Solution manual accounting principles 9e by kieso kimmel chapter 26

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CHAPTER 26
Incremental Analysis and Capital Budgeting
ASSIGNMENT CLASSIFICATION TABLE

Study Objectives

Questions

Brief
Exercises

Do It!

Exercises

1.

Identify the steps
in management’s
decision-making process.

1, 2

1

3

1

2.

Describe the concept
of incremental analysis.

3, 4

2

4

1

3.

Identify the relevant
costs in accepting an
order at a special price.

5

3

7

4.

Identify the relevant costs
in a make-or-buy decision.

6, 7

4

5.

Give the decision rule
for whether to sell or
process materials further.

8

5

6.

Identify the factors to
consider in retaining or
replacing equipment.

9

6

7

7.

Explain the relevant
factors in whether to

eliminate an unprofitable
segment.

10

7

8, 9

8.

Determine which products
to make and sell when
resources are limited.

11

8

10

9.

Contrast annual rate of
return and cash payback
in capital budgeting.

12, 13, 14,
15, 16

9, 10

11, 12, 13

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A
Problems

B
Problems

2, 3

1A

1B

9

4

2A

2B

10

5, 6

3A

3B

4A, 5A

4B, 5B

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ASSIGNMENT CLASSIFICATION TABLE (Continued)
Study Objectives

Questions

10.

17, 18, 19,
20

26-2

Distinguish between

the net present value
and internal rate of
return methods.

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Brief
Exercises
11, 12, 13

Do It!

Exercises
12, 13, 14,
15

A
Problems

B
Problems

4A, 5A, 6A

4B, 5B, 6B

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ASSIGNMENT CHARACTERISTICS TABLE
Problem
Number

Description

Difficulty
Level

Time
Allotted (min.)

Simple

20–30

1A

Make incremental analysis for special order, and identify
nonfinancial factors in decision.

2A

Make incremental analysis related to make or buy; consider
opportunity cost, and identify nonfinancial factors.

Moderate

30–40

3A

Compute contribution margin, and prepare incremental
analysis concerning elimination of divisions.

Moderate

30–40

4A

Compute annual rate of return, cash payback, and net
present value.

Moderate

30–40

5A

Compute annual rate of return, cash payback, and net
present value.

Complex

30–40

6A

Compute net present value and internal rate of return.

Moderate

20–30

1B

Make incremental analysis for special order, and identify
nonfinancial factors in decision.

Simple

20–30

2B

Make incremental analysis related to make or buy; consider
opportunity cost, and identify nonfinancial factors.

Moderate

30–40

3B

Compute contribution margin, and prepare incremental
analysis concerning elimination of divisions.

Moderate

30–40

4B

Compute annual rate of return, cash payback, and net
present value.

Moderate

30–40

5B

Compute annual rate of return, cash payback, and net
Present value.

Complex

30–40

6B

Compute net present value and internal rate of return.

Moderate

20–30

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WEYGANDT ACCOUNTING PRINCIPLES 9E
CHAPTER 26
INCREMENTAL ANALYSIS AND CAPITAL BUDGETING
Number

SO

BT

Difficulty

Time (min.)

BE1

1

K

Simple

2–3

BE2

2

AN

Simple

3–5

BE3

3

AN

Simple

4–6

BE4

4

AN

Simple

5–7

BE5

5

AN

Simple

5–7

BE6

6

AN

Simple

4–6

BE7

7

AN

Simple

4–6

BE8

8

AP

Simple

3–5

BE9

9

AP

Simple

4–6

BE10

9

AP

Simple

5–7

BE11

10

AN

Simple

5–7

BE12

10

AP

Simple

4–6

BE13

10

AN

Simple

2–4

DI1

3

AN

Simple

4–6

DI2

4

AN

Simple

8–10

DI3

7

AN

Simple

6–8

DI4

9

AP

Simple

6–8

DI5

10

AN

Simple

6–8

EX1

1, 2

K

Simple

8–10

EX2

3

E

Moderate

8–10

EX3

3

E

Simple

8–10

EX4

4

E

Simple

8–10

EX5

5

E

Moderate

10–12

EX6

5

E

Simple

8–10

EX7

6

E

Simple

6–8

EX8

7

E

Simple

6–8

EX9

7

E

Simple

8–10

EX10

8

E

Simple

8–10

26-4

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INCREMENTAL ANALYSIS AND CAPITAL BUDGETING (Continued)
Number

SO

BT

Difficulty

Time (min.)

