PPM 3-1

1. The following statements have been made about cost plus pricing.

(1) A price in excess of full cost per unit will ensure that a company will cover all its costs and make a profit.

(2) Cost plus pricing is an appropriate pricing strategy when jobs are carried out to customer specifications.

Which of the above statements is/are true?

2. A benefit sacrificed by taking one course of action instead of the most profitable alternative course of action is known as which of the following?

3. Which of the following terms would NOT normally be used to describe a relevant cost for a decision?

4. High Limited is considering a new project that will require the use of a currently idle machine. The machine has a current book value of $12,000 and a potential disposal value of $10,500 (before $200 disposal costs) and hence has been under depreciated by $1,500 over its life to date. If the machine is to be fit for purpose on the new project it will have to be relocated at a cost of $500 and refitted at a further cost of $800.

What is the relevant cost of using the machine on the new project?

5. A decision tree is a way of representing decision choices in the form of a diagram. It is usual for decision trees to include probabilities of different outcomes.

The following statements have been made about decision trees.

(1) Each possible outcome from a decision is given an expected value.

(2) Each possible outcome is shown as a branch on a decision tree.

Which of the above statements is/are true?

6. The standard costs and revenues of Deep Co’s only product are as follows:

$ per unit

Sales price                                                                            60

Direct materials                                                                  12

Direct labour                                                                       15

Variable production overhead                                          3

Fixed production overhead                                              15

Profit                                                                                    15

Fixed overheads are absorbed on budgeted production and sales of 10,000 units per year. Sales staff receive a sales commission of 5% of sales revenue.

What is Deep Co’s margin of safety (to the nearest whole %)?

7. A company has fixed costs of $1.3 million. Variable costs are 55% of sales up to a sales level of $1.5 million, but at higher volumes of production and sales, the variable cost for incremental production units falls to 52% of sales.

What is the breakeven point in sales revenue, to the nearest $1,000?

8. Analysing the range of different possible outcomes from a particular situation, with a computer model that uses random numbers, is known as which of the following?

9. An organisation is considering the costs to be incurred in respect of a special order opportunity. The order would require 1,250 kgs of material R, that is readily available and regularly used by the organisation on its normal products.

There are 265 kgs of material R in inventory which cost $795 last week. The current market price is $3.24 per kg. Material R is normally used to make product J. Each unit of J requires 3 kgs of material R, and if material R is costed at $3 per kg, each unit of J yields a contribution of $15.

What is the relevant cost of material R to be included in the costing of the special order?

10. A company uses linear programming to decide on the production and sales budget that will maximise total contribution and profit for a financial period. The optimal solution involves using all available direct labour hours, for which the shadow price is $4.50 per hour, and machine hours, for which the shadow price is $3 per machine hour. Direct labour is paid $8 per hour.

If the objective of the company is to maximise total contribution and profit in each period, how much should the company be willing to pay per hour to obtain additional direct labour hours of production capacity?

11. GG Company has been asked to quote for a special contract. The contract requires 100 hours of labour. However, the labourers, who are each paid $15 per hour, are working at full capacity. There is a shortage of labour in the market. The labour required to undertake this special contract would have to be taken from another contract, H, which currently utilises 500 hours of labour and generates $5,000 worth of contribution.

If the labour was taken from contract H, then the whole of contract would have to be delayed, and such delay would invoke a penalty fee of $1,000.

What is the relevant cost of the labour for the special contract?

12. Steven is short of labour for a new one-off project needing 600 hours of labour and has choices as to where to source this. He could hire new people temporarily from an agency at a cost of $9 per hour. Alternatively, he could recruit new temporary staff at a fixed cost of advertising of $1,200 but then only pay $6 per hour for the time. He could also redirect some staff from existing work who are currently paid $7 per hour and who make sandals that generate a contribution of $3 per hour after all variable costs. Sandals are a good selling product and Steven will lose the production and the related sales whilst staff is working on the new one-off project.

What is the relevant cash flow?

