 The target cost for a product has been calculated to be $60,

which is 3% less than the actual cost currently achievable

 The business is considering providing some internal training
to improve efficiency of labour and hence reduce the cost
gap. The current material cost is $10 per unit and this will
not change as efficiency changes. Labour rates are $8 per
hour.
 How much of an efficiency improvement (measured
by the % reduction in labour time per unit) will be
necessary to remove the cost gap completely?
Solution question One
 Expected Actual cost currently achievable 60/0.97
61.8557
 Standard cost card
 Material Cost 10
 Labour cost 6.482 hours at $8 per hour 51.8557
 Cost per unit 61.8557
 At target cost , the expected number of hours to produce one unit 60
less 10 material cost=50
 Number of hours required to produce one unit 50/8
6.25 hours
 Efficiency measured by the % reduction in labour time per unit
6.482-6.25/6.482= 3.6%
 B
Issues to remember in Target costing
 Target costing involves setting a target cost by subtracting a
desired profit from a competitive market price. In effect it is the
opposite of conventional 'cost plus pricing'.
 Step 1: A target price is set, based on the customers’ perceived
value of the product.This will therefore be a market based price
 Step 2: The required target operating profit per unit is then
calculated.This may be based on either return on sales, or return
on investment.
 Step 3: The target cost is derived by subtracting the target profit
from the target price.
 Step 4: The cost gap is then calculated
 Step 5: If there is a cost gap, attempts will be made to close the
gap.
Question two
 Company B uses an activity based costing system and
manufactures three products, details
 of which are given below:
 Product X
Product Y Product Z
 Annual production in units 160,000 200,000
100,000
 Batch Size 100 50
25
 Number of Inspections / Batch 3 4
6
 Annual inspection costs amount to $150,000.
 What is the inspection cost per unit of Product Y closest to?
Solution question 2
 Total Number of Batches
 X 160,000/100 1,600
 Y 200,000/50 4,000
 Z 100,000/25 4,000
 Total Inspections (1,600 x 3)+ (4,000 x4) +(4,000 x6) = 44,800
inspections
 Annual Inspection cost 150,000/44,800 =$3.35 per
inspection
 Total inspection cost forY $3.35*16,000 =
$53,600
 Total number of units 200,000
 cost per unit = 53,600/200,000 0,2680 B
Question 3 and solution
 The following statements have been made about the advantages of using
expected values:
 (1) Calculations are relatively simple.
 (2) The information is reduced to a single number, resulting in easier
decisions.
 Which of the above statements is/are true?
 A (1) only
 B (2) only
 C Neither (1) nor (2)
 D Both (1) and (2)
 D
 Both statements are correct: the simplicity of calculations is a major
advantage of the Expected Values technique.
 An expected value is a weighted average of all possible
outcomes. It calculates the average return that will be made if
a decision is repeated again and again.
 EV = Σ px
 Suitable if organisation has a risk neutral approach to risk.
 The organisation would commit to the course of action
that would deliver the highest average outcome (EV).
 Not useful for one off decisions.
Question 4
 The following statements have been made about throughput accounting:
 (1) Throughput accounting considers that the only variable costs in the
short run are materials and components.
 (2) In throughput accounting, priority should be given to products that
earn the largest throughput per unit.
 Which of the above statements is/are true?
 A (1) only
 B (2) only
 C Neither (1) nor (2)
 D Both (1) and (2)
 A
 The second statement is not true. In Throughput Accounting, priority
should be given to products that earn the largest throughput per unit of
the bottleneck resource
Question 5
 A product is manufactured by mixing two materials.The standard
material cost per unit of the product is as follows:
 Material A 36 litres @ $20 $720
 Material B 24 litres @ $15 $360
 In January this year, the actual mix used was 2,460 litres of A, and
2,040 litres of B. The actual output was 90 units.
 What was the total material yield variance for January?
