CHAPTER 12
PRICING DECISIONS AND COST MANAGEMENT
12-17 Relevant-cost approach to short-run pricing decisions.
1.
Analysis of special order:
Sales, 3,000 units  $75
Variable costs:
Direct materials, 3,000 units  $35
Direct manufacturing labor, 3,000 units  $10
Variable manufacturing overhead, 3,000 units  $6
Other variable costs, 3,000 units  $5
Sales commission
Total variable costs
Contribution margin
$225,000
$105,000
30,000
18,000
15,000
8,000
176,000
$ 49,000
Note that the variable costs, except for commissions, are affected by production volume, not sales
dollars.
If the special order is accepted, operating income would be $1,000,000 + $49,000 = $1,049,000.
2.
Whether McMahon’s decision to quote full price is correct depends on many factors. He is incorrect if
the capacity would otherwise be idle and if his objective is to increase operating income in the short
run. If the offer is rejected, San Carlos, in effect, is willing to invest $49,000 in immediate gains
forgone (an opportunity cost) to preserve the long-run selling-price structure. McMahon is correct if he
thinks future competition or future price concessions to customers will hurt San Carlos’s operating
income by more than $49,000.
There is also the possibility that Abrams could become a long-term customer. In this case, is a price
that covers only short-run variable costs adequate? Would Holtz be willing to accept a $8,000 sales
commission (as distinguished from her regular $33,750 = 15%  $225,000) for every Abrams order of
this size if Abrams becomes a long-term customer?
12-1
12-25 Life-cycle product costing.
1.
Variable cost per unit = Production cost per unit + Mktg and distribn. cost per unit
= $20 + $5 = $25
Contribution margin per unit = Selling price – Variable cost per unit = $50 – $25 = $25
Marketing and
Total fixed
Design
Production
distribution
costs over life =
+
+
fixed costs
fixed costs
fixed costs
of robot
= $650,000 + $3,560,000 + $2,225,000
= $6,435,000
BEP in units =
2a.
2b.
Fixed costs
$6, 435, 000

 257, 400 units
Contribution margin per unit
$25
Option A:
Revenues ($50  500,000 units)
Variable costs ($25  500,000 units)
Fixed costs
Operating income
$25,000,000
12,500,000
6,435,000
$ 6,065,000
Option B:
Revenues
Year 2 ($70  100,000 units)
Years 3 & 4 ($40  600,000 units)
Total revenues
Variable costs ($25  700,000 units)
Fixed costs
Operating income
$ 7,000,000
24,000,000
31,000,000
17,500,000
6,435,000
$ 7,065,000
Over the product’s life-cycle, Option B results in an overall higher operating income of $1,000,000
($7,065,000 – $6,065,000).
12-2
12-29 Target prices, target costs, value engineering, cost incurrence, locked-in cost, activity-based
costing.
1.
Direct materials costs
Direct manufacturing labor costs
Machining costs
Testing costs
Rework costs
Ordering costs
Engineering costs
Total manufacturing costs
Old
CE100
$182,000
28,000
31,500
35,000
14,000
3,360
21,140
$315,000
Cost Change
$2.20  7,000 = $15,400 less
$0.50  7,000 = $3,500 less
Unchanged because capacity same
(20%  2.5  7,000) × $2 = $7,000
(See Note 1)
(See Note 2)
Unchanged because capacity same
New
CE100
$166,600
24,500
31,500
28,000
5,600
2,100
21,140
$279,440
Note 1:
10% of old CE100s are reworked. That is, 700 (10% of 7,000) CE100s made are reworked. Rework costs =
$20 per unit reworked  700 = $14,000. If rework falls to 4% of New CE100s manufactured, 280 (4% of
7,000) New CE100s manufactured will require rework. Rework costs = $20 per unit  280 = $5,600.
Note 2 :
Ordering costs for New CE100 = 2 orders/month  50 components  $21/order
= $2,100
Unit manufacturing costs of New CE100 = $279,440 ÷ 7,000 = $39.92
2. Total manufacturing cost reductions based on new design
Reduction in unit manufacturing costs based on new design
= $315,000 – $279,440
= $35,560
= $35,560 ÷ 7,000
= $5.08 per unit.
The reduction in unit manufacturing costs based on the new design can also be calculated as
Unit cost of old design, $45 ($315,000 ÷ 7,000 units) – Unit cost of new design, $39.92 = $5.08
Therefore, the target cost reduction of $6 per unit is not achieved by the redesign.
3. Changes in design have a considerably larger impact on costs per unit relative to improvements in
manufacturing efficiency ($5.08 versus $1.50). One explanation is that many costs are locked in once
the design of the radio-cassette is completed. Improvements in manufacturing efficiency cannot reduce
many of these costs. Design choices can influence many direct and overhead cost categories, for
example, by reducing direct materials requirements, by reducing defects requiring rework, and by
designing in fewer components that translate into fewer orders placed and lower ordering costs.
12-3
12-30 Cost-plus, target return on investment pricing.
1. Target operating income = Return on capital in dollars = $13,000,000  10% = $1,300,000
2.
Revenues*
Variable costs [($3.50 + $1.50)  500,000 cases
Contribution margin
Fixed costs ($1,000,000 + $700,000 + $500,000)
Operating income (from requirement 1)
$6,000,000
2,500,000
3,500,000
2,200,000
$1,300,000
* solve backwards for revenues
Selling price =
$6,000,000
 $12 per case.
500,000 cases
Markup % on full cost
Full cost = $2,500,000 + $2,200,000 = $4,700,000
Unit cost = $4,700,000 ÷ 500,000 cases = $9.40 per case
Markup % on full cost =
$12 - $9.40
 27.66%
$9.40
3.
Budgeted Operating Income
For the year ending December 31, 20xx
Revenues ($14  475,000 cases*)
$6,650,000
Variable costs ($5  475,000 cases)
2,375,000
Contribution margin
4,275,000
Fixed costs
2,200,000
Operating income
$2,075,000
*New units = 500,000 cases  95% = 475,000 cases
Return on investment =
$2,075,000
 15.96%
$13,000,000
Yes, increasing the selling price is a good idea because operating income increases without increasing
invested capital, which results in a higher return on investment. The new return on investment exceeds
the 10% target return on investment.
12-4