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• Due on Jul. 25, 2009
• Asked on Jul. 23, 2009 at 11:15:01AM

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Q:
ACCT 346
Relevant Cost Exercise

Name_________________

1. Mr. Soapy, President of Soapys Car Wash, has just written a check for \$20,000 as full payment for the new waxing machine installed today. The machine cost \$15,000 per year to operate (exclusive of depreciation). It will have no disposal value at the end of its four-year useful life. The first car to go through the new machine, is that of a sales rep for another car wash machine manufacturer. He says your new machine works pretty well, but that particular model is prone to scratching customers car paint and breaking side mirrors. His machine doesnt do that, and only costs \$24,000. Annual operating costs of his machine are \$9,000. His machine will also have a four-year useful life and have zero disposal value in four years. He informs you that there is a combination car wash and auto body shop on the other side of town. They will pay you \$10,000 for the newly purchased old machine, but the transport company will charge you \$2,000 to move it across town. In either case, annual sales will be \$150,000 and other cash expenses will be \$110,000.

Requirement A: Indicate if the following data is relevant or irrelevant.

\$20,000 cost of the old machine _____________________

\$24,000 cost of the new machine _____________________

\$15,000 old machine operating costs _____________________

\$9,000 new machine operating costs _____________________

Annual sales of \$150,000 _____________________

Other cash expenses of \$110,000. _____________________

\$10,000 value of old machine today _____________________

\$2,000 relocation charge of old machine____________________

Requirement B: What is the cost differential between the two alternatives? Should Mr. Soapy purchase the new machine?

2. The Squeaky Company makes a motor for carpet cleaners; it is the only product the company makes. Maximum production capacity of the company is 90,000 units. For 2002 budgeted sales are 80,000 units at \$50 each. Variable costs are \$35 per unit and total fixed expenses are \$750,000. Interest expenses will be \$50,000 and the tax rate is 34%.

a. An order has been received for 6,000 additional units at a reduced price of \$40 per unit. Special modifications to each motor would add \$4 per unit to the variable costs. Using relevant data only, how much would this special order increase or decrease earnings before taxes? Should the company accept this order?

b. (Disregard item a) An order is received for 20,000 units at a sales price of \$45 per unit. There would be no changes in the cost components but some of the regular sales would have to be rejected. Using relevant data only, what would be the increase or decrease in earnings before taxes if this order is accepted? From a financial point of view should the company accept the Order?

3. The Gill Bates Co. produces two products, Ones and Zeroes, for sale to home computer users. They are produced in a joint process called digitalization. The joint (or common) costs incurred are \$500,000 for a standard production run that produces 60,000 gallons of Ones, and 40,000 gallons of Zeroes. Ones sell for \$8 per gallon, and Zeroes sell for \$3 per gallon. Joint costs are allocated based on the gallons of output volume (60% to Ones, and 40% to Zeroes). By processing further at a cost of \$1.00 per gallon of Ones and \$1.25 per gallon of Zeroes, the company can increase the sales price of  Ones to \$8.75 per gallon, and the Price of Zeroes to \$4.50. Using relevant data only, which, if either, should the company process further?

4. List the other situations where relevant costs might be an issue and how an informed manager would use relevant costs in each situation to make a proper business decision.

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