EX11

9

AP

Moderate

8–10

EX12

9, 10

E

Moderate

12–15

EX13

9, 10

AP

Simple

6–8

EX14

10

E

Simple

8–10

EX15

10

E

Simple

8–10

PIA

3

E

Simple

20–30

P2A

4

E

Moderate

30–40

P3A

7

E

Moderate

30–40

P4A

9, 10

E

Moderate

30–40

P5A

9, 10

E

Complex

30–40

P6A

10

E

Moderate

20–30

P1B

3

E

Simple

20–30

P2B

4

E

Moderate

30–40

P3B

7

E

Moderate

30–40

P4B

9, 10

E

Moderate

30–40

P5B

9, 10

E

Complex

30–40

P6B

10

E

Moderate

20–30

BYP1

6, 9, 10

AP, AN

Moderate

20–25

BYP2

4

E

Moderate

10–15

BYP3

2

AN

Simple

8–12

BYP4

10

AP

Simple

10–15

BYP5

9

E

Moderate

15–20

BYP6

2, 7

E

Simple

10–15

BYP7

1, 2

S

Simple

25–30

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26-6

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Describe the concept of incremental
analysis.

Identify the relevant costs in accepting
an order at a special price.

Identify the relevant costs in a makeor-buy decision.

Give the decision rule for whether to
sell or process materials further.

Identify the factors to consider in
retaining or replacing equipment.

Explain the relevant factors in whether
to eliminate an unprofitable segment.

Determine which products to make
and sell when resources are limited.

Contrast annual rate of return and
cash payback in capital budgeting.

Distinguish between the net present
value and internal rate of return
methods.

2.

3.

4.

5.

6.

7.

8.

9.

10.

Broadening Your Perspective

Identify the steps in management’s
decision-making process.

1.

Study Objective

BE26-8
E26-11
E26-13

BE26-12
E26-13

Q26-17

Q26-18
Q26-19
Q26-20

Exploring the Web
Decision Making
Across the
Organization

Q26-16 BE26-9
BE26-10
DI26-4

Q26-12
Q26-14
Q26-15

Synthesis

E26-12
E26-14
E26-15
P26-4A
P26-5A

E26-12
P26-4A
P26-5A

E26-10

E26-8
E26-9

E26-7

E26-5
E26-6

E26-4
P26-2A

E26-2
E26-3

P26-6A
P26-4B

P26-5B
P26-6B

P26-4B
P26-5B

P26-3A
P26-3B

P26-2B

P26-1A
P26-1B

Evaluation

Decision Making All About Managerial Analysis
You
Decision Making
Across the
Across the
Organization
Activity
Organization
Real-World
Communication
Focus
Ethics Case

BE26-11

BE26-13
DI26-5

BE26-7
DI26-3

Q26-10

BE26-5

BE26-4
DI26-2

BE26-3
DI26-1

BE26-2

BE26-6

E26-1

E26-1

Analysis

Q26-9

Q26-6
Q26-7

Q26-5

Q26-3
Q26-4

Q26-1
Q26-2

Application

Q26-13

Q26-11

Q26-8

BE26-1

Knowledge Comprehension

Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems

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BLOOM’S TAXONOMY TABLE

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ANSWERS TO QUESTIONS
1.

The following steps are frequently involved in management’s decision-making process:
(a) Identify the problem and assign responsibility.
(b) Determine and evaluate possible courses of action.
(c) Make a decision.
(d) Review results of the decision.

2.

Your roommate is incorrect. Accounting contributes to the decision-making process at only two
points: (1) prior to the decision, accounting provides relevant revenue and cost data for each
course of action, and (2) following the decision, internal reports are prepared to show the actual
effect of the decision on net income.

3.

Disagree. Incremental analysis involves the identification of financial data that change under alternative
courses of action.

4.

In incremental analysis, the important point to consider is whether costs will differ (change) between the
two alternatives. As a result, (1) variable costs may change under the alternative courses of action and
(2) fixed costs may not change.

5.