13. Which TWO statements are true when using linear programming to solve production problems?

14. What is the main purpose of sensitivity analysis?

15. What method of uncertainty or risk analysis is also called ‘What if?’ analysis?

16. In order to utilise some spare capacity, V is preparing a quotation for a special order which requires 2,000 kgs of material O.

V has 800 kgs of material O in inventory (original cost $7.00 per kg). Material O is used in the company’s main product I. Each unit of I uses 5 kgs of material O and, based on an input value of $7.00 per kg of O, each unit of I yields a contribution of $10.00.

The resale value of material O is $5.50 per kg. The present replacement price of material O is $8.00 per kg. Material O is readily available in the market.

What is the relevant cost of the 2,000 kgs of material O to be included in the quotation?

17. Richard is considering a new project but is unsure how much overhead to include in the calculations to help him decide whether or not to proceed. Existing fixed overheads are absorbed at the rate of $8 per hour worked. Richard is certain that the project will involve an incremental 500 labour hours.

The project will involve extra machine running costs and these variable overheads cost him $4 per hour. The number of extra machine hours is expected to be 450 hours. The difference between this figure and the 500 labour hours above is expected idle time.

The project will require a little more temporary space that can be rented at a fixed cost of $1,200 for the period of hire. This overhead is not included in the fixed overhead absorption rate above

What is the overhead to be charged against the project decision?

18. T plc intends to use relevant costs as the basis of the selling price for a special order: the printing of a brochure. The brochure requires a particular type of paper that is not regularly used by T plc although a limited amount is in T plc’s inventory which was left over from a previous job. The cost when T plc bought this paper last year was $15 per ream and there are 100 reams in inventory. The brochure requires 250 reams. The current market price of the paper is $26 per ream, and the resale value of the paper in inventory is $10 per ream.

What is the relevant cost of the paper to be used in printing the brochure?

19. Tulip Limited is considering changing the way it is structured by asking its employed staff to become freelance. Employees are currently paid a fixed salary of $240,000 per annum, but would instead be paid $200 per working day. On a typical working day, staff can produce 40 units. Other fixed costs are $400,000 per annum.

The selling price of a unit is $60 and material costs are $20 per unit.

What will be the effect of the change on the breakeven point of the business and the level of operating risk?

20. Which TWO pieces of information are required when deciding, purely on financial grounds, whether or not to process a joint product further?

21. The following decision tree shows four decision options: 1, 2, 3 and 4

Using the expected value rule, which choice should be made so as to optimise the expected benefit?

22. Which of the following statements about graphical linear programming with the objective of maximising profit is true?

(1) If a resource constraint line does not pass through the optimum point on the graph, then the shadow price of that resource is zero

(2) The shadow price is the maximum amount a company should pay for one more unit of a scarce resource

(3) The slope or gradient of the objective function depends on the amount of resources available to the organization

23. A company has produced the following Profit/Volume (P/V) chart for its sole product:

What are the total fixed costs for the product?

24. A business produces three products, P1, P2 and P3. Each of these products requires different amounts of material (material Y), which is a scarce resource. The following budgeted data relates to the three products:

Per unit:                                                                         P1                                   P2                                   P3

$                                      $                                     $

Selling price                                                                 200                                  150                                100

Materials ($5 per kg)                                                 (35)                                  (20)                               (10)

Labour ($20 per hour)                                               (50)                                  (25)                               (10)

Variable overheads                                                    (45)                                  (45)                               (30)

Fixed overheads                                                         (30)                                   (25)                              (20)

Profit per unit                                                              40                                      35                                30

Give the products to the order in which they should be manufactured to ensure profit is maximised.

25. N Co uses a marginal cost plus pricing system to determine the selling price for one of its products, Product K.

Product K has the following costs:

$

Direct materials                                    12

Direct labour                                          5

Variable overheads                               3

Fixed overheads                                   40

Fixed overheads are $20,000 for the year. Budgeted output and sales for the year are 500 units and this should be sufficient for Product K to break even.

What profit mark-up would N Co need to add to the marginal cost to allow N Co to break even?

