Managerial economics applications strategies and tactics 13th edition mcguigan solutions manual

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Chapter 8/Cost Analysis

Chapter 8

Cost Analysis Solutions to Exercises 1. USAir should not build the training center at this location. The true "opportunity" cost of the land is $2,500,000. We know that the project is unacceptable for any land cost over $850,000. USAir would be better off selling the land for $2,500,000 and building the training center elsewhere.

2. Howard Bowen’s cotton farm analysis appears below. a. Accounting profits: Revenues Less: Variable operating costs Less: Depreciation Less: Wages Equals: Operating Income Less: Interest expense Accounting income before tax b. Economic profits: Revenues Less: Variable operating costs Less: Opportunity value of Bowen's income potential Less: Economic depreciation Equals: Economic profit before financial costs Less: Interest expense Less: Opportunity cost of net $1 million equity @10% Equals: Economic profit, or (loss)

$5,000,000 4,500,000 40,000 50,000 $410,000 400,000 +$10,000

$5,000,000 4,500,000 30,000 60,000 $410,000 400,000 100,000 ($90,000)

If these calculations are representative of Bowen's regular performance, he would be better off financially by selling the farm and working for someone else. This analysis ignores many intangible factors that may affect Bowen's decision.

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Chapter 8/Cost Analysis 3. Mary Graham’s work at Piedmont Properties. a. Pro forma Accounting pre-tax profits for the first year: Revenues Less: Salaries Operating expenses Depreciation Total Operating income Less: Interest expense Accounting profit before tax

$2,000,000 1,500,000 250,000 5,000 1,775,000 245,000 75,000 $170,000

b. Pro forma Economic pre-tax profits for the first year: Revenues Less: Salaries 1,500,000 Operating expenses 250,000 Depreciation 20,000 Graham's foregone income 100,000 Total Economic profit before financial costs Less: Interest expense Economic profit before tax

$2,000,000

1,870,000 130,000 75,000 $55,000

c. Explicit costs⎯salaries, operating expenses, depreciation for tax purposes ($5,000), and interest expenses.

Implicit costs⎯Graham's foregone income and additional depreciation ($15,000 = $20,000 − $5,000).

Note that Mary Graham would decide to start the new real estate agency using accounting data, because it produces more than her current $100,000 income. But, she would more likely decide to continue to work for Piedmont Properties using the economic data.

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Chapter 8/Cost Analysis 4. Complete the table. Bold figures reflect the given values.

Q 0 10 20 30 40 50 60 70 80

TC 125 175 210 235 255 275 305 350 420

FC 125 125 125 125 125 125 125 125 125

VC ATC AFC 0 50 17.50 12.50 85 10.50 6.25 110 7.83 4.17 130 6.38 3.13 150 5.50 2.50 180 5.08 2.08 225 5.00 1.79 295 5.25 1.56

AVC 5.00 4.25 3.67 3.25 3.00 3.00 3.21 3.69

MC 5.00 3.50 2.50 2.00 2.00 3.00 4.50 7.00

5. Operating expenses rise above 80% capacity (800 units), with AFC at $50 at 800 units.

Accordingly, FC = $40,000. AVC is $100 at 800 units, so VC is $80,000 at 800 units. Complete the table for examining cost curves.

Q TC FC VC ATC 500 90000 40000 50000 180.00 600 100000 40000 60000 166.66 700 110000 40000 70000 157.14 800 120000 40000 80000 150 900 139000 40000 99000 154.44 1000 165000 40000 125000 165.00 1100 205000 40000 165000 186.36

AFC 80.00 66.66 57.14 50 3.13 12.50 1.79

AVC 100 100 100 100 110 125 150

MC --100.00 100.00 100.00 190.00 260.00 400.00

6. The Blair Company has multiple plant locations. a. One centralized plant in Missouri: TC = $900,000 + (6,000 + 4,500 + 3,000) $250 = $4,275,000 Three subassembly plants: TC = ($475,000 + $425,000 + $400,000) + (6000 + 4500 + 3000) $225 = $4,337,500 One centralized plant would be cheaper. b. One centralized plant at full capacity: TC = $900,000 + (18,000)$250 = $5,400,000 Three plants: TC = ($475,000 + $425,000 + $400,000) + (8,000 + 6,000 + 4,000)$225 = $5,350,000.

Three plants should be built.

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Chapter 8/Cost Analysis c. It would be helpful to have a credible forecast of the future demand for subassemblies.

7. Kitchen Helper Company is considering different types of plant facilities. a.

Plant A

Output 25000 50000 75000 100000 125000 150000 175000 200000 225000 250000 275000 300000 325000 350000 b.

