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Chapter 25: 26PGA (page 1418)

Oak Petroleum has spent \(202,000 to refine 63,000 gallons of petroleum distillate, which can be sold for \)6.00 per gallon. Alternatively, Oak can process the distillate further and produce 58,000 gallons of cleaner fluid. The additional processing will cost \(1.80 per gallon of distillate. The cleaner fluid can be sold for \)9.10 per gallon. To sell the cleaner fluid, Oak must pay a sales commission of \(0.12 per gallon and a transportation charge of \)0.19 per gallon.

Requirements

1. Diagram Oak’s decision alternatives, using Exhibit 25-18 as a guide.

2. Identify the sunk cost. Is the sunk cost relevant to Oak’s decision?

3. Should Oak sell the petroleum distillate or process it into cleaner fluid? Show the expected net revenue difference between the two alternatives.

Short Answer

Expert verified

The company should focus onprocessing the product further.

Step by step solution

01

Meaning of Sunk Cost

The term sunk cost refers to the cost that has already been incurred by a business concern and is irrecoverable.Such costs are considered irrelevant when making decisions regarding outsourcing, making, buying, and processing a product further.

02

Diagram for decision alternatives

03

Identification of sunk cost

According to the given scenario, Oak Petroleum has to bear the sunk cost in both situations. Hence, thejoint cost is irrelevant in making a decision to choose an alternative.

04

Preparation of analysis

Differential analysis of revenue:

Particulars

Sell ($)

Processed further ($)

Difference ($)

Revenue

378,000

527,800

149,800

Incremental analysis of whether Oak should sell or process further:

Particulars

Amounts ($)

Expected increase in revenue

149,800

Less: Expected increase in cost (63000*1.80)

(113,400)

Expected increase in profit

$36,400

According to the analysis, it is concluded that the company should process the petroleum distillatebecause it will increase the profits by $36,400.

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Most popular questions from this chapter

What is differential analysis?

Nautical manufactures flotation vests in Tampa, Florida. Nautical’s contribution margin income statement for the month ended December 31, 2018, contains the following data:

NAUTICAL

Income Statement

For the Month Ended December 31, 2018

Sales in Units 29,000

Net Sales Revenue \(551,000

Variable Costs:

Manufacturing 116,000

Selling and Administrative 111,000

Total Variable Costs 227,000

Contribution Margin 324,000

Fixed Costs:

Manufacturing 123,000

Selling and Administrative 92,000

Total Fixed Expenses 215,000

Operating Income \)109,000

Suppose Water Works wishes to buy 4,800 vests from Nautical. Nautical will not incur any variable selling and administrative expenses on the special order. The Nautical plant has enough unused capacity to manufacture the additional vests. Water Works has offered \(15 per vest, which is below the normal sales price of \)19.

Requirements

1. Identify each cost in the income statement as either relevant or irrelevant to Nautical’s decision.

2. Prepare a differential analysis to determine whether Nautical should accept this special sales order.

3. Identify long-term factors Nautical should consider in deciding whether to accept the special sales order.

Each morning, Max Smith stocks the drink case at Max’s Beach Hut in Myrtle Beach, South Carolina. The drink case has 120 linear feet of refrigerated drink space. Each linear foot can hold either six 12-ounce cans or three 20-ounce bottles.

Max’s Beach Hut sells three types of cold drinks:

1. Licious-Ade in 12-oz. cans for \(1.40 per can

2. Licious-Ade in 20-oz. bottles for \)1.90 per bottle

3. Pep-Cola in 20-oz. bottles for \(2.20 per bottle

Max’s Beach Hut pays its suppliers:

1. \)0.20 per 12-oz. can of Licious-Ade

2. \(0.35 per 20-oz. bottle of Licious-Ade

3. \)0.55 per 20-oz. bottle of Pep-Cola

Max’s Beach Hut’s monthly fixed costs include:

Hut rental \(355

Refrigerator rental 65

Max’s salary 1,700

Total fixed costs \)2,120

Max’s Beach Hut can sell all the drinks stocked in the display case each morning.

Requirements

1. What is Max’s Beach Hut’s constraining factor? What should Max stock to maximize profits?

2. Suppose Max’s Beach Hut refuses to devote more than 80 linear feet to any individual product. Under this condition, how many linear feet of each drink should Max’s stock? How many units of each product will be available for sale each day?

What are sunk costs? Give an example.

What is differential analysis?
See all solutions

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