26. Wilton sells two products with selling prices and contributions as follows:

Product D                                  Product M

Selling price per unit                                                                    $40                                              $20

Contribution per unit                                                                   $10                                               $4

Budgeted sales units                                                                150,000                                      100,000

Wilton’s’ fixed costs are $1,400,000 per year.

What is Wilton’s’ current breakeven revenue (to the nearest $)?

27. Wilton sells two products with selling prices and contributions as follows:

Product D                                  Product M

Selling price per unit                                                                    $40                                              $20

Contribution per unit                                                                   $10                                               $4

Budgeted sales units                                                                150,000                                      100,000

Wilton’s’ fixed costs are $1,400,000 per year.

Wilton now anticipates that more customers will buy the cheaper product M and that budgeted sales will be 150,000 units for each product.

What would be the impact on the break-even revenue if the sales volume of M increases?

28. A company makes and sells product F and product G. Twice as many units of product G are made and sold as that of product F. Each unit of product F makes a contribution of $10 and each unit of product G makes a contribution of $4. Fixed costs are $90,000.

What is the total number of units which must be made and sold to make a profit of $45,000?

29. A company is making product Z with the following cost card:

$                                  $

Selling price                                                                                      100

Marginal                                                        25

Labour                                                           30

Variable overheads                                     20

Fixed overheads                                          10

(85)

Profit                                                                                                   15

Each unit of Z takes one hour to make, and the available labour and machinery are fully used in its current production of Z. The company is considering making a new product, L, but would have to divert labour and machine use from product Z.

What is the relevant total cost per hour for labour and variable overheads which should be included in the cost of product L?

30. A manufacturing company makes two joint products, CP1 and CP2, in a common process. These products can be sold at the split-off point in an external market, or processed further in separate processes to produce products FP1 and FP2. Details of these processes are shown in the diagram.

CP1 has a market price of $6 per kg and CP2 has a market price of $5 per kg. Relevant further processing costs are $2 per input kg in the process to make FP1 and $3 per input kg in the process to make FP2. Both FP1 and FP2 sell for $9 per kg.

For each 10,000 kg input to the common process, how much additional profit is obtained by further processing each of the joint products instead of selling them at the split-off point?

31. A company manufactures and sells a single product with a variable cost per unit of $36. It has a contribution to sales ratio (C/S ratio) of 25%. The company has weekly fixed costs of $18,000. Which of the following is the weekly breakeven point in units?

32. A company makes two products, X and Y, using the same type of direct labour. Production capacity per period is restricted to 60,000 direct labour hours. The contribution per unit is $8 for Product X and $6 for Product Y. The following constraints apply to production and sales:

x                        ≤ 10,000                   (Sales demand for Product X)

y                        ≤ 12,000                   (Sales demand for Product Y)

5x + 4y             ≤ 60,000                   (Direct labour hours)

The contribution-maximising output is to produce and sell 10,000 units of Product X and 2,500 units of Product Y.

What is the shadow price per direct labour hour and for how many additional hours of labour does this shadow price per hour apply?

33. E Co makes two products – E1 and E2 – budgeted details of which are as follows:

E1                                  E2

$                                    $

Selling price                                                              10.00                              8.00

Cost per unit:

Direct materials                                                        3.50                               4.00

Direct labour                                                             1.50                               1.00

Variable overhead                                                    0.60                               0.40

Fixed overhead                                                         1.20                               1.00

Profit per unit                                                           3.20                               1.60

Budgeted production and sales for the year ended 30 November 20X7 are:

Product E1                    10,000 units

Product E2                    12,500 units

The fixed overhead costs included in E1 relate to apportionment of general overhead costs only. However, E2 also includes specific fixed overheads totaling $2,500.

If only product E1 were to be made, how many units (to the nearest unit) would need to be sold in order to achieve a profit of $60,000 each year?

34. The price elasticity of demand for a product at its current price level is inelastic. What will happen to the total revenue and the profit if the price of the product is reduced?

A. Total revenue 

B. Profit 

35. Which method of pricing is most easily applied when two or more markets for the product or service can be kept entirely separate from each other?