The relevant data in deciding whether to accept an order at a special price are the incremental
revenues to be obtained compared to the incremental costs of filling the special order.

6.

The manufacturing costs that are relevant in the make-or-buy decision are those that will change
if the parts are purchased.

7.

Opportunity cost may be defined as the potential benefit that may be obtained by following an
alternative course of action. Opportunity cost is relevant in a make-or-buy decision when the facilities
used to make the part can be used to generate additional income.

8.

The decision rule in a decision to sell a product or to process it further is: Process further as long as the
incremental revenue from the additional processing exceeds the incremental processing costs.

9.

A sunk cost is a cost that cannot be changed by any present or future decision. Sunk costs,
therefore, are not relevant in a decision to retain or replace equipment.

10.

Net income will be lower if an unprofitable product line is eliminated when the product line is producing a positive contribution margin and its fixed costs cannot be avoided or reduced.

11.

Contribution margin per unit of limited resource is determined by dividing the contribution margin
per unit of the product by the number of units of the limited resource required to produce one unit
of the product.

12.

The screening of proposed capital expenditures may be done by a capital budgeting committee
which submits its findings to the officers of the company. The officers, in turn, select the projects
they believe to be the most worthy of funding and submit them to the board of directors. The directors
ultimately approve the capital expenditure budget for the year.

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Questions Chapter 26 (Continued)
13.

The formula for the annual rate of return technique is: Annual net income ÷ average investment.

14.

Cost of capital is the rate of return that management expects to pay on all borrowed and equity
funds. The decision rule is: A project is acceptable if its rate of return is greater than or equal to
management’s minimum rate of return (which often is its cost of capital), and the project is unacceptable
when the rate of return is less than the minimum rate of return.

15.

Pete is not correct. The formula for the cash payback technique is: Cost of the capital investment ÷
net annual cash flows. The formula for the annual rate of return is: Expected annual net income ÷
average investment.

16.

The cash payback technique is relatively easy to compute and understand. However, it should not
ordinarily be the only basis for the capital budgeting decision because it ignores the profitability of
the investment and the time value of money.

17.

The two tables are:
(1) Table 1 is the present value of a single future amount. This table is used when a project has
uneven cash flows over its useful life.
(2) Table 2 is the present value of a series of future cash flows. This table is used when a project
has equal cash flows occurring at equal intervals of time over its useful life.

18.

The decision rule is: Accept the project when net present value is zero or positive; reject the project

when net present value is negative.

19.

The steps are:
(a) Compute the rate of return factor by dividing Capital Investment by Net Annual Cash Flows.
(b) Use the factor and the present value of an annuity of 1 table to find the internal rate of return.

20.

Under the internal rate of return method, the objective is to find the rate that will make the present
value of the expected annual cash inflows equal the present value of the proposed capital expenditure.
The decision rule under the internal rate of return method is: Accept the project when the internal rate
of return is equal to or greater than the required rate of return, and reject the project when the internal
rate of return is less than the required rate.

26-8

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SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 26-1
The correct order is:

1.
2.
3.
4.

Identify the problem and assign responsibility.
Determine and evaluate possible courses of action.
Make a decision.
Review results of the decision.

BRIEF EXERCISE 26-2

Sales
Costs
Net income

Alternative
A

Alternative
B

$150,000
100,000
$ 50,000

$180,000
120,000
$ 60,000

Net Income
Increase
(Decrease)
($ 30,000
( (20,000)
($ 10,000

Alternative B is better than Alternative A.

BRIEF EXERCISE 26-3

Revenues
Costs—Variable manufacturing
Shipping
Net income

Reject
Order

Accept
Order

Net Income
Increase
(Decrease)

$0
0
0
$0

$92,000
80,000
4,000
$ 8,000

($ 92,000
((80,000)
( (4,000)
($ 8,000

The special order should be accepted.

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BRIEF EXERCISE 26-4

Variable manufacturing costs
Fixed manufacturing costs
Purchase price
Total annual cost

Make

Buy

Net Income
Increase
(Decrease)

$50,000
30,000

$
0
30,000
53,000
$83,000

$(50,000)
0)
(53,000)
$ (3,000)

$80,000

The decision should be to continue to make the part.