 A $16,200 (F)
 B $16,200 (A)
 C $32,400 (F)
 D $32,400 (A)
Question 5 Solution
 2,460+2,040 (4,500) should yield / (36+24)
75 units
 But it did yield
90 Units
 Varience 15
 Standard Cost per Unit (36 x20) +(24 x 15)
1,080

16,200 F
 Catan Ltd produces four products as follows:
 Product Brick Lumber
Ore Wool
 $ $ $
$
 Selling Price 10 25 40 60
 Variable costs 6 18 20 50
 Fixed costs 2 3 15
4
 Profit per unit 2 4 5 6
 In what order would the products usually be drawn in a multi-product profit-volume
chart?
 A Brick, Lumber, Ore, Wool
 B Brick, Ore, Lumber, Wool
 C Ore, Brick, Lumber, Wool
 D Ore, Wool, Brick, Lumber
 In a multi-product profit volume graph, products are usually
drawn based on their contribution to sales ratio, in the ‘highest to
lowest’ order:
 Product Brick Lumber Ore
Wool
 $ $ $ $
 Contribution 4 7 20 10
 Selling price 10 25 40 60
 C/S ratio (%) 40 28 50 17
 Rank 2 3 1 4
 C
Question 7 and Solution
 The following statements have been made about the purposes of a standard
costing system:
 (1) A standard costing system is used to replace budgets and budgeting.
 (2) A standard costing system is used to simplify costing procedures.
 Which of the above statements is/are true?
 A (1) only
 B (2) only
 C Neither (1) nor (2)
 D Both (1) and (2)
 Only Statement 2 is true. Standard costing simplifies costing procedures by
using one predetermined standard cost, rather than re-calculating costs each
time actual costs change.
 Then, variances from standard are analysed. Standard costs do not replace
budgets and budgeting: standards are a per-unit measure,whereas budgets are
for totals, not just units.
Question 8 and solution
 The following statements have been made about the purposes of flexible
budgeting:
 (1) Flexible budgeting is a reporting system where the planned level of
activity is adjusted to the latest forecast level of activity.
 (2) Its purpose is to break down the budget into variable per unit and
fixed costs components, so that at any level of activity, a budget may be
created and then mapped against the actuals at that level of activity so as
to provide a ‘like for like’ comparison.
 Which of the above statements is/are true?
 A (1) only
 B (2) only
 C Neither (1) nor (2)
 D Both (1) and (2)
 Only Statement 2 is true, Statement 1 is not B
 A business that uses the throughput contribution measure to optimise the use of a
bottleneck resource has decided on the four steps it should take to determine the best
production plan. It has already identified the bottleneck. The following are all steps
needed to be taken to determine the best production:
 (1) Allocate the bottleneck resource.
 (2) Calculate throughput contribution per bottleneck hour for each product.
 (3) Rank the product.
 (4) Calculate throughput contribution per unit for each product.
 Which of the following represents the correct sequence?
 A (1), (2), (3), (4)
 B (3), (2), (4), (1)
 C (2), (1), (4), (3)
 D (4), (2), (3), (1)
 The right sequence is: calculation of a throughput contribution per unit for each
product, then per bottleneck hour for each product; then, ranking products accordingly
and last, allocating the bottleneck resource based on the rankings. D
Question 10 and solution
 The following statements have been made about activity-based budgeting
(ABB):
 (1) ABB is especially useful when an organisation has a significant level of
overheads.
 (2) ABB should not be used in a Total Quality Management environment.
 Which of the above statements is/are true?
 A (1) only
 B (2) only
 C Neither (1) nor (2)
 D Both (1) and (2)
 Statement (1) is true: ABB is especially useful in a business with a high level of
overheads.
 Statement (2) is not true: ABM can be used alongside performance management
improvement strategies, such as Total Quality Management, where the
information provided can support the projects.
Performance Reports
 Performance reports (output reports) are produced for managers from
the MIS.
 A variety of reports are produced, e.g. from general monthly
management accounts to more specific reports such as an inventory
report for the production manager.
 Designing a good performance management report
 Purpose
 The report should reflect the organisation’s mission and objectives.
 Information
 The information should match the purpose and be a mix of financial and
non-financial (quantitative and qualitative).
 Audience
 The report must be relevant and adaptable to the needs of the user easy
to use and understandable.
Question 11
 In a responsibility accounting system, which TWO of the following costs are least likely
to appear on the performance report for the divisional manager of a production
department?