Plant B

TC ATC TC ATC 150000+9(25000)=$375000 $15.00 $450,000 $18.00 150000+9(50000)=600,000 12.00 650,000 13.00 150000+9(75000)=825,000 11.00 850,000 11.33 300000+9(100000)=1,200,000 12.00 1,050,000 10.50 300000+9(125000)=1,425,000 11.40 1,250,000 10.00 300000+9(150000)=165,0000 11.00 1,450,000 9.67 450000+9(175000)=2,025,000 11.57 1,900,000 10.86 450000+9(200000)=2,250,000 11.25 2,100,000 10.50 450000+9(225000)=2,475,000 11.00 2,300,000 10.22 600000+9(250000)=2,850,000 11.40 2,500,000 10.00 600000+9(275000)=3,075,000 11.18 2,700,000 9.82 600000+9(300000)=3,300,000 11.00 2,900,000 9.67 750000+9(325000)=3,675,000 11.31 3,350,000 10.31 750000+9(350000)=3900000 11.14 3,550,000 10.14

Output 25,000 50,000 75,000 100,000 125,000 150,000 175,000 200,000 225,000 250,000 275,000 300,000 325,000 350,000

____

Plant C___ TC ATC__ $625,000 25.00 800,000 16.00 975,000 13.00 1,150,000 11.50 1,325,000 10.60 1,500,000 10.00 1,67,5000 9.57 1,850,000 9.25 2,025,000 9.00 2,200,000 8.80 2,375,000 8.64 2,550,000 8.50 2,725,000 8.38 2,900,000 8.29

ATC $15.00(A) 12.00(A) 11.00(A) 10.50(B) 10.00(B) 9.67(B) 9.57(C) 9.25(C) 9.00(C) 8.80(C) 8.64(C) 8.50(C) 8.38(C) 8.29(C)

The long run ATC is declining in output volume.

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Chapter 8/Cost Analysis 8. ARA should not build the maintenance facility at this location. The true "opportunity" cost of the land is $1,000,000. We know that the project is unacceptable for any land cost over $500,000. ARA would be better off selling the land for $1,000,000 and building the maintenance facility elsewhere.

9. The Emerson Corporation finds that there is learning by doing in airplane landing gear equipment. The estimated cost of the 200th unit is Log C = 3.30755 - .28724 Log(200) = 3.30755-.28724(2.301) = 2.6466, so the antilog of this is 10 2.6466 = $443.20.

[Note: It was apparent that Emerson used base-10 logarithms rather than natural logarithm by trying 75 units and finding the result was closest to the log versus the ln fit].

The percentage of learning is [1 – (C2/C1)100%]. The cost per unit is compared at a doubling of output. We are given 25, 75, and 125, which are not examples of doubling.

We could “interpolate” between 25 and 75 for what 62.5 might have cost (which is half of 125), or we could use the estimated fit to find a doubling amount.

At 150 units, the estimated per unit cost would be $481.38. From 75 to 150 is a doubling of output: [1 – (481.38/600)100%] = 19.77% percentage of learning.

Solution to Case Exercise: Cost Analysis 1. Incremental costs per chair for Leisure Products are equal to the variable costs, consisting of direct labor ($2.25) and materials ($2.30), for a total of $4.55 per chair in incremental costs.

2. It was assumed that all of plant overhead and administrative and selling expense were fixed costs. One would like to know what portion of these costs (if any) represents variable costs. For example, part of plant overhead, such as power and supplies, may vary with the output level. Likewise, part of the selling costs (e.g., billing) may constitute variable costs.

3.

Based on incremental economic reasoning, the Southeast order should be accepted since the price ($5.50) exceeds the calculated variable costs ($4.55). The order will contribute approximately $28,500 (($5.50 − $4.55)  30,000) to the profits of the firm.

4. One would have to consider the long-run impact on the firm of accepting the order. For example, if other customers find out the LP is selling chairs considerably below the standard quoted price of $7.15, these other customers may begin demanding lower prices

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Chapter 8/Cost Analysis on their orders. The net effect could be lower prices for all customers and lower profits for LP. Solution to Case Exercise: Profit Margins on the Amazon Kindle 1.

Variable costs ($35 display screen, $25 touchscreen, $11 assembly labor, $12 battery, $18 processor chip, $5 DRAM memory chip, $37 software licenses, $8 8 GB memory module, $6 wireless WIFI/Bluetooth, $34 hardcase) = $191.

Fixed costs allocated to the individual Kindle reader ($7 advertising campaign, $12 R&D expense, $14 overhead) = $33.

Contribution margin (CM) = ($199 - $191) / $199 = .040 (4 percent).

2.

Handsets would tend to have higher margins than Kindles for several reasons:

(1) Samsung, RIM and Nokia have realized volume discounts on the purchase of their electronic and other inputs, lowering variable costs, thereby raising their handset CMs. (2) Samsung, RIM, and Nokia have experienced such long production runs that learning curve suggestions have lowered their variable costs thereby raising their CMs. (3) Customer loyalty to RIM and Nokia handsets raises switching costs, reducing the price elasticity of demand, and increasing their CMs. (4) Handsets offer value-added features that Kindle readers do not such as telecommunications and photo transfer, thereby raising their CMs. 3.

Apple iPads would have still higher margins for all the reasons above plus the brand premium in Apple prices, thereby raising margins. Branding expenses are enormous but these are fixed costs recovered by higher margins.

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