Question: The owner of Zivanov’s Pancake House
The owner of Zivanov’s Pancake House is considering an expansion of the business. He has identified two alternatives, as follows:
• Build a new restaurant near the mall.
• Buy and renovate an old building downtown for the new restaurant.
The projected cash flows from these two alternatives are shown below. The owner of the restaurant uses a 10 percent after-tax discount rate.
Required:
1. Compute the net present value of each alternative restaurant site.
2. Compute the profitability index for each alternative.
3. How do the two sites rank in terms of (a) NPV and (b) the profitability index?
4. Comment on the difficulty of ranking the owner’s two options for the new restaurant site.
Transcribed Image Text:
Net After-Tax Cash Inflows Investment Cash Outflow: Proposal Time 0 Years 1-10 Years 11-20 Mall restaurant $400,000 $50,000 $50,000 Downtown restaurant 200,000 35,800 * Includes after-tax cash flows from all sources, including incremental revenue, incremental expenses, and depreciation tax shield.
> Distinguish between a service department and a production department. Give an example of the counterpart of a manufacturer’s “production” department in a bank.
> Define the term net realizable value, and explain how this concept can be used to allocate joint costs.
> What are the two main drawbacks of the payback method?
> Give an example of a cash flow that is not on the income statement. How do you determine the after-tax amount of such a cash flow?
> What is a depreciation tax shield? Explain the effect of a depreciation tax shield in a capital-budgeting analysis.
> Aurora National Bank has two service departments, the Human Resources (HR) Department and the Computing Department. The bank has two other departments that directly service customers, the Deposit Department and the Loan Department. The usage of the two s
> Briefly describe the time-and-material pricing approach
> Could tear-down methods be used effectively for target pricing in a service-industry company, such as a hotel or an airline? Explain.
> Explain the role of value engineering in target costing
> Why is a focus on the customer such a key principle of target costing?
> Explain the phrase price-led costing.
> Briefly explain the concept of return-on-investment pricing.
> Explain the behavioral problem that can result when cost-plus prices are based on variable cost.
> What is the primary disadvantage of basing the cost plus pricing formula on absorption cost?
> Explain how to compute the after-tax amount of a cash revenue or expense.
> Determining the best approach to pricing requires a cost-benefit trade-off. Explain.
> Briefly define total cost and marginal cost.
> Comment on the following remark made by a bank president: “The prices of our banking services are determined by the financial-services market. Costs are irrelevant.”
> Explain what is meant by unlawful price discrimination and predatory pricing.
> Describe the following approaches to pricing new products: skimming pricing, penetration pricing, and target costing.
> The decision to accept or reject a special order and the selection of a price for a special order are very similar decisions. Explain.
> Explain the importance of the excess-capacity issue in setting a competitive bid price.
> List three advantages of pricing based on variable cost.
> List four reasons often cited for the widespread use of absorption cost as the cost base in cost-plus pricing formulas
> List the four common cost bases used in cost-plus pricing. How can they all result in the same price?
> Give an example of a noncash expense. What impact does such an expense have in a capital-budgeting analysis? Explain how to compute the after-tax impact of a noncash expense.
> Write the general formula for cost-plus pricing, and briefly explain its use.
> Describe three limitations of the economic, profit maximizing model of pricing.
> Define the following terms: total revenue, marginal revenue, demand curve, price elasticity, and cross-elasticity.
> Briefly explain the concept of economic, profit maximizing pricing. It may be helpful to use graphs in your explanation.
> Explain the following assertion: “Price setting generally requires a balance between market forces and cost considerations.”
> Explain what is meant by the following statement: “In considering the reactions of competitors, it is crucial to define your product.”
> List and briefly describe four major influences on pricing decisions.
> “All this marginal revenue and marginal cost stuff is just theory. Prices are determined by production costs.” Evaluate this assertion.
> Briefly explain the potential negative consequences in pricing decisions from using a traditional, volume based product-costing system.
> Refer to the data f or Riverside Clinic given in Exhibits 17–2 and 17–5. Exhibit 17-2: Exhibit 17-5: Required: Use the reciprocal-services method in combination with the dual-allocation approach to allocate Rive
> What is meant by a post audit of an investment project?