 (1) Machine rental costs
 (2) Lost contribution due to machine breakdown
 (3) Compulsory machine testing costs.
 (4) Machinery repairs
 A (1) and (2)
 B (1) and (3)
 C (2) and (3)
 D (2) and (4)
 Machine rental costs and compulsory machine testing costs are least likely to appear on
the performance report for the manager of a production department. Machine rental
will often be agreed by Head Office; and the testing costs are compulsory.
B
Question 12
 Division A
Division B
 Capital required for the project $35
million $29 million
 Sales generated by project $15 million
$12 million
 Net Profit margin 30%
19%
 Cost of capital 8%
8%
 If Residual Income is used as the basis for the investment decision,
which division(s) would choose to invest in the project?
 Controllable operating profit
X
 Less: Imputed interest (controllable capital employed × cost of
capital) (X)
 Residual Income
X
 Advantages of RI
 -Reduces problems of ROI, i.e. dysfunctional behaviour and
holding onto old assets
 -Easy decision rule
 - Makes divisional managers more aware of cost of finance
 -Different cost of capitals can be applied to divisions with different
risk profiles
 Disadvantages
 Absolute figure so does not facilitate comparisons
 Difficult to determine appropriate cost of capital
 Different accounting policies can confuse comparison
 May encourage manipulation of profit or capital employed
figures
Solution question 12
 Net Profit margin = Profit/Sales and therefore profit = Sales
× Net Profit margin.
 Residual Income = Divisional profit – (Capital Employed ×
cost of capital)
 For Division A, RI = (30% × $15 m) – (8% × $35 m)
 RI = $1.7 million
 For Division B, RI = (19% × $12 m) – (8% × $29 m)
 RI = $(40,000)
Question 13
 The following statements have been made about Value For Money
(VFM) as a public sector objective:
 (1) VFM is considered to be the best combination of services from
the least amount of resources taking into account the 3Es:
Economy, Efficiency and Effectiveness.
 (2) The key to effectiveness is in finding an optimum pattern of
spending to achieve a given objective.
 Which of the above statements is/are true?
 A (1) only
 B (2) only
 C Both (1) and (2)
 D Neither (1) nor (2)
 Both statements are correct C
 Bradley Ltd produces two products, Pinky and Perky. These
account for 60% and 40% of the
 total sales dollars of Bradley Ltd respectively. As a percentage
of sales dollars, variable costs
 are 60% for Pinky and 85% for Perky. Total fixed costs are
$150,000.There are no other
 costs.
 What is Bradley’s breakeven revenue?
 Percent of sales Percent of
variable costs Value
 Pinky 60 60
36%
 Perky 40 85
34%
 Weighted average of variable costs to sales
70%
 Weighted average contribution = 100% – 70% = 30%
 The breakeven point is fixed costs of $150,000/0.3 weighted
average c/s ratio: $500,000
 The following statements have been made about performance
analysis in the public sector:
 (1) In the public sector, there is no single, straightforward way of
measuring success.
 (2) Unlike private companies, public sector organisations cannot
make their own strategic decisions in isolation.
 Which of the above statements is/are true?
 A (1) only
 B (2) only
 C Both (1) and (2)
 D Neither (1) nor (2)
 C
SECTION B
 Chemistry Magic produces mathematics text books for use in schools. The production of
textbooks involves many complexities, and production is very labour-intensive. Due to a
lack of recent investment,the printing machines are obsolete and break down often.
 A new version of the text book has just been finalised. The following standard cost
estimates have been made for the first batch to be manufactured in Month 1.
 Standard costs for the batch
 S $
 500 labour hours @ $8 per hour
4,000
 55 units of direct materials @ $100 per unit
5,500
 Variable overhead 500 hours @ $15 per hour
7,500

17,000
 From experience the firm knows that labour will benefit from a
learning effect and labour times
 will be reduced.This is expected to approximate to an 80%
learning curve.
 The actual production for the first six months was as follows:
 Month 1 20 batches
 Month 2 30 batches
 Month 3 25 batches
 Month 4 24 batches
 Month 5 33 batches
 Month 6 28 batches
Question 16
 What is the labour time taken to produce the last batch in
month 6?