BRIEF EXERCISE 26-5

Sales per unit

Cost per unit
Variable
Fixed
Total
Net income per unit

Sell

Process
Further

Net Income
Increase (Decrease)

$60.00

$72.00

$ 12.00

30.00
10.00
40.00
$20.00

38.00
10.00
48.00
$24.00

(8.00)
0
( (8.00)
$ 4.00

The bookcases should be processed further because the incremental revenues
exceed incremental costs by $4.00 per unit.

BRIEF EXERCISE 26-6

Variable manufacturing costs
New machine cost
Total

Retain
Equipment

Replace
Equipment

Net 4-Year
Income
Increase
(Decrease)

$2,400,000

$1,760,000
200,000
$1,960,000

($ 640,000*
* (200,000)
$ 440,000

$2,400,000

*$160,000 X 4
The old factory machine should be replaced.
26-10

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BRIEF EXERCISE 26-7

Sales
Variable expenses
Contribution margin
Fixed expenses
Net income

Continue

Eliminate

$200,000
180,000
20,000
40,000
($ (20,000)

(

Net Income
Increase (Decrease)

0)
0
0)
($ 34,000)
($(34,000)

$(200,000)
180,000)
(20,000)
6,000)
$ (14,000)

The Eagle product line should be continued because $20,000 of contribution
margin will not be realized if the line is eliminated. This sum is greater than
the $6,000 saving of fixed costs.
BRIEF EXERCISE 26-8
Product A

Contribution margin per unit (a)
Machine hours required (b)
Contribution margin per unit of limited resource
[(a) ÷ (b)]

$11
2
$5.50

Product B
$12
2.5
$4.80

BRIEF EXERCISE 26-9
$300,000 ÷ ($10,000 + $30,000) = 7.5 years
BRIEF EXERCISE 26-10
The annual rate of return is calculated by dividing expected annual income
by the average investment. The company’s expected annual income is:
$130,000 – $80,000 = $50,000
Its average investment is:
$490,000 + $10,000
= $250,000
2
Therefore, its annual rate of return is:
$50,000/$250,000 = 20%
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BRIEF EXERCISE 26-11
Project A
Cash
9% Discount Present
Flows X
Factor
= Value
Present value of net annual cash flows
Capital investment
Positive net present value

$70,000 X

6.41766

= $449,236
395,000
$ 54,236

Project B
Cash
9% Discount Present
Flows X

Factor
= Value
Present value of net annual cash flows
Capital investment
Positive net present value

$50,000 X

6.41766

= $320,883
270,000
$ 50,883

Since Project A has a higher net present value than Project B, it should be
selected.

BRIEF EXERCISE 26-12
When net annual cash flows are expected to be equal, the internal rate of
return can be approximated by dividing the capital investment by the net
annual cash flows to determine the discount factor, and then locating this
discount factor on the present value of an annuity table.
$170,000/$33,740 = 5.03853
By tracing across on the 7-year row we see that the discount factor for 9% is
5.03295. Thus, the internal rate of return on this project is approximately 9%.

BRIEF EXERCISE 26-13
Present Value
Net annual cash flows $34,000 X 6.71
Capital investment $225,000 X 1.00

Positive net present value

$228,140
225,000
$ 3,140

The investment should be made because net present value is positive.
26-12

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SOLUTIONS FOR DO IT! REVIEW EXERCISES

DO IT! 26-1

Revenues
Costs
Net income

Reject
$ –0–
$ –0–
$ –0–

Accept
$186,000
132,000*
$ 54,000

Net Income
Increase (Decrease)
$186,000
132,000
$ 54,000

*(6,000 X $20) + (6,000 X $2)
Given the results of the above analysis, Corn Company should accept the
special order.
DO IT! 26-2
(a)

Direct materials
Direct labor
Variable manufacturing
costs
Fixed manufacturing
costs
Purchase price
Total cost

Make
$ 30,000
42,000

Buy
$ –0–
–0–

45,000

–0–

60,000
–0–
$177,000

Net Income
Increase (Decrease)
$ 30,000
42,000
45,000

40,000
165,000
$205,000

20,000
(165,000)
$ (28,000)

Given the results of the above analysis, Barney Company will incur
$28,000 of additional costs if it buys the switches.
(b)

