# 29 by SabeerAli1

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Section 6

1. Enola, Inc. manufactures a product that sells for \$400.     The
variable costs per unit are:

Direct materials..............................\$100
Direct labor..................................\$ 80
Variable selling costs........................\$ 20

For the coming year the budgeted fixed manufacturing overhead is
estimated to be \$500,000 and budgeted fixed selling and administrative
costs are expected to be \$250,000.
Required:
a. Determine the break-even point in units.
Solution: Total variable cost = \$100+\$80+\$50+\$20 = \$250 = VC
Total fixed cost = \$500,000 + \$250,000 = \$750,000
Suppose the break even occurs at n units.
Therefore, 400n = 750,000 + 250n
Or (400-250)n = 750,000
Or 150n = 750,000
Therefore, n = 750,000/150 = 5000 units

b. Determine the number of units that must be sold to earn a target net
income of \$300,000.
Solution: Since each unit sells for \$400, number of units required to
be sold to earn an income of \$300,000 = \$300,000/\$400 = 750 units

2. Holbrook, Inc. has identified the following overhead costs and cost
drivers for next year.

Item.............Cost.......Driver............Quantity
------------------------------------------------------
Setup costs....\$960,000..Number of setups.......4,800
Ordering costs..160,000..Number of orders......20,000
Maintenance.....640,000..Machine hours.........64,000
Power............80,000..Kilowatt hours...... 200,000

The following are two of the jobs completed during the year.

Job 701        Job 702

Prime costs..............\$25,000........\$18,000
Units completed..............650............500
Direct labor hours...........180............220
Number of setups..............12.............15
Number of orders..............16.............30

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Machine hours................360............300
Kilowatt hours...............180............650

The company’s normal activity is 40,000 direct labor hours.

Required:
a. Determine the unit cost for each job using direct labor hours to
hours.)
b. Determine the unit cost for each job using the four cost drivers.
(Round amounts to 2 decimal places.) (That is there are four
overhead rates: setups, orders, maintenance and power.)
c. Which method produces the more accurate cost assignment? Why?

3. Brentwood Associates uses a job-order costing and applies overhead
on the basis of direct labor hours. At the beginning of the year,
management estimated that 26,000 direct labor hours would be worked
and \$1,300,000 of manufacturing overhead costs would be incurred.

During the year, the company actually worked 24,000 direct labor hours
and incurred the following manufacturing costs:

Direct materials used in production.....\$1,240,000
Direct labor.............................1,800,000
Indirect labor.............................280,000
Indirect materials.........................220,000
Insurance..................................150,000
Utilities..................................190,000
Repairs & maintenance......................180,000
Depreciation...............................320,000

(Note: So actual overhead is \$1,340,000)

Required:
a. Calculate the predetermined overhead application rate (Dollars per
Direct Labor Hour) for the year.
Solution: The predetermined overhead application rate
= \$1,300,000/ 26000 direct labor hours = \$50 per direct labor hour

Determine the amount (in dollars) of manufacturing overhead applied to
work in process during the year.
*Actual activity = \$50*24,000 = \$1,200,000

Determine the amount (in dollars) of underapplied or overapplied
Solution: Underapplied overhead = \$1,340,000 - \$1,200,000 = \$140,000

Section 7

4. Phil Goode will receive \$175,000 in 50 years. (That is at the end of
50 year from today Phi will receive a lump sum of \$175,000). His

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friends are very jealous of him. If the funds are discounted back at a
rate of 14 percent, what is the present value (in dollars) of his
n
    r 
Solution: Assuming interest is compounded yearly, P = A1    
 100 
50
    14 
= 175,0001               175,000(1.14) 50  \$250approx ……………Ans
 100 

5. If employer offered to set aside \$2,500 a year for you for the next
20 years, how much (in dollars) would you have in your account after 20
years if the funds grew at 8 percent? (Note: Your answer is greater
than \$2,500.)
Solution: Assuming compound interest,
Amount after 1’st year, A1  P1  0.08   P(1.08)
Principal for second year = P  P(1.08)  P(1  1.08)
Amount after 2’nd year, A2  P1  1.08 1.08   P(1.08  1.08 )
2

Principal for 3rd year = P  P(1  1.08 )(1.08 )  P(1  1.08  1.08 )
2


Amount after 3’rd year, A3  P 1  1.08  1.08
2
1.08   P(1.08  1.08   2
 1.08 3 )
………………
Therefore, Amount after 20th year, A20  P (1.08  1.08  .....  1.08
2                   20
)