 Y=a×xb
 Where:
 X = cumulative number of units
 Y = cumulative average time per unit to produce X units
 a = time required to produce the first unit of output
 b = index of learning = log r/log 2, where r = the learning
rate expressed as a decimal.
 Total batches for months 1 to 6 = 160
 b = log r/ log 2 (r = rate of learning); b = log 0.8/log 2 so b = –
0.321928
 Average time taken per batch for 160 batches
 Y160 = 500 × 160^–0.321928 = 97.5893 hours
 Total time for 160 batches = 97.5893 × 160 = 15,614.288 hours
 Average time taken per batch for 159 batches Y159 = 500 ×
159^–0.321928 = 97.7864 hours
 Total time for 159 batches = 97.7864 × 159 = 15,548.0376
hours
 Therefore, the total time taken for the 160th batch is 15,614.288
– 15,548.0376 = 66.25 hours
 B
Question 17
 The following statements have been made about the
appropriateness of the use of the learning curve model in
Chemistry Magic:
 (1) The learning effect is limited in Chemistry Magic, because the
machines break down often.
 (2) The learning curve effect will take longer to reach a plateau
because of the complexities of the production process.
 Which of the above statements is/are true?
 A (1) only
 B (2) only
 C Both (1) and (2)
 D Neither (1) nor (2)
 Both statements are true.
 Chemistry Magic is considering the implementation of a new budgeting system. At
present, the firm uses an incremental budgeting system but is considering changing to an
activitybased budgeting (ABB) system, or perhaps a flexible budgeting system.
 Which of the following statements regarding the benefits of such a change are correct?
 (1) ABB would draw attention to the costs of overhead activities.
 (2) ABB would recognise that it is activities which drive overhead costs.
 (3) ABB would ensure that the budget is continuously updated by adding a new budget
period once the most recent budget period has ended.
 (4) Flexible budgeting would recognise different cost behavior patterns and so would
take into account the organisation’s overall strategy during the budget process.
 A (1) and (2) only
 B (1), (2) and (4) only
 C (3) and (4)
 D (1), (2), (3) and
 Statements 3 and 4 are not correct.
 Which of the following statements regarding the drawbacks of Activity-Based Budgeting
are correct?
 (1) A considerable amount of time and effort might be needed to establish the key
activities and their cost drivers.
 (2) It could be argued that in the short-term many overhead costs are not controllable
 and do not vary directly with changes in the volume of activity for the cost driver.
 (3) There may not be suitably trained staff available to implement the change successfully.
 (4) The cost of the new ABB system should be evaluated against the perceived benefits.
 Benefits may be difficult to quantify and therefore a rigorous investment appraisal of the
project may be difficult to prepare.
 A (1) and (2) only
 B (1), (2) and (4) only
 C (3) and (4)
 D (1), (2), (3) and (4)
 All statements are correct.
Question 20
 Chemistry Magic is suffering from declining sales and is predicted
to make a loss in the next year. As a result, management have
identified a number of possible actions:
 (1) Shut down the company and sell off all its assets
 (2) Undertake a major upgrade to the printing machines costing
$4.5 m
 (3) Undertake a minor upgrade to the printing machines costing
$2 m
 The upgrades are predicted to have variable results and the
probability of good results after a major upgrade is 0.8, whereas
the probability of good results after a minor upgrade is 0.7.
 Which decision should the company make?
 EV for major upgrade = (0.8 × $10m) + (0.2 × $7m) =
$9.4 m
 EV for minor upgrade = (0.7 × $8 m) + (0.3 × $8m) =
$8.0 m
 Decision:
 Shut down and sell $5m
 Major upgrade ($9.4 m – $4.5 m) = $4.9m
 Minor upgrade ($8.0m – $2 m) = $6 m
 As the minor upgrade has the highest expected return, that
should be the option chosen.
 Sydney Co manufactures mobile phone handsets. In its
factory, three handsets (X,Y and Z) are in
 continuous mass production. Each of these handsets
incorporates around 40 raw material and
 semi-finished items which are bought from outside suppliers.
