Short-Run Alternative Choice Decisions

• Alternative choice decisions: manager seeks to choose best out of several

alternatives.
• Introduces construct of differential costs and revenues for several types of
problems, each having a relatively short time horizon.

Differential Costs

• Costs that are different under one set of conditions than under another.
• Avoidable costs – costs that may be avoided if a specific course of action is
not taken.
• Out-of-pocket costs – costs requiring cash disbursements in the current
accounting period or additional costs that incurred in a specific course of
action.
• Opportunity cost –value / income lost or sacrificed by giving up an
alternative course of action.

Sunk Cost

• a cost that has already been incurred and therefore cannot be changed by
any decision currently being considered.
• Not differential cost.

Alternative Choice Problems

• Change of operation method.

• Make or buy.
• Constrained resources and product mix
• Discontinuing a product / business segment
• Additional business (e.g. special orders)
• Sell or process further
Exercises

1. Ilaw Inc. budgeted sales of 400,000 lamps at P20 per lamp. Variable manufacturing costs were budgeted at P8
per unit and fixed manufacturing costs were also budgeted at P5 per unit. A special order offering to buy
40,000 lamps at P11.50 per lamp was received by Ilaw. Ilaw has sufficient capacity to manufacture the
additional lamps; however, the production would have to be done by the present work force on an overtime
basis at an estimated additional cost of P1.50 per lamp. Ilaw will not incur any selling expenses from this
special order. Should Ilaw accept this offer?

2. You have been approached by a foreign customer who wants to place an order for 15,000 units of Product C
at P22.50 per unit. You currently sell this item for P39 per unit and the item has a total cost of P29 per unit.
Further analysis reveals that you will not be paying sales commission of P2.50 per unit on this sales and its
packaging requirement will save you an additional P1.50 per unit. However, the additional graphics required on
this job will cost you P30,000. Note also that fixed costs amounting to P400,000 for the production of 50,000
units of such products will not change. Should you accept the special order?

3. The cost to produce 24,000 units consist of the following:

Direct materials P 360,000

Direct labor 540,000
Factory overhead, all fixed 290,000
Selling expense (35% variable, 65% fixed) 240,000

What unit price would the company have to charge to make P22,500 on a sale of 1,500 additional units that
would be shipped out of the normal market area?

4. Alejar Corp. manufactures a product with a unit variable cost of P50 and a unit sales price of P88. Fixed
manufacturing costs were P240,000 when 10,000 units were produced and sold. The company has a one-time
opportunity to sell an additional 3,000 units at P70 per unit in a foreign market. This special sale would not
affect its present sales. If the company has sufficient capacity to produce the additional units, what will be the
effect on net income as a result of accepting the special order?

5. Refer to number 4. Assume that selling the 3,000 units will affect regular sales. This means that the 3,000 units
will come from the regular sales and that Alejar does not have enough capacity to produce the 3,000 units. Will
Alejar accept the special order?

6. A business is currently operating at 90% and is currently purchasing a part, which is being used in its
manufacturing operations for P15 per unit. The unit cost for the business to make the part is P20, including
fixed costs and P12, not including fixed costs. Fixed costs will remain the same regardless of buying or making
the part. If 30,000 units of the part are normally purchased during the year could be manufactured using the
unused capacity, what would be the amount of savings from making the part rather than purchasing it?

7. Sylvan Processing Corp. is considering whether to make 2,000 units of product Whirl, which has a total unit
cost of P16 or buy it from an outside supplier for P15 per unit. A further analysis shows that if product Whirl is
outsourced, fixed costs of P8,000 attributable to this product will be reduced by 25%. Should Sylvan make or
buy the product?

8. It costs P450,000 to make 15,000 units of a part in a manufacturing plant. This cost includes direct material of
P90,000, direct labor of P120,000, variable overhead of P15,000 and P225,000 in fixed overhead inclusive of
P45,000 in depreciation and common overhead allocation of P150,000. The balance is for the section
supervisor’s salary. The part can be purchased for P20. If the part is purchased, the space released can be
rented to potential lessees for P65,000 and the supervisor will be unemployed. If the company decides to
purchase the part, what will be the effect on income?

