Chapter 2 Answers

2-1

(a)

Average cost for 500 parts = $13.00

The marginal cost is the same as the average cost of $13, as the next discount stage is after 1,000 products.

(b)

Average cost for 1,500 parts = (1,000 13 + 500 12)/(1,000 + 500)
= $12.67

The marginal cost for 1,500 products is $12.

(c)

Average cost for 2,500 parts = (1,000 13 + 1,500 12)/(1,000 + 1,500)
= $12.40

The marginal cost for 2,500 products is $12.

(d)

Average cost for 3,500 parts = (1,000 13 + 2,000 12 + 500 11)/(1,000 + 2,000 + 500)
= $12.14

The marginal cost for 3,500 products is $11.



2-3

(a)

Venus Computer daytime shift calculations are presented below:
Fixed cost of day shift = $2,000,000
Labour cost of day shift = $9,109,000
Total manufacturing cost of day shift = $11,109,000
No of PCs produced in day shift = 23,000 units annually

Therefore, the unit manufacturing cost for the day shift is $483.00 per PC.

(b)

The second shift and first shift together will produce 46,000 units annually.
Fixed cost is increased to $2,400,000.
Labour cost is increased by 25% in the second shift, with respect to the first shift.
Now, since production is the same for both shifts,
Labour cost in the second shift = $11,386,250, which is simply 25% more than total labour cost of the day shift
Total labour cost for both shifts = $20,495,250
Total manufacturing costs for both shifts = $22,895,250 after adding the revised fixed cost
Therefore, unit cost of production for both shifts combined = $497.72 per PC

Thus, the addition of a second shift would increase the unit manufacturing cost from $483 in the day shift to $498 overall.


2-5

(a)

$1,000


(b)

$5,000

(c)

90

(d)

10

(e)

Equating the two expressions for the annual costs for Systems I and II, we have:

0.9x + 1 = 0.1x + 5

where x = (5 1)/(0.9 0.1) thousands, as the unit of the break-even chart is thousands of maps

= 5,000 maps

Thus, the two systems have equal annual costs when 5,000 maps are dispensed annually.

(f)

less than 5,000

(g)

more than 5,000


(h)

At a dispensing rate of 3,000 maps per year, the average and marginal costs for Systems I and II are calculated below:

System I

Total cost = [1 + 0.9 (3,000/1,000)] 1,000
= $3,700 (remember that the units of costs and maps in the graph are in thousands)

Average cost = $1.23 upon dividing the total cost by 3,000

Thus, the average cost is $1.23 and the marginal cost (which is obviously the unit variable cost) is 90.

System II

Total cost = (5 + 0.1 3,000/1,000) 1,000
= $5,300

Average cost = $1.77 upon dividing the total cost by 3,000

Thus, the average cost is $1.77 and the marginal cost (which is obviously the unit variable cost) is 10.


2-7

(a)

The total cost (TC) equation for the Tummy Tugger (TT) is given by
TC = 10,000 + 2.5x, where x is the number of visitors annually

The total cost (TC) equation for the Head Buzzer (HB) is given by
TC = 4,000 + 4x, where x is the number of visitors annually

In order for both total costs to be equal, we can set these two expressions equal to each other and solve for x.

Thus, 10,000 + 2.5x = 4,000 + 4x

Where x = (10,000 4,000)/(4 2.5)
= 4,000

Thus, the break-even number of visitors for the two rides to have equal annual costs is 4,000 visitors per year.


(b)

Cost (thousands of $)
Annual
visitors

TT

HB
500 11.25 6.00
1,000 12.50 8.00
1,500 13.75 10.00
2,000 15.00 12.00
2,500 16.25 14.00
3,000 17.50 16.00
3,500 18.75 18.00
4,000 20.00 20.00
4,500 21.25 22.00
5,000 22.50 24.00
5,500 23.75 26.00
6,000 25.00 28.00

0
5
10
15
20
25
30
500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500 5,000 5,500 6,000 A
n
n
u
a
l

C
o
s
t
s

(
t
h
o
u
s
a
n
d
s

o
f

$
)
Annual Visitors
Break-even Analysis
TT
HB
even Point - Break
x 5 . 2 + 000 , 10 TC equation is
x 4 + 000 , 4 TC equation is


The Head Buzzer is preferred if there are less than 4,000 visitors per year.
The Tummy Tugger is preferred if there are more than 4,000 visitors per year.


2-9

This problem is best solved graphically. The cost equations of the three alternative designs, A, B, and C, are given below:
Note: x is the number of units produced.