Sum of a Geometric Progression is given as

 1.0820  1 
Therefore, A20                   1.08  1  = \$123557.30
 2500 *1.08 *             
            

6. Madison Corporation has a \$1,000 par value bond outstanding paying
annual interest of 7%. The bond matures in 20 years. If the present
yield to maturity for this bond is 9%, calculate the current price of
the bond (in dollars) using annual compounding. (That is interest is

Section 8

7. The Taylor Corporation is using a machine that originally cost
\$88,000. The machine is being depreciated by the straight-line method
over 8 years (\$11,000 per year). The machine has a book value of
\$66,000 and a current market value of \$40,000. Assume the machine is
sold at the current market value of \$40,000. Jack Elliott, the Chief
Financial Officer of Taylor, is considering replacing this machine with
a newer model costing \$75,000. The new machine will save \$7,000 in
after-tax earnings each year for the next six years. The new machine is

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in the 5-year MACRS category. Taylor Corporation is in the 34% tax
bracket. What is the cash inflow (in dollars) from the sale of the old
machine? (Note: You do not have to calculate depreciation expense.)

(Hint: 1. Calculate the gain or loss on sale.
2. Calculate the tax saving or tax expense.
3. Calculate the cash inflow or outflow on the sale.

8. The Knight Manufacturing Company is evaluation a capital investment
project requires an investment of \$1,000,000. It has an expected life
of five years with annual cash flows of \$240,000 received at the end of
each year. Assume the residual value is zero.

Required:
a. Compute payback (in number of years) for the project.
Solution:
Year          Cash Flow    Net Cash Flow
0             -1,000,000   -1,000,000
1             240,000      -760,000
2             240,000      -520,000
3             240,000      -280,000
4             240,000      -40,000
5             240,000      200,000

Payback Period = Last year with a negative NCF + Absolute value of NCF
in that year/Total Cash flow in the following year
= 4 + 40,000/240,000 = 4.167 years……..Ans

b. Compute the net present value (in dollars) of the project using a 12
percent discount rate. Ignore income taxes.
n      valuej
Solution: NPV =    1  rate
j 1
j
=NPV(0.12,-

1000000,240000,240000,240000,240000,240000) in Excel.
= -\$120,405.10……..Ans

d. Would you recommend this project be accepted? Why?
Solution: No, Since the NPV is negative, we should reject the project.

Section 9

9. Hunter International pays a \$3.80 dividend at the end of year one on
its common stock that has a stock price of \$50 and a constant growth
rate of 4%. What is the required rate (in percentage) of return on such
a common stock?
D1
Solution: According to Gordon Dividend Valuation Model, P0           ,
Ks  g
Where D1 = dividends at year 1, Ks = Investor’s required rate of
return, g = growth rate in dividends. From this formula, we get

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D1     3.80
KS        g       4  4.076 % …………………….Ans
P0      50

10. The Harding Company manufactures skates. The company’s income
statement for 2002 is as follows:

Harding Company
Income Statement
For the Year Ended December 31, 2002

Sales (10,000 units @ \$50 each)                        \$500,000
Less: Variable costs (10,000 units @ \$20)               200,000
Fixed costs                                       150,000
Earnings before interest and taxes                      150,000
Interest expense                                         60,000
Earnings before taxes                                    90,000
Income tax expense                                       36,000
Earnings after taxes                                   \$ 54,000

There is no preferred stock in this Company.

What is the degree of operating leverage for Harding Company?
QP  AVC 
Solution:     Degree of Operating Leverage DOL =
Q( P  AVC )  Q( AFC )
Here Q = 10000, P = \$50, AVC = \$20, AFC = \$150000/10000 = \$15
10000 (50  20 )          30
 DOL                                        2 ………………Ans
10000 (50  20 )  10000 (15 ) 15

11. Refer to the data presented in the above question, what is the
degree of financial leverage for Harding Company?
EBIT
Solution: DFL =                 , where EBIT = Q(P-AVC)-F, I = Interest Paid
EBIT  I
Here EBIT = 10000(50-20) = \$300,000
I = \$60,000
EBIT       300000
DFL =                              1.25 ………………..Ans
EBIT  I 300000  60000

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