Differential Analysis

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Differential Analysis

  1. 1. UNIVERSIDAD CUAUHTEMOC CAMPUS AGUASCALIENTES Differential Analysis Cost Analysis Maestría en Administración
  2. 2. Differential Analysis Universidad Cuauhtémoc – Maestría en Administración Contents Leasing or Selling Equipment1 Discontinuing an unprofitable segment2 Manufacturing or Purchasing a needed part3 Replacing usable fixed assets4 Processing Further or selling and intermediate product5 Accepting additional business at a special price6
  3. 3. Differential Analysis Decisions Differential Analysis Alternative A or Alternative B Differential revenue – Differential costs Differential income or loss Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  4. 4. Lease or Sell Equipment Marcus Company Marcus Company is considering disposing of equipment that cost $200,000 and that has $120,000 of accumulated depreciation. Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  5. 5. Lease or Sell Equipment Marcus Company Sell equipment to Broker The equipment can be sold through a broker for $100,000, less a 6% commission. Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  6. 6. Lease or Sell Equipment Marcus Company Lease equipment to Potamkin Company ORPotamkin Company, the lessee, has offered to lease the equipment for five years for a total consideration of $160,000. Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  7. 7. Lease or Sell Equipment Marcus Company At the end of the fifth year, the equipment is expected to have no residual value. During the period of the lease, Marcus Company expects to incur repair, insurance, and property taxes estimated at $35,000. Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  8. 8. Proposal to Lease or Sell Equipment January 22, 2010 Differential revenue from alternatives: Revenue from lease $160,000 Revenue from sales 100,000 Differential revenue from lease $60,000 Lease the equipment! Differential cost of alternatives: Repairs, insurance, taxes $ 35,000 Commission expense on sale 6,000 Differential cost of lease 29,000 Net differential income from the lease alternative $31,000 Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  9. 9. Discontinue a Segment or Product Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  10. 10. Sales $100,000 $900,000 $1,000,000 Cost of goods sold: Variable costs $ 60,000 $420,000 $ 480,000 Fixed costs 20,000 200,000 220,000 Total cost of goods sold $ 80,000 $620,000 $ 700,000 Gross profit $ 20,000 $280,000 $ 300,000 Operating expenses: Variable expenses $ 25,000 $155,000 $ 180,000 Fixed expenses 6,000 45,000 51,000 Total operating expenses $ 31,000 $200,000 $ 231,000 Income (loss) from operations $ (11,000) $ 80,000 $ 69,000 Battle Creek Cereal Co. Condensed Income Statement For the Year Ended December 31, 2009 Should Bran Flakes be discontinued? Differential items Variable cost $ 60,000 Sales $100,000 Variable expenses $ 25,000 Bran Flakes Other Cereals Total
  11. 11. Battle Creek Cereal Co. Condensed Income Statement For the Year Ended December 31, 2009 Differential items Sales $100,000 $900,000 $1,000,000 Cost of goods sold: Variable costs $ 60,000 $420,000 $ 480,000 Fixed costs 20,000 200,000 220,000 Total cost of goods sold $ 80,000 $620,000 $ 700,000 Gross profit $ 20,000 $280,000 $ 300,000 Operating expenses: Variable expenses $ 25,000 $155,000 $ 180,000 Fixed expenses 6,000 45,000 51,000 Total operating expenses $ 31,000 $200,000 $ 231,000 Income (loss) from operations $ (11,000) $ 80,000 $ 69,000 Variable cost $ 60,000 Sales $100,000 Variable expenses $ 25,000 Bran Flakes Other Cereals Total If Bran Flakes is discontinued, net income will decrease by $15,000.
  12. 12. Proposal to Discontinue Bran Flakes January 22, 2010 Differential revenue from annual sales of Bran Flakes: Revenue from sales $100,000 Differential cost of annual sales of Brian Flakes: Variable cost goods sold $60,000 Variable operating expenses 25,000 85,000 Annual differential income from sales of Bran Flakes $15,000 Don’t discontinue! Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  13. 13. or Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  14. 14. Currently, a firm manufactures the dashboards that it uses in making automobiles. The cost of manufacturing this part is summarized below. An outside supplier has offered to provide the part for $240. Should the car manufacturer accept the offer? Direct materials $ 80 Direct labor 80 Variable factory overhead 52 Fixed factory overhead 68 Total cost per unit $280 INITIAL REACTION—DON’T MAKE INTERNALLY Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  15. 15. Proposal to Manufacture Automobile Part January 22, 2010 Purchase price of part $240.00 Differential cost to manufacture: Direct materials $80.00 Direct labor 80.00 Variable factory overhead 52.00 212.00 Cost savings from manufacturing part $ 28.00 The fixed factory overhead is excluded because it is not relevant—so continue making the part. Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  16. 16. Replace Equipment Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  17. 17. Assume that a business is considering the disposal of several identical machines having a total book value of $100,000 and an estimated remaining life of five years. The old machines can be sold for $25,000. They can be replaced by a single high-speed machine at a cost $250,000. The new machine has an estimated useful life of five years and no residual value. Analyses indicate an estimated annual reduction in variable manufacturing costs from $225,000 with the old machine to $150,000 with the new machine. No other changes in the manufacturing costs or the operating expenses are expected. Should the new machine be purchased? Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  18. 18. Annual variable costs—present equipment $225,000 Annual variable costs—new equipment 150,000 Annual differential decrease in cost $ 75,000 Number of years applicable x 5 Total differential decrease in cost $375,000 Proceeds from sale of present equipment 25,000 $400,000 Cost of new equipment 250,000 Net differential decrease in cost, 5-years $150,000 Annual net differential—new equipment $ 30,000 Proposal to Replace Equipment January 22, 2010 Buy the new equipment! Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  19. 19. Process or Sell Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  20. 20. A refinery produces kerosene in batches of 4,000 gallons at a processing cost of $0.60 per gallon. Kerosene can be sold without further processing for $0.80 per gallon or further processed to yield gasoline, which can be sold for $1.25 per gallon. The additional processing cost is $650 per batch, and 20% of the gallons of kerosene will evaporate during production. Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  21. 21. Differential revenue from further processing per batch: Revenue from sale of gasoline [(4,000 gallons – 800 gallons evaporation) x $1.25] $4,000 Revenue from sale of kerosene (4,000 gallons x $0.80) 3,200 Differential revenue $800 Differential cost per batch: Additional cost of producing gasoline 650 Differential income from further processing gasoline per batch $150 Proposal to Process Kerosene Further January 22, 2010 Process further! Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  22. 22. Accept Business at a Special Price Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  23. 23. The monthly capacity of a sporting goods business is 12,500 basketballs. Current sales and production are averaging 10,000 basketballs per month. The current manufacturing cost is $20 (variable, $12.50; fixed, $7.50). The domestic selling price is $30. Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  24. 24. The manufacturer receives an offer from an exporter for 5,000 basketballs at $18 each. Production can be spread over three months, so these basketballs can be manufactured using normal capacity. Domestic sales would not be affected. Should the offer be accepted or rejected? Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  25. 25. Differential revenue from accepting offer: Revenue from sale of 5,000 additional units at $18 $90,000 Differential cost of accepting offer: Variable cost of 5,000 additional units at $12.50 62,500 Differential income from accepting offer $27,500 Proposal to Sell Basketballs to Exporter January 22, 2010 Accept the offer! Differential Analysis Universidad Cuauhtémoc – Maestría en Administración
  26. 26. UNIVERSIDAD CUAUHTEMOC CAMPUS AGUASCALIENTES Maestría en Administración

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