Question

Integrative Case 5-72. Cost Estimation, CVP Analysis, and Decision Making (@LO 54, 5,9) Luke Corporation produces a variety of products, each within their own division. Last year, the managers at Luke developed and began marketing a new chewing gum, Bubbs, to sell in vending machines. The product, which sells for $5.25 per case, has not had the market sliccess that managers expected, and the company is considering dropping Bubbs. The product-line income statement for the past 12 months follows. $14.682.150 Revenue Costs Manufacturing costs Allocated corporate costs (59) Product line margin Allowance for tax (20%) Product-line profit loss) $14.440,395 734,108 15.174.503 $ (492,353) 98.470 $ (393.883 All products at Luke receive an allocation of corporate overhead costs, which is computed as 5 percent of product

Answer 1

Answer:-

This problem is more subtle than it might appear, because you must consider the effect on Luke Corporation and the Product Manager, Mr. Andre separately. In other words, it anticipates in a small way the issues in management control systems.

a.

$2.24 per case .

The relevant cost is the variable production cost. (The problem states that no corporate overhead will be allocated or affected by the order.) To determine the variable production cost, a regression analysis on the production data can be run. The results follow:

B F G А B C С D E 1 SUMMARY OUTPUT 2 3 Regression Statistics 4 Multiple R 0.980345319 5 R Square 0.961076945 6 Adjusted R Square 0.957184639 7 Standard Error 7969.964262 8 Observations 12 9 10 ANOVA 11 df SS MS F 12 Regression 1 15684258323 1.5684E+10 246.9171 13 Residual 10 635203303.4 63520330.3 14 Total 16319461626 15 Coefficients Standard Error t Stat P-value 17 Intercept 682293.6573 33240.33583 20.5260759 1.66E-09 18 Cases 2.235883256 0.142289713 15.7135973 2.24E-08 Significance F 2.23512E-08 11 16 Lower 95% Upper 95% 608229.5739 756357.7406 1.918842019 2.552924493 19

As shown, the estimated variable production cost is $2.24. This is the minimum that can be charged without reducing profit.

b.

242,120 cases.

To breakeven on the product, Luke has to sell a sufficient number of cases to cover fixed production costs on the product. The contribution margin, however, is lowered by the variable portion of the (truly) corporate costs. To determine these, we can use the High-Low method, because we only have two observations.

Corporate costs are assumed to be variable with respect to revenues, so using data on corporate costs, variable costs are 3.65% of revenue.

Variable cost = (Cost at highest activity – cost at lowest activity)/(Highest activity – lowest activity)

= ($5,337,500 – $4,221,000)/($106,750,000 – $76,200,000)

= 3.65% of Revenue

Let Q be the number of cases sold. Then, profit for Q cases is (note that the fixed costs are from the analysis in part a):

Profit = Revenues – Variable product costs – Variable corporate costs – Fixed production costs

= ($5.25 x Q) – ($2.24 x Q) – (3.65% x $5.25 x Q) – $682,294

or

$2.818 x Q = $682,294

or

Q = 242,120 cases.

c.

274,565 cases.

This problem differs from requirement (b), because the the requirement that the revenue from the product covers the production costs and the full 5% corporate cost allocation makes the corporate cost allocation entirely variable. Therefore, the number of cases to provide a profit equal to 5% of revenue (= 5% x $5.25 x Q) can be determined as follows. Let Q be the number of cases sold. Then, profit for Q cases is:

Profit = Revenues – Variable product costs – Variable corporate costs – Fixed production costs

= $5.25 x Q – $2.24 x Q – 5% x $5.25 x Q – $682,294 (5% x $5.25 x Q) = ($5.25 x Q) – ($2.24 x Q) – (5% x $5.25 x Q) – $682,294

$2.485 x Q = $682,294

Q = 274,565 cases.

d.

$235,314 increase.

Because fixed manufacturing costs can be avoided, Luke will save all the production costs plus the variable corporate overhead.

Lost revenue		$(14,682,150)
Production costs avoided		14,440,395
Savings before corporate costs		$ (241,755)
Corporate costs avoided	(= 3.65% x $14,682,150)	535,898
Increase profits before tax		$ 294,143
Tax (@20%)		58,829
Increased profits		$ 235,314