Design A: 100,000 + 20x
Design B: 200,000 + 5x
Design C: 150,000 + 7.5x

The production range is considered to be between 0 and 30,000 units.
The cost figures based on the above equations are set out in the table below:




Cost (thousands of $) x (thousands
of units) Design A Design B Design C
1 120 205 157.5
2 140 210 165.0
3 160 215 172.5
4 180 220 180.0
5 200 225 187.5
6 220 230 195.0
7 240 235 202.5
8 260 240 210.0
9 280 245 217.5
10 300 250 225.0
11 320 255 232.5
12 340 260 240.0
13 360 265 247.5
14 380 270 255.0
15 400 275 262.5
16 420 280 270.0
17 440 285 277.5
18 460 290 285.0
19 480 295 292.5
20 500 300 300.0
21 520 305 307.5
22 540 310 315.0
23 560 315 322.5
24 580 320 330.0
25 600 325 337.5
26 620 330 345.0
27 640 335 352.5
28 660 340 360.0
29 680 345 367.5
30 700 350 375.0



For a range of production from 0 to 4,000 units per year, Design A will result in the lowest annual cost.
For the range of production from 4,000 to 20,000 units per year, Design C will result in the lowest annual cost.
For the range of production from 20,000 to 30,000 units per year, Design B will result in the lowest annual cost.


2-11

Let the minimum number of units painted per year be P so as to justify the purchase of the robot machine.
If the robot machine were not to be purchased, the total cost of painting using manual labour for 3 years would be 1.4 3 P.
The cost of the robot machine is $15,000, and the scrap value will be $0 in 3 years.
With the machine in place, the cost of painting is 15,000 + 0.2 3 P, as there is no salvage value for the machine.
Equating the two, we have

4.2P = 15,000 + 0.6P

where, P = 15,000/(4.2 0.6)
= 4,167

Thus, a minimum of 4,167 units needs to be painted every year to justify the purchase of the robot machine.


2-13

The cost function C of Bendix is given by

C = 3,000,000 18,000Q + 75Q
2


Clearly, the above function is parabolic in nature and will have a value of Q when the cost is a minimum. Beyond this minimum point the
cost will rise in an unbounded manner.

At the point of minimum cost, the first derivative of C with respect to Q will be zero.
Differentiating the cost function C with regard to Q and setting it to zero, we have

150Q 18,000 = 0

where Q = 18,000/150
= 120

Since the new employee said that Bendix is currently producing only 110 units, we can conclude that Bendix will increase its production
to 120, at which point it will achieve lowest costs and therefore highest profits, since the selling price is fixed.

N.B. The second derivative is 150, which is greater than zero, indicating that at Q = 120, the function has a minimum value.






2-15

(a)

Sales volume S and unit selling price P are related thus:

P = 100 S
Cost of production C = 1,000 + 10S

S P = 100 S C = 1,000 + 10S Income = PS
0 100 1,000 0
10 90 1,100 900
20 80 1,200 1,600
30 70 1,300 2,100
40 60 1,400 2,400
50 50 1,500 2,500
60 40 1,600 2,400
70 30 1,700 2,100
80 20 1,800 1,600
90 10 1,900 900
100 0 2,000 0

0
500
1000
1500
2000
2500
3000
0 10 20 30 40 50 60 70 80 90 100
I
n
c
o
m
e

(
I
)
,

C
o
s
t

(
C
)
Sales (units)
Income and Cost versus Sales
C
I
Units 45 Max Profit at
First Break Even
Second Break Even


(b)

Let us evaluate the points where the costs equal the income:

1,000 + 10S = S (100 S)
Or, 1,000 +10S = 100S S
2

Or, S
2
90S + 1,000 = 0
Or, S = {90 + sqrt (90
2
4 1 1,000)}/2 or {90 sqrt (90
2
4 1 1,000)}/2
Or, S = 77.0 or 13.0

Thus, the break-even point with the lowest sales volume is at a sales volume of 13 units. The other point at which the profit is zero
occurs at 77 units.






(c)

The equation for profit is given by the excess of income over costs.

Thus, Profit = S(100 S) (1,000 + 10S)
Or, Profit = 100S S
2
1,000 10S
Or, Profit =90S S
2
1,000

Taking the first derivative of profit with respect to sales volume and setting it to zero, we have:

90 2S = 0
where S = 45 units

Thus, the firms profit is maximized at a sales volume of 45 units.


2-17

Initial cost in January = $500.00
Salvage cost in December of same year = $200.00
Salvage cost in May of next year = $100.00

If the equipment was bought in early January, and is sought to be disposed of sometime in Deccember:

Average time span of usage = 50 weeks (assuming purchase in mid-January and sale in mid-December)
Frequency of usage = 1 per week
Therefore, usage until December = 50 times in a year
Therefore, cost per use = $6.00 if sold in December
Cost per use = $5.71 if sold in May, which is 20 weeks later

Therefore it doesnt really make a difference whether the equipment is sold in December or the following May, as the cost per use is not
significantly different.

Cost of moving = $25.00 (which is equivalent to 4.4 uses, which is not significant)

Thus, if the student values his health, he should not sell the equipment, as there is no gym available in his new place of work, effective
in May.