> Chemco, Inc., manufactures two products out of a joint process: Compod and U ltrasene. The joint costs incurred are $750,000 for a standard production run that generates 120,000 gallons of Compod and 80,000 gallons of Ultrasene. Compod sells for $6.00 pe
> Wyalusing Chemicals uses a joint process to produce MJ-4, a chemical used in the manufacture of paints and varnishes; HD-10, a chemical used in household cleaning products; and FT-5, a by-product that is sold to fertilizer manufacturers. Joint production
> Allegheny River Sawmill manufactures two lumber products from a joint milling process. The two products developed are mine support braces (MSB) and unseasoned commercial building lumber (CBL). A standard production run incurs joint costs of $750,000 and
> Gleed Company manufactures products Alpha, Beta, and Gamma from a joint process. Production, sales, and cost data for July follow. Required: 1. Assuming that joint costs are allocated using the relative-sales-value method, what were the joint costs allo
> Le Monde Company is a manufacturer of chemicals for various purposes. One of the processes used by Le Monde produces HTP–3, a chemical used in hot tubs and swimming pools; PST–4, a chemical used in pesticides; and RJ&a
> Travelcraft, Inc., manufactures a complete line of fiberglass suitcases and attaché cases. The firm has three manufacturing departments: Molding, Component, and Assembly. There are also two service departments: Power and Maintenance. The sid
> Refer to the data given in the preceding problem. When Jacksonville Instrument Company established its service departments, the following long-run needs were anticipated. Data given in preceding problem: Jacksonville Instrument Company manufactures gaug
> Jacksonville Instrument Company manufactures gauges for construction machinery. The company has two production departments: Machining and Finishing. There are three service departments: Human Resources (HR), Maintenance, and Design. The budgeted costs in
> Vallejo Cablevision Company provides television cable service to two counties in Southern California. The firm’s management is considering the construction of a new satellite dish in December of 20x0. The new antenna would improve reception and the servi
> The Golden Triangle Theater is a nonprofit enterprise in downtown Pittsburgh. The board of directors is considering an expansion of the theater’s seating capacity, which will entail significant renovations to the existing facilities. The board has
> For what purpose should the managerial accountant be careful to not use joint cost allocations?
> Refer to the data given in the preceding problem. The owner of Zivanov’s Pancake House will consider capital projects only if they have a payback period of six years or less. The owner also favors projects that exhibit an accounting rat
> Weisinger Corporation’s management is considering the replacement of an old machine. It is fully depreciated but it can be used by the corporation through 20x5. If management decides to replace the old machine, James Company has offered to purchase it fo
> LifeLine Corporation manufactures fire extinguishers. One part used in all types of fire extinguishers is a unique pressure fitting that requires specialized machine tools that need to be replaced. LifeLine’s production manager has concluded that the onl
> MicroTest Technology, Inc., is a high-technology company that manufactures sophisticated testing instruments for evaluating microcircuits. These instruments sell for $3,500 each and cost $2,450 each to manufacture. An essential component of the company’s
> Flotilla Beam, the owner of the Bay City Boatyard, recently had a brilliant idea. There is a shortage of boat slips in the harbor during the summer. Beam’s idea is to develop a system of “dry slips.” A dry slip is a large storage rack in a warehouse on w
> Refer to the data given in Problem 6. The County Board of Representatives believes that if the county conducts a promotional effort costing $20,000 per year, the proposed long runway will result in substantially greater economic development than was proj
> Refer to the data given in the preceding problem. Data given in preceding: Adams County’s Board of Representatives is considering the construction of a longer runway at the county airport. Currently, the airport can handle only private aircraft and smal
> Adams County’s Board of Representatives is considering the construction of a longer runway at the county airport. Currently, the airport can handle only private aircraft and small commuter jets. A new, long runway would enable the airport to handle the m
> Special People Industries (SPI) is a nonprofit organization which employs only people with physical or mental disabilities. One of the organization’s activities is to make cookies for its snack food store. Several years ago, Special Peo
> Are joint cost allocations useful? If they are, for what purpose?
> Refer to the data in the preceding problem regarding Medical Arts Hospital. Data from preceding problem: Medical Arts Hospital’s board of trustees is considering the addition of a comprehensive medical testing laboratory. In the past, the hospital has s
> Medical Arts Hospital’s board of trustees is considering the addition of a comprehensive medical testing laboratory. In the past, the hospital has sent all blood and tissue specimens to Diagnostic Testing Services, an independent testing service. The hos
> Community Challenges, a nonprofit organization for physically and mentally challenged people, manufactures a variety of products in four plants located in California. The company is currently purchasing an electronic igniter from an outside supplier for
> Refer to the data given in the preceding problem for Vallejo Cablevision Company. Data from preceding problem: Vallejo Cablevision Company provides television cable service to two counties in Southern California. The firm’s management is considering the
> Portsmouth Printing Corporation recently purchased a truck for $36,000. Under MACRS, the first year’s depreciation was $7,200. The truck driver’s salary in the first year of operation was $38,400. Required: Show how each of the amounts mentioned above
> For each of the following assets, indicate the MACRS property class and depreciation method. 1. A pharmaceutical company bought a new microscope to use in its Research and Development Division. 2. A mid western farmer constructed a new barn to house bee
> The state’s secretary of education is considering the purchase of a new computer for $150,000. A cost study indicates that the new computer should save the Department of Education $45,000, measured in real dollars, during each of the next eight years. Th
> Yankay Specialty Metals Corporation is reviewing an investment proposal. The initial cost as well as the estimate of the book value of the investment at the end of each year, the net after-tax cash flows for each year, and the net income for each year ar
> The management of Iroquois National Bank is considering an investment in automatic teller machines. The machines would cost $124,200 and have a useful life of seven years. The bank’s controller has estimated that the automatic teller machines will save t
> The owner of Cape Cod Confectionary is considering the purchase of a new semi-automatic candy machine. The machine will cost $30,000 and last 10 years. The machine is expected to have no salvage value at the end of its useful life. The owner projects tha
> Describe the relative-sales-value method of joint cost allocation.