Total Cost
Opportunity cost
Total cost

Make
$177,000
30,000
$207,000

Buy
$205,000
–0–
$205,000

Net Income
Increase (Decrease)
$(28,000)
30,000
$ 2,000

Yes, the answer is different: The analysis shows that net income will
be increased by $2,000 if Barney Company purchases the switches.
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26-13

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DO IT! 26-3

Sales
Variable costs
Contribution margin
Fixed costs
Net income

Continue
$500,000
375,000
125,000
150,000
$ (25,000)

Eliminate
$
0
0
0
40,000
$(40,000)

Net Income
Increase (Decrease)
$(500,000)

375,000
(125,000)
110,000
$ (15,000)

The analysis indicates that Lion should not eliminate that gloves and mittens
line because net income would decrease $15,000.
DO IT! 26-4
(a) Average investment = ($350,000 + 0) ÷ 2 = $175,000
Annual rate of return = $40,000 ÷ $175,000 = 22.9%
(b) Net annual cash flow = $40,000 + $70,000 = $110,000
Cash payback period = $350,000 ÷ $110,000 = 3.2 years
DO IT! 26-5
(a) Estimated annual cash inflows
Estimated annual cash outflows
Net annual cash flow

Present value of net annual
cash flows
Capital investment
Net present value
*Table 4, Appendix A.

$300,000
140,000
$160,000

Cash Flow

9% Discount

Factor

Present
Value

$160,000

4.48592*

$717,747
700,000
$ 17,747

Since the net present value is greater than zero, Maranantha should
accept the project.
(b) $700,000 ÷ 160,000 = 4.375. Using Table 2 of Appendix C and the
factors that correspond with the six-period row, 4.375 is between the
factors for 9% and 10% (just under 10%). Since that project has an
internal rate that is close to 10% and the required rate of return is only
9%, the company should accept the project.
26-14

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SOLUTIONS TO EXERCISES
EXERCISE 26-1
1.
2.
3.
4.
5.
6.
7.
8.
9.

False. The first step in management’s decision-making process is “identify
the problem and assign responsibility”.
False. The final step in management’s decision-making process is to
review the results of the decision.
True.
False. In making business decisions, management ordinarily considers
both financial and nonfinancial information.
True.
True.
False. Costs that are the same under all alternative courses of action do
not affect the decision.
False. When using incremental analysis, either costs or revenues or both
will change under alternative courses of action.
False. Sometimes variable costs will not change under alternative courses
of action, but fixed costs will.

EXERCISE 26-2

(a)

Revenues (40,000 X $6.00)
Cost of goods sold
Operating expenses
Net income

Reject
Order
$0
0
0
$0

Accept
Order
$240,000
168,000 (1)
62,000 (2)
$ 10,000

Net Income
Increase
(Decrease)
$ 240,000
((168,000)
( (62,000)
$ 10,000

(1) Variable cost of goods sold = $2,400,000 X 70% = $1,680,000.

Variable cost of goods sold per unit = $1,680,000 ÷ 400,000 = $4.20.
Variable cost of goods sold for the special order = $4.20 X 40,000 =
$168,000.
(2) Variable operating expenses = $900,000 X 60% = $540,000;
$540,000 ÷ 400,000 = $1.35 per unit;
40,000 X $1.35 = $54,000;
$54,000 + $8,000 = $62,000.
(b) As shown in the incremental analysis, Wyco Company should accept
the special order because incremental revenues exceed incremental
expenses by $10,000.
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EXERCISE 26-3
(a)

Revenues
Materials ($0.50)
Labor ($1.50)
Variable overhead ($1.00)
Fixed overhead
Sales commissions

Net income

Reject
Order

Accept
Order

$ -0-0-0-0-0-0$ -0-

$23,750
(2,500)
(7,500)
(5,000)
(5,000)
-0$ 3,750

Net Income
Increase
(Decrease)
$23,750
(2,500)
(7,500)
(5,000)
(5,000)
-0$ 3,750

(b) As shown in the incremental analysis, Innova should accept the special
order because incremental revenue exceeds incremental expenses by
$3,750.

(c) It is assumed that sales of the golf disc in other markets would not be
affected by this special order. If other sales were affected. Innova would
have to consider the lost sales in making the decision. Second, if Innova
is operating at full capacity, it is likely that the special order would be
rejected.