9. Mars Corp. is a multi-product firm that currently manufactures 30,000 units of Part Q each month for use in the
production of its main product. The facilities now being used to produce Part Q have a fixed monthly cost of
P150,000 and a capacity to produce 84,000 units per month. If Mars were to buy the part from an outside
supplier, the facilities would be idle, but 40% of the fixed costs will continue. The variable production cost of
Part Q is P11 per unit. If Mars is able to purchase the part from an outside supplier, the purchase price is
P12.875 per unit. What is the monthly usage at which it will be indifferent between making or buying product
Q?
 10. Katawa Corp. produces two products from a joint process. Information about the two joint products follows:

X Y
Anticipated Production (pounds) 2,000 4,000
Selling Price per pound, as is (at split off) P30 P16
Additional Processing Cost per pound after split off (all variable) P15 P30
Selling Price per pound after further processing P40 P50

The joint cost is P85,000. Katawa is currently selling the products as is. Should Katawa process further
products X and Y? How much will be the increase in net income?

11. Matador Manufacturing schedules a weekly production of 15,000 units of Product M and 30,000 units of
Product N for which P800,000 common variable costs are incurred. These products can be sold as is or
processed further. Further processing of either product does not delay the production of subsequent batches of
the joint products. Below are some data:

M N
Unit price without further processing P25 P19
Unit price with further processing P31 P23
Total separate weekly variable cost of further processing P100,000 P110,000

Should Matador sell or process further Products M and N?

12. Hilo Corp. manufactures electricity carpentry tools. The production department had met all production
requirements for the current month and has an opportunity to produce additional units with excess capacity.
Unit selling prices and unit costs for three different drill products are as follows:

Home Deluxe Pro

Selling Price P58 P65 P80
Direct Material 16 20 19
Direct Labor (Workers are paid P10 per hour) 10 15 20
Variable Overhead 8 12 16
Fixed Overhead 16 5 15

Variable overhead is applied on the basis of direct labor pesos, while fixed overhead is applied on the basis of
machine hours. There is sufficient demand for the additional production of any model in the product line. If it has
a limited amount of labor time, to which product or products should Hilo Corp. devote its excess production?

13. Product A sells for P12 per unit and its variable cost per unit is P10. Product B sells for P15 per unit and its
variable cost per unit is P12. The plant capacity is 350,000 machine hours and Product A requires 48 minutes
to complete while Product B requires 75 minutes to complete. Which of the following will provide the best sales
mix of Product A and Product B assuming the market limitation of Product A is 200,000 units and the market
limitation of Product B is 250,000 units?

For numbers 14 to 17, answer the following problem:

Nucup Company operates two stores in Luzon, one in Manila and another in Quezon City. The operating results for the
month of October 2007, which are also the approximate monthly results, are condensed as follows:

Manila QC Total
Sales P400,000 P600,000 P1,000,000
Less: Variable Cost (160,000) ( 420,000) ( 580,000)
Contribution Margin 240,000 180,000 420,000
Less: Direct Fixed Cost (100,000) (200,000) ( 300,000)
Store Margin 140,000 ( 20,000) 120,000
Less: Indirect Fixed Cost (allocated based on peso sales) ( 20,000) ( 30,000) ( 50,000)
Operating Income P120,000 (P50,000) P70,000

Additional Information:
  30% of each store’s direct fixed cost cannot be eliminated even if either store is closed.
 If the Quezon City Store were closed, the Manila sales would decrease by 20%. However, closing the
Manila Store would not affect the Quezon City sales.

14. The Quezon City Store suffered in operating loss of P50,000. Should the store be closed? What is the effect
on overall operating income?

15. In order to improve the profitability of the Quezon City Store, Nucup is considering a promotional campaign
that would not affect the Manila Store. The campaign would cost P300,000 annually and it is expected to
increase the Quezon City Store Sales by 20%. The campaign would result in a monthly increase (decrease) in
overall operating income of?

16. Assume that at present (refer to the original data), one-half of the Quezon City sales are from items sold at
variable cost to attract customers to the store. Nucup is considering to stop selling such items. This action
would reduce the remaining sales by 20% and the direct cost to 85%. The changes would not affect the Manila
Store. The company’s decision to eliminate the items sold at variable cost would result in a monthly increase
(decrease) in overall operating income by?

17. Refer to the original data. Nucup is considering a promotional campaign for the whole company, which will
increase sales in both stores by 20% and double the total indirect fixed costs. What will be the effect on overall
operating income?

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