Exam 26: Incremental Analysis and Capital Budgeting

In deciding on the future status of an unprofitable segment management should recognize that net income could decrease by eliminating the unprofitable segment.

Northern States Dairy Inc. has 4 product lines: sour cream ice cream yogurt and butter. The allocated fixed costs are based on units sold and are unavoidable. Demand of individual products is not affected by changes in other product lines. 40% of the fixed costs are direct and the other 60% are allocated. Results of June follow: $\begin{array}{lcccccc}&\text { Sour Cream }&\text{Ice Cream}&\text{ Yocurt }&\text{Butter }&\text{Total }\\ \text { Units sold } & 2,000 & 500 & 400 & 200 & 3,100 \\ \text { Revenue } & \$ 10,000 & \$ 20,000 & \$ 10,000 & \$ 20,000 & \$ 60,000 \\ \text {Variable departmental costs } & 6,000 & 13,000 & 4,200 & 4,800 & 28,000 \\ \text { Fxed costs } & 6,000 & 2,000 & 3,000 & 7,000 & 18,000 \\ \text { Net income (loss) } & \$(2,010) & \$ 5,000 & \$ 2,800 & \$ 8,200 & \$ 14,000 \\\end{array}$ Instructions Prepare an incremental analysis of the effect of dropping the sour cream product line.

It is always better to sell now rather than process further because of the time value of money.

Sardine Kitchen Company produces three sizes of crock pots: small medium and large. A condensed segmented income statement for a recent period follows: $\begin{array}{lcccc}&\text { Large }&\text { Medium } & \text { Small }&\text { Total }\\ \text { Sales } & \$ 200,000 & \$ 200,000 & \$ 105,000 & \$ 505,000 \\ \text { Variable expenses } & 125,000 & 110,000 & 65,000 & 300,000 \\ \text { Contrbution margin } & 75,000 & 90,000 & 40,000 & 205,000 \\\text { Fixed expenses } & 55,000 & 55,000 & 47,000 & 157,000 \\ \text { Net income (loss) } & \$ 20,000 & \$ 35,000 & \$(7,000) & \$ 48,000 \\\end{array}$ Assume none of the fixed expenses for the small size crock pot are avoidable. What will be total net income if the line is dropped?

A company projects an increase in net income of $180000 each year for the next five years if it invests $900000 in new equipment. The equipment has a five-year life and an estimated salvage value of $300000. What is the annual rate of return on this investment?

If a company's required minimum rate of return is 9% and in using the net present value method a project's net present value is zero this indicates that the

All of the following are relevant in deciding whether to eliminate an unprofitable segment except the segment's

If a company is operating at full capacity the incremental costs of a special order will likely include fixed manufacturing costs.

Hooverville Service Center just purchased an automobile hoist for $16900. The hoist has a 5-year life and an estimated salvage value of $1250. Installation costs were $3770 and freight charges were $960. Hooverville uses straight-line depreciation. The new hoist will be used to replace mufflers and tires on automobiles. Hooverville estimates that the new hoist will enable his mechanics to replace four extra mufflers per week. Each muffler sells for $84.50 installed. The cost of a muffler is $46.50 and the labor cost to install a muffler is $13. Instructions (a) Compute the payback period for the new hoist. (b) Compute the annual rate of return for the new hoist. (Round to one decimal.)

An important step in management's decision-making process is to determine and evaluate possible courses of action.

Which of the following is not relevant information in a decision whether old equipment presently being used should be replaced by new equipment?

The cash payback formula is

In a make-or-buy decision opportunity costs are

Mississippi Forest Corporation operates two divisions the Commercial Division and the Consumer Division. The Commercial Division manufactures and sells logs to paper manufacturers. The Consumer Division operates retail lumber mills which sell a variety of products in the do-it-yourself homeowner market. The company is considering disposing of the Consumer Division since it has been consistently unprofitable for a number of years. The income statements for the two divisions for the year ended December 31 2014 are presented below: $\begin{array}{lr}&\text { Commercial}&\text { Consumer}&\text { Total}\\\text { Sales revenue } & \$ 1,500,000 &\$500,000&\$2,000,000\\\text { Cost of goods sold } & 900,000 &350,000&1,250,000\\ \text { Gross profit } & 600,000&150,000&750,000 \\\text { Selling } \& \text { administrative expenses } & 250,000 &180,000&430,000\\\text { Net income } & \$ 350,000&\$(30,000)&\$320,000 \\\end{array}$ In the Consumer Division 70% of cost of goods sold are variable costs and 35% of selling and administrative expenses are variable costs. The management of the company feels it can save $45000 of fixed cost of goods sold and $42000 of fixed selling expenses if it discontinues operation of the Consumer Division. Instructions (a) Determine whether the company should discontinue operating the Consumer Division. (b) If the company had discontinued the division for 2014 determine what net income would have been.

A company is considering eliminating a product line. The fixed costs currently allocated to the product line will be allocated to other product lines upon discontinuance. If the product line is discontinued

The discounted cash flow technique considers estimated total cash inflows from the investment but not the time value of money.

The net present value method can only be used in capital budgeting if the expected cash flows from a project are an equal amount each year.

Lagusta Company incurred the following costs for 50000 units: Variable costs $180000 Fixed costs 240000 Lagusta has received a special order from a foreign company for 5000 units. There is sufficient capacity to fill the order without jeopardizing regular sales. Filling the order will require spending an additional $8500 for shipping. If Lagusta wants to earn $9000 on the order what should the unit price be?

In incremental analysis total variable costs will always change under alternative courses of action and total fixed costs will always remain constant.

The two discounted cash flow techniques used in capital budgeting are (1) the _______________________ method and (2) the ______________________ method.