EXERCISE 26-4
(a)

Direct materials (40,000 X $4.00)
Direct labor (40,000 X $6.00)
Variable manufacturing costs
($240,000 X 50%)
Fixed manufacturing costs
Purchase price (40,000 X $13.50)
Total annual cost

26-16

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Make
$160,000
240,000

$

0
0

Net Income
Increase
(Decrease)
$ 160,000
240,000

120,000
40,000
0
$560,000

0
40,000
540,000
$580,000

120,000
0
( (540,000)
($ (20,000)

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EXERCISE 26-4 (Continued)
(b) No, Shannon Inc. should not purchase the lamps. As indicated by the
incremental analysis, it would cost the company $20,000 more to purchase
the lamps.
(c) Yes, by purchasing the lamp shades, a total cost saving of $15,000 will
result as shown below.

Total annual cost (above)
Opportunity cost
Total cost

Make

Buy

$560,000
35,000
$595,000

$580,000
0
$580,000

Net Income
Increase
(Decrease)
$(20,000)
35,000)
$ 15,000)

EXERCISE 26-5

Sell
(Basic Kit)

Process Further
(Stage 2 Kit)

Net Income
Increase
(Decrease)

Sales per unit
Costs per unit
Direct materials
Direct labor
Total

$27.00

($33.00

$ 6.00)

$12.00
0
$12.00

( ) $ 6.00 (1)
( ) 9.00 (2)

( ) $15.00)

$(6.00)
(9.00)
$(3.00)

Net income per unit

$15.00

($18.00)

$ 3.00)

(1) The cost of materials decreases because Stacy can make two Stage 2 Kits
from the materials for a basic kit.
(2) The total time to make the two kits is one hour at $18 per hour or $9
per unit.
Stacy should carry the Stage 2 Kits. The incremental revenue, $6.00, exceeds
the incremental processing costs, $3.00. Thus, net income will increase by
processing the kits further.

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EXERCISE 26-6
(a)

Sales per unit
Costs per unit
Materials
Labor
Variable overhead (70%)
Fixed overhead
Total
Net income per unit

Sell

Process
Further

Net Income
Increase
(Decrease)

$400

($450

$ 50

150
70
49
21
$290
$110

(155
( 90
63
21
329
$121

(5)
(20)
(14)
-0(39)
$ 11

(b) As shown in the incremental analysis, Donkey Bikes should process further
(rather than sell unassembled) because incremental revenue exceeds
incremental expenses by $11 per unit.

EXERCISE 26-7

Operating costs
New machine cost (Depr.)
Salvage value (old)
Total

Retain
Machine

Replace
Machine

Net Income
Increase
(Decrease)

$120,000 (1)
0
0
$120,000

($100,000)(2)
( 21,000)
( (5,000)
($116,000

($ 20,000)
( (21,000)
( 5,000)
($ 4,000)

(1) $24,000 X 5.
(2) $20,000 X 5.
The current machine should be replaced. The incremental analysis shows
that net income for the five-year period will be $4,000 higher by replacing the

current machine.

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EXERCISE 26-8

Sales
Variable expenses
Cost of goods sold
Operating expenses
Total variable
Contribution margin
Fixed expenses
Cost of goods sold
Operating expenses
Total fixed
Net income (loss)

Continue

Eliminate

$ 98,200)

$

(56,000)
12,000)
68,000)
30,200)
(20,470)
26,600)
47,070)
$(16,870)

(

Net Income
Increase
(Decrease)

0

$(98,200)

0
0
0
0

(56,000)

12,000)
68,000
(30,200)

(20,470
26,600
47,070
$(47,070)

(

0
0)
0)
$(30,200)

Judy is incorrect. The incremental analysis shows that net income will be
$30,200 less if the Ketchum Division is eliminated. This amount equals the
contribution margin that would be lost by discontinuing the division.
EXERCISE 26-9
(a)

$30,000 + $75,000 – $30,000 = $75,000

(b)

Stunner
Sales
Variable expenses
Contribution margin

Fixed expenses
Net income

$300,000
150,000
150,000
142,500*
$ 7,500

Double-Set
$500,000
200,000
300,000
262,500**
$ 37,500

Total
$800,000
350,000
450,000
405,000
$ 45,000

*$30,000 + [($300,000 ÷ $800,000) X $300,000]
**$75,000 + [($500,000 ÷ $800,000) X $300,000]
(c)

As shown in the analysis above, Shatner should not eliminate the
Mega-Power product line. Elimination of the line would cause net income
to drop from $75,000 to $45,000. The reason for this decrease in net

income is that elimination of the product line would result in the loss
of $60,000 of contribution margin while saving only $30,000 of fixed
expenses.