2-29

Cost of paint:
Area to be painted = 6,000 sq ft
One can covers 300 sq ft
Therefore, no. of cans = 20 for one coat
Since there are 2 coats,
No. of cans to be purchased = 40
Cost per can = first 10 cans at $15 each; next 15 cans at $10 each; next 50 cans at $7.50 each
Cost of 40 cans = $412.50

Cost of labour:
No. of painters = 5 men
No. of hours per day = 10 hours per day
Duration of work = 4.5 days
Painters rate = $8.75 per man per hour
Total labour cost = $1,968.75

Fixed cost = $200.00

Therefore, total cost of paint job = $2,581.25






2-31

Unit Cost $ per unit
Material $112
Labour $85
Overhead $213
Manufacturing Cost $410

(a)

Profit is 30% of manufacturing unit cost, which works out to $123 per unit.

(b)

Cost of manufacturing 10,000 units = $4,100,000

(c)

Total production = 10,000
Product scrapped = 1%
Therefore, saleable product = 9,900
Product unsold = 3%
Therefore, no. of units sold = 9,603
Sales returned = 2% of what is sold, which works out to 192 units
Goods successfully sold = 9,411 units
Selling cost = $533 per unit
Net sales = $5,016,031
Therefore, net BATCH profit = $916,031 (net sales total costs)

Sales revenue accrues to SungSam only when the customer keeps the product. Cost is to be deducted whether a product is scrapped, good
(i.e., sold successfully), not sold, or returned because of defects. Hence, the cost has been considered for the ENTIRE batch. Profit is
rightly the net sales value less the total costs.

(d)

Material cost = $112
50% reduction = $56
For 10,000 units, material cost = $560,000

The contract value cannot exceed $560,000 to maintain the same profit levels.


2-33

Cost per sq ft 25 years ago = 12
Current cost per sq ft = 72
Current index number = (72/12) 100 = 600
Cost per sq ft last year = (525/100) 12 = 63


2-35

Equipment
(capacity units)
Original
capacity
Cost of
original
equipment
($)
Power-
sizing
exponent
Capacity
of new
equipment
Multiplying
factor
Cost of
new
equipment
($)
Varnish bath (gal) 50 3,500 0.80 75 1.383 4,841
Power scraper (hp) 0.75 250 0.22 1.5 1.165 291
Paint booth (cu ft) 3 3,000 0.60 12 2.297 6,892
Total 6,750 12,024

The multiplying factor is the ratio of the new capacity to the old raised to a suitable exponent, which is the power-sizing exponent.
For the varnish bath, this figure is (150/75)
0.8
. Other multiplying factors have been calculated accordingly.

Constances net investment is the cost of the new equipment less 15% of the value of the old equipment, which works out to
$11,012.
2-37

Capacity of desired (larger) reactor = 4,500 gallons per hour
Capacity of known reactor = 1,500 gallons per hour
Power-sizing factor = 0.75
Cost ratio of larger to smaller reactor = (4,500/1,500)
0.75
, which works out to 2.280
Cost of smaller reactor = $40,000 5 years ago

Therefore, the cost of the larger reactor upon using the above ratio = $91,180 5 years ago

The above scaling up of capacity now needs to be adjusted for inflation by using the relevant cost indices:
Current cost index = 300
Index 5 years ago = 120
Multiplying factor = (300/120) = 2.5

Therefore, the cost of the larger reactor adjusted for inflation is (2.5 91180), which works out to $227,951.


2-39

The learning curve equation states that T
n
= T
i
N
b


where
T
n
is the time required for the nth unit of production
T
i
is the time required for the initial unit of production
N is the number of completed units
b is the learning curve exponent (slope in a log-log plot)

Plugging in the values of T
n
= 60, T
i
= 200, N = 7, we find b using the formula b = (log (T
n
/T
i
))/(log N), which works out to 0.61872.

Therefore, the learning curve rate is 2
0.61872
, or 65%.


2-41

The learning curve equation states that T
n
= T
i
N
b


where
T
n
is the time required for the nth unit of production
T
i
is the time required for the initial unit of production
N is the number of completed units
b is the learning curve exponent (slope in a log log plot)
b is defined as (log of learning curve expressed as a decimal)/log 2

If we take T to be the scrap rate, and n to be the number of months after the SPC program has been implemented, then T
n
/T
i
gives the ratio
of the scrap rate after n months to the initial rate.

We have a learning curve exponent of log (0.8,10)/log( 2,10) because there is an 80% learning curve, which is 0.3219.
Thus, the ratio of T
n
/T
i
= 12
0.3219

=0.45

Thus, the scrap reduction is 100% 45%, or 55%.


2-45

Year/Item Capital ($) O&M ($) Overhaul ($) Salvage ($)
0 20,000
1 2,500
2 2,500
3 2,500
4 2,500 5,000
5 2,500
6 2,500
7 2,500 2,000
2000 +
20000 -
0 2 3 4 5
6 7
7500 -
1

Cash Flow Diagram
-$25,000
-$20,000
-$15,000
-$10,000
-$5,000
$0
$5,000
0 1 2 3 4 5 6 7
Year of Operation
C
a
s
h

F
l
o
w

(
$
)
Salvage
Overhaul
O&M
Capital