CHAPTER 11
DECISION MAKING AND RELEVANT INFORMATION
11-16 Disposal of assets.
Answer the following questions.
1. A company has an inventory of 1,250 assorted parts for a line of missiles that has been
discontinued. The inventory cost is $76,000. The parts can be either (a) remachined at total
additional costs of $26,500 and then sold for $33,500 or (b) sold as scrap for $2,500. Which
action is more profitable? Show your calculations.
2. A truck, costing $100,500 and uninsured, is wrecked its first day in use. It can be either (a)
disposed of for $18,000 cash and replaced with a similar truck costing $103,000 or (b) rebuilt
for $88,500 and thus be brand-new as far as operating characteristics and looks are
concerned. Which action is less costly? Show your calculations.
SOLUTION
1. This is an unfortunate situation, yet the $76,000 costs are irrelevant regarding the
decision to remachine or scrap. The only relevant factors are the future revenues and future costs.
By ignoring the accumulated costs and deciding on the basis of expected future costs, operating
income will be maximized (or losses minimized). The difference in favor of remachining is
$4,500:
(a) (b)
Remachine Scrap
Future revenues $33,500 $2,500
Deduct future costs 26,500 –
Operating income $ 7,000 $2,500
Difference in favor of remachining $4,500
2. This, too, is an unfortunate situation. But the $101,500 original cost is irrelevant to this
decision. The difference in relevant costs in favor of replacing is $3,500 as follows:
(a) (b)
Replace Rebuild
New truck $103,000 –
Deduct current disposal
price of existing truck 18,000 –
Rebuild existing truck – $88,500
$ 85,000 $88,500
Difference in favor of replacing $3,500
Note, here, that the current disposal price of $18,000 is relevant, but the original cost (or book
value, if the truck were not brand new) is irrelevant.
,11-17 Relevant and irrelevant costs.
Answer the following questions.
1. DeCesare Computers makes 5,200 units of a circuit board, CB76, at a cost of $280 each.
Variable cost per unit is $190 and fixed cost per unit is $90. Peach Electronics offers to
supply 5,200 units of CB76 for $260. If DeCesare buys from Peach it will be able to save $10
per unit in fixed costs but continue to incur the remaining $80 per unit. Should DeCesare
accept Peach’s offer? Explain.
2. LN Manufacturing is deciding whether to keep or replace an old machine. It obtains the
following information:
LN Manufacturing uses straight-line depreciation. Ignore the time value of money and
income taxes. Should LN Manufacturing replace the old machine? Explain.
, SOLUTION
1.
Make Buy
Relevant costs
Variable costs $190
Avoidable fixed costs 10
Purchase price ____ $260
Unit relevant cost $200 $260
DeCesare Computers should reject Peach’s offer. The $80 of fixed costs is irrelevant because it
will be incurred regardless of this decision. When comparing relevant costs between the choices,
Peach’s offer price is higher than the cost to continue to produce.
2.
Keep Replace Difference
Cash operating costs (3 years) $52,500 $46,500 $6,000
Current disposal value of old machine (2,200) 2,200
Cost of new machine _ _____ 9,000 (9,000)
Total relevant costs $52,500 $53,300 $ (800)
LN Manufacturing should keep the old machine. The cost savings are less than the cost to
purchase the new machine.
DECISION MAKING AND RELEVANT INFORMATION
11-16 Disposal of assets.
Answer the following questions.
1. A company has an inventory of 1,250 assorted parts for a line of missiles that has been
discontinued. The inventory cost is $76,000. The parts can be either (a) remachined at total
additional costs of $26,500 and then sold for $33,500 or (b) sold as scrap for $2,500. Which
action is more profitable? Show your calculations.
2. A truck, costing $100,500 and uninsured, is wrecked its first day in use. It can be either (a)
disposed of for $18,000 cash and replaced with a similar truck costing $103,000 or (b) rebuilt
for $88,500 and thus be brand-new as far as operating characteristics and looks are
concerned. Which action is less costly? Show your calculations.
SOLUTION
1. This is an unfortunate situation, yet the $76,000 costs are irrelevant regarding the
decision to remachine or scrap. The only relevant factors are the future revenues and future costs.
By ignoring the accumulated costs and deciding on the basis of expected future costs, operating
income will be maximized (or losses minimized). The difference in favor of remachining is
$4,500:
(a) (b)
Remachine Scrap
Future revenues $33,500 $2,500
Deduct future costs 26,500 –
Operating income $ 7,000 $2,500
Difference in favor of remachining $4,500
2. This, too, is an unfortunate situation. But the $101,500 original cost is irrelevant to this
decision. The difference in relevant costs in favor of replacing is $3,500 as follows:
(a) (b)
Replace Rebuild
New truck $103,000 –
Deduct current disposal
price of existing truck 18,000 –
Rebuild existing truck – $88,500
$ 85,000 $88,500
Difference in favor of replacing $3,500
Note, here, that the current disposal price of $18,000 is relevant, but the original cost (or book
value, if the truck were not brand new) is irrelevant.
,11-17 Relevant and irrelevant costs.
Answer the following questions.
1. DeCesare Computers makes 5,200 units of a circuit board, CB76, at a cost of $280 each.
Variable cost per unit is $190 and fixed cost per unit is $90. Peach Electronics offers to
supply 5,200 units of CB76 for $260. If DeCesare buys from Peach it will be able to save $10
per unit in fixed costs but continue to incur the remaining $80 per unit. Should DeCesare
accept Peach’s offer? Explain.
2. LN Manufacturing is deciding whether to keep or replace an old machine. It obtains the
following information:
LN Manufacturing uses straight-line depreciation. Ignore the time value of money and
income taxes. Should LN Manufacturing replace the old machine? Explain.
, SOLUTION
1.
Make Buy
Relevant costs
Variable costs $190
Avoidable fixed costs 10
Purchase price ____ $260
Unit relevant cost $200 $260
DeCesare Computers should reject Peach’s offer. The $80 of fixed costs is irrelevant because it
will be incurred regardless of this decision. When comparing relevant costs between the choices,
Peach’s offer price is higher than the cost to continue to produce.
2.
Keep Replace Difference
Cash operating costs (3 years) $52,500 $46,500 $6,000
Current disposal value of old machine (2,200) 2,200
Cost of new machine _ _____ 9,000 (9,000)
Total relevant costs $52,500 $53,300 $ (800)
LN Manufacturing should keep the old machine. The cost savings are less than the cost to
purchase the new machine.