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EXERCISE 26-10
(a)

Product
A
Contribution margin per unit (a)
Machine hours required (b)
Contribution margin per unit of limited resource
(a) ÷ (b)

$7
2
$3.50

B

C

$4
1
$4

$6
2
$3

(b) Product B should be manufactured because it results in the highest
contribution margin per machine hour.
(c) (1)
A
Machine hours (a) (3,000 ÷ 3)
Contribution margin per unit of
limited resource (b)
Total contribution margin [(a) X (b)]

Product
B

C

1,000

1,000

1,000

$ 3.50
$3,500

$
4
$4,000

$
3
$3,000

The total contribution margin is $10,500 ($3,500 + $4,000 + $3,000).
(2)

Product
B
Machine hours (a)
Contribution margin per unit of limited resource (b)
Total contribution margin [(a) X (b)]

3,000
$
4
$12,000

EXERCISE 26-11
(a) Cost of hoist: $15,000 + $2,900 + $820 = $18,720.
Net annual cash flow:
Number of extra mufflers: 4 X 52 weeks

Contribution margin per muffler ($65 – $35 – $10)
Total net annual cash flow (a) X (b)
Cash payback = $18,720 ÷ $4,160 = 4.5 years.

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EXERCISE 26-11 (Continued)
(b) Average investment: ($18,720 + $1,080) ÷ 2 = $9,900.
Annual depreciation: ($18,720 – $1,080) ÷ 5 = $3,528.
Annual net income: $4,160 – $3,528 = $632.
Average annual rate of return = $632 ÷ $9,900 = 6.4% (rounded).

EXERCISE 26-12
(a)
Year
1

2
3

AA
Annual Net
Cash Flow
$ 7,000
9,000
15,000

Cumulative Net
Cash Flow
$ 7,000
16,000
31,000

Cash payback 2.40 years (2 + .4*)
*$22,000 – $16,000 = $6,000;
$6,000 ÷ $15,000 = .4
BB
22,000 ÷ (28,500 ÷ 3) = 2.32 years

Year
1
2
3

CC
Annual Net
Cash Flow

$13,000
10,000
9,000

Cumulative Net
Cash Flow
$13,000
23,000
32,000

Cash payback 1.9 years (1 + .9*)
*$22,000 – 13,000 = $9,000;
$9,000 ÷ $10,000 = .9
The most desirable project is CC because it has the shortest payback
period. The least desirable project is AA because it has the longest payback period. As indicated, only CC is acceptable because its cash
payback is 1.9 years.

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EXERCISE 26-12 (Continued)
(b)

AA

Year

12%
Discount
Factor

Net
Annual
Cash
Flow

BB

Present
Value

1
.89286
$ 7,000 $ 6,250
2
.79719
9,000
7,175
3
.71178
15,000
10,677

Total present value
24,102
Investment
22,000
Net present value
$ 2,102

Net
Annual
Cash
Flow
$9,500
9,500
9,500

CC

Present
Value

Net Cash
Flow

$ 8,482
$13,000
7,573
10,000
6,762
9,000
22,817 (1)

22,000
$
817

Present
Value
$ 11,607
7,972
6,406
25,985
22,000
$ 3,985

(1) This total may also be obtained from Table 2: $9,500 X 2.40183 =
$22,817. Project CC is still the most desirable project. Also, on
the basis of net present values, all of the projects are acceptable.
Project BB is the least desirable.
EXERCISE 26-13
(a) (1) Annual rate of return: $18,000 ÷ [($150,000 + $0) ÷ 2] = 24%.
(2) Cash payback: $150,000 ÷ $48,000 = 3.13 years.
(b)

