (Direct Costs) Manufacturing Overhead - all manufacturing costs except direct materials and direct labor (Indirect labor/materials) (Indirect Costs) --EX. lubricants and cleaning supplies used in the automobile assembly plant --EX. maintenance workers, janitors, and security guards Direct Materials & Direct Labor Prime Cost Direct Labor & Manufacturing Overhead Conversion Cost Nonmanufacturing Costs Selling - costs necessary to secure customer orders and get the finished product into the hands of the customer --EX. advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods warehouses. Administrative - executive, organizational, and clerical costs associated with the general management of an organization --EX. executive compensation, general accounting, secretarial, public relations Product Costs VS. Period Costs Product - direct materials, direct labor, and manufacturing overhead –Inventory on Balance sheet SALE Cost of Goods Sold Income Statement Period - all selling costs and administrative costs – Expenses on Income Statement Cost Classifications for Predicting Cost Behavior Cost Behavior – How a cost will react to changes in the level of the relevant range Variable Cost – Varies in total in direct proportion to changes in activity level EX. Texts are 5cents, texting bill increases with each text sent Variable Cost Per Unit – constant. EX Each text is always 5cents Activity Base (Cost Driver) – As the level of the activity base increases, the total variable cost increases proportionally. Units produced (or sold) is not the only activity base, a cost can be variable if it varies with the activity bases such as miles driven, machine hours, or labor. Fixed Cost – Constant with the relevant range. EX, Monthly contract fee for cell phone is fixed for minutes- does not change based on amount of calls Fixed Cost Per Unit is inversely related to activity- the cost unit decreases when activity increases and vise versa Types of Fixed Costs Committed – Long-term cannot be significantly reduced in the short term. EX. Depreciation on Buildings and Equipment and Real Estate Taxes Discretionary – May be altered in the short-term by current managerial decisions EX. Advertising and Research and Development The linearity Assumption and Relevant Range - A straight line closely approximates a curvilinear variable cost line within the relevant range Relevant Range – Range of activity within which the assumption made about cost behavior are valid EX. Office space rented is $30,000 per 1000ft2. If the space rented is 1,100ft2 then cost will be 60,000 Mixed Costs - y=a+bx Y- The total mixed cost A- The total fixed cost B- The Variable cost per unit of activity X- The level of activity EX. Monthly utility charge is $40 Variable cost is .03 per kilowatt hour, and your monthly activity level is 2,000 kilowatt hours Y=40+ (.03x2,000) Y=100 Scattergraph Plots (High Low method) Variable cost = Change in cost / Change in Activity EX. Cost low is $7400 High is $9800 Activity low is 450hours high is 850. 9800-7400/850-450 = $2400/400 = $6 an hour variable cost Total fix
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