36. A special job for a customer will require eight tonnes of a Material S. The company no longer uses this material regularly although it holds 3 tonnes in inventory. These originally cost $44 per tonne, and could be resold to a supplier for $35 per tonne. Alternatively, these materials could be used to complete another job instead of using other materials that would cost $126 to purchase. The current market price of Material S is $50 per tonne.

The company must decide whether to agree to the customer’s request for the work, and to set a price. What would be the relevant cost of Material S for this job?

37. The following statements have been made about price elasticity of demand.

(1) When sales demand is inelastic, a company can increase profits by raising the selling price of its product.

(2) Price elasticity of demand is measured as the amount of change in sales price (measured as a percentage of the current sales price) divided by the amount of change in quantity demanded (measured as a percentage of the current sales volume).

Which of the above statements is/are true?

38. An organisation manufactures and sells a single product, the R. It has produced the following budget for the coming year:

$000                                   $000

Sales revenue (20,000 units)                                                                          5,000

Manufacturing costs

Fixed                                                                      1,600

Variable                                                                1,400

Selling costs

Fixed                                                                      1,200

Variable                                                                  400

Cost of sales                                                                                                    (4,600)

––––––

Profit                                                                                                                   400

––––––

If inventory levels are negligible, what is the breakeven point in units?

39. 

What does the shaded area on the breakeven chart above represent?

40. A company produces and sells a single product. Budgeted sales are $2.4 million, budgeted fixed costs are $360,000 and the margin of safety is $400,000. What are budgeted variable costs?

41. The following breakeven chart has been drawn for a company’s single product:

Which of the following statements about the product are correct?

(1) The product’s selling price is $10 per unit.

(2) The product’s variable cost is $8 per unit.

(3) The product incurs fixed costs of $30,000 per period.

(4) The product earns a profit of $70,000 at a level of activity of 10,000 units.

42. A company makes and sells a single product. When sales per month are $6.8 million, total costs are $6.56 million. When sales per month are $5.2 million, total costs are $5.44 million. There is a step cost increase of $400,000 in fixed costs when sales are $6.0 million, but variable unit costs are constant at all levels of output and sales.

What is the breakeven point for sales revenue per month?

43. A company makes and sells four products. Direct labour hours are a scarce resource, but the company is able to sub-contract production of any products to external suppliers. The following information is relevant.

Product                                                     P                              Q                               R                           S

$ per unit                $ per unit               $ per unit             $ per unit

Sales price                                              10                               8                              12                         14

Variable cost                                           8                                5                               8                          12

Cost of external purchase                    9                              7.1                             10                         13

Direct labour hours per unit              0.1                            0.3                            0.25                       0.2

Give the products to the order of priority in which the company should make them in-house, rather than purchase them externally.

44. The demand for a product at its current price has a price elasticity greater than 1.0 (ignoring the minus sign). Which of the following statements must be correct?

(1) A reduction in the sales price will increase total revenue.

(2) A reduction in the sales price by x% will result in a percentage increase in sales demand which is greater than x%.

(3) An increase in the selling price will increase total profit.

45. A company makes a single product with the following data:

$                             $

Selling price                                                                                    25

Material                                                             5

Labour                                                               7

Variable overhead                                           3

Fixed overhead                                                4                          (19)

–––

Profit per unit                                                                                 6

–––

Budgeted output is 30,000 units.

In relation to this data, which of the following statements is correct?

46. A company wishes to go ahead with one of three mutually exclusive projects, but the profit outcome from each project will depend on the strength of sales demand, as follows.

Strong demand                   Moderate demand                 Weak demand

Profit                                        Profit                                Profit/(Loss)

$                                                $                                              $

Project 1                                       70,000                                      10,000                                   (7,000)

Project 2                                       25,000                                      12,000                                     5,000

Project 3                                       50,000                                      20,000                                   (6,000)

Probability of demand                   0.1                                             0.4                                          0.5

What is the value to the company of obtaining this perfect market research information, ignoring the cost of obtaining the information?

47. The management accountant of Colin plc has calculated the firm’s breakeven point from the following data:

Selling price per unit                                                 $20

Variable costs per unit                                               $8

Fixed overheads for next year                             $79,104

It is now expected that the product’s selling price and variable cost will increase by 8% and 5.2% respectively.

