Class: Problem #1

Cushion Company is launching a new line of cushions. The company invests $4,000,000 in operating assets, such as production equipment, and plans to produce and sell 400,000 units per year.

Cushion wants to make a return on investment of 25% each year.

Cushion needs to know what price to charge for this product.

Use the absorption costing approach to determine the markup necessary make the desired return on investment.

Cost information is provided below.

REQUIRED: CALCULATE THE SELLING PRICE.

Round your answer to two decimal places.

Per Unit cost:

Direct Materials $30.00

Direct Labor $ 8.00

Variable Manufacturing Overhead $2.00

Fixed Manufacturing Overhead $600,000 (total)

Variable Selling and Admin. Expense is $ 2.00 per unit

Fixed Selling and Admin. Expense $120,000 (total)

{Help: Since they invested $4,000,000 and they want to earn 25% on their investment, then the desired profit is $4,000,000×25% or $1,000,000.}

CLASS: Problem #2 (SPECIAL ORDER)

Slow Manufacturing produces a single product, “G”.

Budgeted amounts for the coming year are as follows:

Sales (120,000 units @ $10 each) $1,200,000

Direct material $360,000 ($3 per unit)

Direct Labor $240,000 ($2 per unit)

Variable overhead $120,000 ($1 per unit)

Fixed overhead $240,000 (MANAGEMENT MIGHT INCORRECTLY THINK OF THIS AS $2 PER UNIT BUT THAT IS NOT HOW FIXED EXPENSES WORK)

Fast Industries has offered to purchase 1,000 units of “G” at a price of $7.25 per unit. These will have additional variable costs of $0.25 per unit. Slow has the capacity to produce this order and will not affect any of their other operations.

a) What is the incremental revenue associated with accepting this special order?

b) What is the incremental cost associated with the special order?

c) What is the incremental profit or loss expected to be generated?

Class: (Easier) Problem #3

A company has $20.00 per unit in variable costs and $10,000,000 per year in fixed costs. If the company expects to sell 1,000,000 units and wishes to earn a profit of $2,000,000, what markup percentage (to the nearest whole %) must be applied to the total cost?

Class: FUN question:

In Michael Jordan’s last year with the Bulls, Dennis Rodman wanted approximately $14,000,000 and the Bulls offered $7,000,000. They were very far apart. They compromised. The Bulls deposited a little more than $7,000,000 into an account that Rodman could not touch for 10 years and would be worth $14,000,000 at the end. Rodman told everyone he was earning $14,000,000 but it only cost the Bulls a little over $7,000,000! Rodman went on TV and bragged he was paid $14,000,000.

What was he really paid (at the moment that he received the contract) based on present value computations of 10 years, 6%?

Please discuss how this relates to our material on Present Value. What was the APPROXIMATE PRESENT VALUE (at the time of the payment) of the amount that he would receive in 10 years at an interest rate of 6%?

(Please understand that Rodman’s agent was brilliant. Rodman got exactly what he wanted and the Bulls paid Rodman approximately what they wanted to in the beginning. Show how this is true. )

Class: Problem #4:

Recently on the Golf Channel there was a film report of a person hitting a hole-in-one and winning $1 million. He went crazy in the film. HOWEVER, it was $50,000 every year paid out over the next 20 years. He wasn’t offered the lump sum.

Questions: A) If the money is valued at 14% what was the REAL PRESENT VALUE of his winnings? (What was it worth that day?) Explain your answer. If you use a TABLE be careful which Table you are using. This is an annuity. NOT a payment once. Make sure your answer is logical.

B) If the money is valued at 6% what was the REAL PRESENT VALUE of his winnings? (What was it worth that day?) Explain your answer.

C) Note that the rule is that the higher the interest rate the Lower the Present Value and the lower the interest rate the Higher the Present Value. (As you should see from your answers to parts A and B) Can you explain why this rule is true?

CLASS: Problem #5

Lauren Corp buys equipment for $194,000 that will last for 9 years. The equipment will generate cash flows of $36,000 per year and will have no salvage value at the end of its life. Ignore taxes. Use 10% required rate of return.

a) What is the Present Value (PV) of this investment? (This is asking “what is the PV of $36,000 per year for 9 years”)

B) What is the NET Present Value (NPV) of this investment? (It is important to note that NPV is the PV less the cost.)

c) What is the Internal Rate of Return (IRR) of this investment?

d) What is the payback period?

CLASS: Problem #6

A new investment costs $380,000. It will save $60,000 per year for 10 years and we need a return of 8%.

Note that the investment does not give it’s principal back at the end of the life and therefore we need to know if it is returning our desired rate of return despite no principal return. (If I put my money in the bank I would get a lower return per year plus all my money back whenever I want it. Here I don’t get my money back.)

a) What is the PV of the amounts we receive? Use the annuity table or Excel.

b) What is the NPV of this investment?

c) Do we reach our desired return of 8%? (Is IRR at least 8%?) What is the IRR?

d) What is the Payback period?