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Cheyenne Company operates a small factory in which it manufactures two products: C and D....

Question:

Cheyenne Company operates a small factory in which it manufactures two products: C and D. Production and sales results for last year were as follows.

CD(respectively)

Units sold 9,000 19,500

Selling price per unit $96 $78

Variable cost per unit 53 41

Fixed cost per unit 24 24

For purposes of simplicity, the firm averages total fixed costs over the total number of units of C and D produced and sold.

The research department has developed a new product (E) as a replacement for product D. Market studies show that Cheyenne Company could sell 11,800 units of E next year at a price of $113; the variable cost per unit of E is $45. The introduction of product E will lead to a 11% increase in demand for product C and discontinuation of product D. If the company does not introduce the new product, it expects next year?s results to be the same as last year?s.

Compute company profit with products C & D and with products C & E.

a. Net profit with products C & D ($

b. ) b.Net profit with products C & E ($)

c. Should Cheyenne Company introduce product E next year

Relevant Costing

Relevant costing involves companies considering specific costs that will impact decision making. Examples of such decisions include make or buy decisions and special order decisions. Make or buy decisions are outsourcing decisions where companies calculate the costs of manufacturing a product themselves or purchasing them from an external supplier. Special order decisions involve the calculation of costs associated with once-off, short term decisions when deciding whether to supply goods or services to a customer. Relevant costs are future costs that differ between alternatives when making decisions. An example of a relevant cost includes the cost of direct material in make or buy decisions. If the company decides to buy future products from an external supplier, it will not incur direct material costs. However, if a company chooses not to purchase products and continues manufacturing its own products, it will incur direct material costs. If costs do not differ between alternatives, they are considered irrelevant costs and will not be included in decision making. An example of irrelevant cost includes fixed costs in special order decisions. Fixed costs do not change regardless of whether the special order is accepted or not, hence it is irrelevant. Besides quantitative data, companies will also need to examine qualitative information before making decisions. An example of qualitative information includes the reliability of an external supplier if a company decides to outsource manufacturing.

Answer and Explanation:

a.

C D Total
Selling Price 96 78
Variable Cost per unit 53 41
Contribution Margin per unit 43 37
Units Sold 9,000 19,500
Total Contribution 387,000 721,500 1,108,500

Total Fixed Costs of C and D = (24 x 9,000) + (24 x 19.500) = 216,000 + 468,000 = 684,000

Net Income = 1,108,500 - 684,000 = 424,500

b.

C E Total
Selling Price 96 113
Variable Cost per unit 53 45
Contribution Margin per unit 43 68
Units Sold 9,990 11,800
Total Contribution 429,750 802,400 1,232,150

Net Income = 1,232,150 - 684,000 = 548,150

c.

Based on quantitative analysis, Cheyenne Company should introduce Product E as it will result in increased profits of $123,650 (548,150 - 424,500).


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Relevant Costs in Eliminating a Product or Segment

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