By how much will Colin’s breakeven point for next year change by as a result of these changes?

48. Darim Ltd manufactures and sells a single product that has the following cost and selling price structure:

$/unit

Selling price                                                       199

Direct material                                                   54

Direct labour                                                      50

Variable overhead                                             20

Fixed overhead                                                  22

–––

53

–––

The fixed overhead absorption rate is based on the normal budgeted capacity of 6,200 units per month. The same amount is spent each month on fixed overheads.

Which TWO of the following statements about the performance of Darim Ltd next month are correct?

49. A company wishes to decide on a selling price for a new product. Weekly sales of each product will depend on the price charged and also on customers’ response to the new product. The following pay-off table has been prepared.

Probability           Price P1           Price P2            Price P3          Price P4

$                       $                         $                      $

Price                                                                            5.00                  5.50                   6.00                 6.50

Unit contribution                                                      3.00                  3.50                   4.00                 4.50

Weekly demand                                                       Units                 Units                 Units               Units

Best possible                                  0.3                    10,000               9,000                8,000              7,000

Most likely                                      0.5                     8,000                7,500                7,000               6,000

Worst possible                               0.2                     6,000                5,000                4,000               3,000

If the choice of selling price is based on a maximin decision rule, which price would be selected?

50. A company makes two products with the following characteristics.

Product F                        Product G

Contribution to sales ratio                                 0.3                                     0.5

Selling price per unit                                        $3.00                                 $4.80

Maximum demand                                       8,000 units                      3,000 units

Fixed costs are $9,000.

What is the minimum revenue required for production to break even?

51. The following profit-volume chart for three products, has been prepared:

Which TWO of the following statements about the above chart are correct?

52. A company wants to decide whether to make its materials in-house or to sub-contract production to an external supplier. In the past it has made four materials in-house, but demand in the next year will exceed in-house production capacity of 8,000 units. All four materials are made on the same machines and require the same machine time per unit: machine time is the limiting production factor.

The following information is available.

Material                                                   A                                B                              C                           D

Units required                                    4,000                         2,000                      3,000                   4,000

Variable cost of

in-house Manufacture                 $8 per unit              $12 per unit            $9 per unit       $10 per unit

Directly attributable

fixed cost expenditure                    $5,000                       $8,000                    $6,000                $7,000

Cost of external purchase           $9 per unit              $18 per unit          $12 per unit       $12 per unit

Directly attributable fixed costs are fixed cash expenditures that would be saved if production of the material in-house is stopped entirely.

If a decision is made solely on the basis of short-term cost considerations, what materials should the company purchase externally?

53. The contribution to sales (C/S) ratio for a business is 0.4 and its fixed costs are $1,600,000. Budget revenue has been set at 6 times the amount of the fixed costs.

What is the margin of safety % measured in revenue (to 1 decimal place)?

54. A company budgets to sells its three products X, Y and Z in the ratio 2:3:5 respectively, measured in units of sales. Unit sales prices and variable costs are as follows.

Product                                   X                               Y                                 Z

$ per unit                $ per unit                  $ per unit

Sales price                            20                             18                                24

Variable cost                        11                             12                                18

Budgeted fixed costs are $1.2 million. What sales will be needed to achieve a target profit of $400,000 for the period? Give your answer in millions, to 3 decimal points.

55. The shadow price of skilled labour for CBV is currently $8 per hour. What does this mean?

56. Which of the following statements is true of pricing?

57. Which TWO of the following circumstances (in relation to the launch of a new product) favour a penetration pricing strategy?

58. A product has a prime cost of $12, variable overheads of $3 per unit and fixed overheads of $6 per unit.

Which pricing policy gives the highest price?

59. Market research into demand for a product indicates that when the selling price per unit is $145, demand in each period will be 5,000 units; if the price is $120, demand will be 11,250 units. It is assumed that the demand function for this product is linear. The variable cost per unit is $27.

What selling price should be charged in order to maximise the monthly profit?

60. Which FOUR of the following are to be correctly included in the considerations in a make or buy decision?