> Trenton Fabrication Company purchased industrial tools costing $110,000, which fall in the 3-year property class under MACRS. Required: 1. Prepare a schedule of depreciation deductions assuming: a. The firm uses the accelerated depreciation schedule spe
> Refer to the data given in the preceding exercise. Suppose the Toronto Shakespearean Theater’s board is uncertain about the cost savings with the new lighting system. Data from preceding exercise: Toronto Shakespearean Theater’s board of directors is co
> Toronto Shakespearean Theater’s board of directors is considering the replacement of the theater’s lighting system. The old system requires two people to operate it, but the new system would require only a single opera
> The trustees of the Danube School of Art and Music, located in Tuttlingen, Germany, are considering a major overhaul of the school’s audio system. With or without the overhaul, the system will be replaced in two years. If an overhaul is done now, the tru
> Refer to the data given in Exercise 1. Data from preceding Exercise 1: Jefferson County’s Board of Representatives is considering the purchase of a site for a new sanitary landfill. The purchase price for the site is $234,000 and prepa
> Refer to the data given in the preceding exercise. Data given in preceding exercise: Jefferson County’s Board of Representatives is considering the purchase of a site for a new sanitary landfill. The purchase price for the site is $234,000 and preparato
> Jefferson County’s Board of Representatives is considering the purchase of a site for a new sanitary landfill. The purchase price for the site is $234,000 and preparatory work will cost $88,080. The landfill would be usable for 10 years. The board hired
> Refer to the data in the preceding exercise. Data in preceding exercise: The state’s secretary of education is considering the purchase of a new computer for $150,000. A cost study indicates that the new computer should save the Department of Education
> Heartland Corporation manufactures flour milling machinery according to customer specifications. The company operated at 75 percent of practical capacity during the year just ended, with the following results (in thousands): Sales revenue ...............
> Danish Interiors, Ltd., manufactures easy-to-assemble wooden furniture for home and office. Management is considering modification of a table to make it more attractive to individuals and businesses that buy products through outlets such as Office Max, O
> Briefly explain how to use the physical-units method of joint cost allocation.
> Super Sounds, Inc. manufactures two models of stereo speaker sets. The company uses an absorption (or full) product-costing system, which means that both variable and fixed overhead are included in the product cost. Cost estimates for the two models for
> Portland Electronics Company’s (PEC) president, Marsha Kunselman, is concerned about the prospects of one of the firm’s major products. The president has been reviewing a marketing report with Jeff Keller, marketing pr
> Maritime Services Corporation (MSC) will soon enter a very competitive marketplace in which it will have limited influence over the prices that are charged. Management and consultants are currently working to fine-tune the company’s sole service, which t
> Detroit Synthetic Fibers, Inc., specializes in the manufacture of synthetic fibers used in many products such as blankets, coats, and uniforms. The company applies overhead on the basis of direct-labor hours. Management has recently received a request to
> For many years, Lehigh Corporation has used a straightforward cost-plus pricing system, marking its goods up approximately 25 percent of total cost. The company has been profitable; however, it has recently lost considerable business to foreign competito
> The marginal cost, marginal revenue, and demand curves for Houston Home and Garden’s deluxe wheelbarrow are shown in the graph at the top of the next page. Required: Before completing any of the following requirements, read over the e
> Refer to Exhibit 15–7 . Suppose the Repair Department of Sydney Sailing Supplies adds a markup of 5 percent on the material charges of a job (including the cost of material handling and storage). Exhibit 15-7: Required: 1. Rewrite the
> Bair Company is a manufacturer of standard and c ustom-designed bottling equipment. Early in December 20x0 Lyan Company asked Bair to quote a price for a custom-designed bottling machine to be delivered in April. Lyan intends to make a decision on the pu
> Handy Household Products, Inc., is a multiproduct company with several manufacturing plants. The Shreveport Plant manufactures and distributes two household cleaning and polishing compounds, standard and commercial, under the Clean & Bright label. Th
> Why can unitized fixed costs cause errors in decision making?
> What potential behavioral problem can result when the dual approach is used?
> List four potential pitfalls in decision making, which represent common errors.
> What is meant by the term contribution margin per unit of scarce resource?
> Are allocated joint processing costs relevant when making a decision to sell a joint product at the split-off point or process it further? Why?
> What is meant by the term differential cost analysis?
> How does the existence of excess production capacity affect the decision to accept or reject a special order?
> Give an example of an irrelevant future cost. Why is it irrelevant?
> Explain why the book value of equipment is not a relevant cost.
> Explain what is meant by the term decision model.
> Distinguish between qualitative and quantitative decision analyses.