Item

Amount

Years

PV Factor

Present Value

Net annual cash flows
Capital investment
Positive net present value

$ 48,000
$150,000

1-5
Now

3.60478
1.00000

$173,029
150,000
$ 23,029

EXERCISE 26-14
(a)

Project

Investment

÷

(Income + Depreciation)

=

Internal
Rate of
Return
Factor

22A
23A
24A

$240,000
$270,000
$288,000

÷
÷
÷

($13,300 + $40,000)
($21,000 + $30,000)
($20,000 + $36,000)

=
=
=

4.503
5.294
5.143

Closest
Discount
Factor

Internal
Rate of
Return

4.48592
5.32825
5.14612

9%
12%
11%

(b) The acceptable projects are 23A and 24A because their rates of return
are equal to or greater than the 11% minimum required rate of return.

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EXERCISE 26-15
(a) Project A: ($50,000 X 3.79079) – $200,000 = $(10,461)
Project B: ($65,000 X 4.86842) – $300,000 = $16,447

(b) Vasquez should invest in Project B only. Project B is acceptable because
it has a positive net present value. Project A is unacceptable because it
has a negative net present value.

(c) Project A (adjusted): ($60,000 X 3.79079) – $220,000 = $7,447. Vasquez’
decision would change. Now both projects are acceptable.

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SOLUTIONS TO PROBLEMS
PROBLEM 26-1A

(a) Production capacity = 20,000 units (16,000 ÷ 80%).
Units for special order = 4,000 (20,000 – 16,000).
Current selling price = $20 ($320,000 ÷ 16,000).
Special order price = $15 ($20 X 75%).

(b) Variable manufacturing cost per unit ..............................................
Fixed manufacturing cost per unit ($56,000 ÷ 16,000) ...............
Total manufacturing cost per unit............................................
(c)

Revenues (4,000 X $15)
Costs
Variable manufacturing
(4,000 X $8.00)
Sales commission
Shipping (4,000 X $2.00)
Stamping machine
Total costs
Net income

$ 8.00
3.50
$11.50

Reject
Order

Accept
Order

Net Income
(Increase
(Decrease)

$0

$60,000

($ 60,000

0

32,000

((32,000)

0
0
0
0
$0

3,500
8,000
2,500
46,000
$14,000

(3,500)
(8,000)
( (2,500)
(46,000)
($ 14,000

Korte Company should accept the special order because it will produce

$14,000 of incremental net income.
(d) The cost of the special order = $46,000 ÷ 4,000 = $11.50 Thus, the
minimum selling price to produce net income of $1.20 per unit is $12.70.
(e) Nonfinancial factors to be considered are: (1) possible effects on domestic
sales, (2) possible alternative uses of the unused plant capacity, and
(3) ability to meet customer’s schedule for delivery without increasing
costs.

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PROBLEM 26-2A

(a)
Make
Direct material (36,000 X $2.00)
Direct labor (2,000 X 3 X $11.00)
Manufacturing overhead costs
Indirect labor
Utilities
Depreciation
Property taxes & insurance

Cost of goods purchased
(36,000 X $3.90)
Receiving
Freight (36,000 X $.30)
Storage (6,000 X $.60)
Total annual cost

$ 72,000
66,000

Net Income
Increase
(Decrease)

Buy
$

0
0

$ 72,000
66,000

5,500
1,300
1,600
1,000
0

0

0
0
0
140,400

5,500
1,300
1,600
1,000
( (140,400)

0
0
3,600
$151,000

8,500
10,800
0
$159,700

( (8,500)
( (10,800)
3,600
($ (8,700)

Decision: Continue to make the part. The cost to make the part and rent
storage space for the finished product is $151,000, while the cost to buy
the part and use the excess space for storage is $159,700. Hence,
continuing to make the part will result in an annual cost savings of $8,700.

(b)

Total annual cost
Opportunity cost
Total cost

Make

Buy

Net Income
Increase
(Decrease)

$151,000
10,000
$161,000

$159,700
0
$159,700

($ (8,700)
( 10,000)
($ 1,300)

Decision: Buy the part.
(c) Nonfinancial factors include: (1) the adverse effect on employees if the
part is purchased, (2) how long the supplier will be able to satisfy the
Martinez Manufacturing Company’s quality control standards at the quoted

price per unit, and (3) will the supplier deliver the units when they are
needed?

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