 Sales of X, Y and Z have recently been declining. Sydney Co is
considering a proposal to discontinue these handsets and
replace them by a large range of differentiated handsets.
 These new handsets would be highly customised and would
be frequently renewed to adopt the latest technologies and
allow for market changes. They would be produced in short,
discontinuous batches with production lines switching
frequently from one product to another. In parallel, Sydney
Question 21
 The following statements have been made about activity-
based costing:
 (1) ABC recognises that some overhead costs do not depend
directly on the volume of output
 (2) The cost of implementing ABC may exceed the benefits
for Sydney Co.
 Which of the above statement is/are true?
 A (1) only
 B (2) only
 C Both (1) and (2)
 D Neither (1) nor (2)
 B
QUESTION 22
 The following statements have been made about introducing
activity-based costing (ABC) in Sydney Co:
 (1) Introducing ABC in Sydney Co will reduce all costs in the
short-term.
 (2) If the cost of a handset is the same using ABC or absorption
costing, there will be no benefit using ABC in Sydney Co.
 Which of the above statement is/are true?
 A (1) only
 B (2) only
 C Both (1) and (2)
 D Neither (1) nor (2)
 Statement (1) is not correct, Statement (2) is not correct
Question 23
 The budgeted distribution costs for next year (2018), are as
follows:
 Transport costs
$2,631,200
 Order processing $1,573,000
 ––––––––––
 Total distribution costs
$4,204,200
 ––––––––––
 It is estimated that in the next year, 325,000 orders will be
processed and that the delivery vehicles will travel 1,495,000
kilometres. A customer has indicated that 138 orders, each of
which will require a journey of 122 kilometres, will be
placed in the next year.
 Transport cost , cost driver is the number of Kms travelled
2,631,200/1,495,00 $1.76/km
 Order processing, cost driver is the number of orders
processed
 1.573,000/325,000 = $4.84 per order processed
 The cost to be quoted is therefore
 Transport 122 kms at $1.76 per kilometre =
$214.72
 Processing $4.84
 Total
$219.56
 138 Orders 219.56 x 138 30,293
 The target cost for one of the handsets has been calculated to be
$45, which is 10% less than the actual cost currently achievable.
 Sydney Co is considering providing some internal training to
improve efficiency of labour, and hence reduce the cost gap. The
current material cost is $12 per unit and this will not change as
efficiency changes. Labour rates are $12 per hour.
 How much of an efficiency improvement (measured by the %
reduction in labour time per unit) will be necessary to remove the
cost gap completely?
 A 13.2%
 B 15.2%
 C 16.8%
 D 17.1%
 Actual cost currently achievable: ($45/(1–10%)) = $50.
 The cost gap is therefore $50 currently achieved - $45 target
cost = $5.00.
 Labour cost is currently Total cost $50 – material cost $12 =
$38.This means it takes $38/$12 = 3.167 hours per unit.
 To achieve the target cost, we need to move to a labour cost
of $38.00 - $5.00 = $33.00 and therefore take $33/$12 =
2.75 hours per unit.
 We therefore need a reduction in time per unit of (3.167 –
2.75) = 0.417 hours, which represents 0.417/3.167 =
13.16% improvement.
 Which of the following statements regarding life-cycle costing are
correct?
 (1) All costs should be taken into account when working out the cost of
a handset and its profitability.
 (2) The maturity phase is characterised by a rapid build-up in demand.
 (3) A lifecycle costing analysis cannot include environmental costs
 (4) Attention to all costs in a lifecycle costing approach will help to
reduce the cost per unit and help an organisation achieve its target cost.
 A (1) and (2)
 B (2) and (3)
 C (3) and (4)
 D (1) and (4)
 Statements 2 and 3 are not correct. It is the growth phase
that is characterised by a rapid
 build-up in demand. A lifecycle costing analysis incudes all
costs
 WTI is planning to launch a new component. Production volume will be
limited, with only 128 components to be produced in total.
 WTI expects the manufacture of the first component to take 25 direct
labour hours. It is anticipated there will be a 90% learning curve that
will continue until all 128 components have been produced. Direct
labour is paid at a rate of $15 per hour.
 Non labour-related costs are expected to be $265 per component; this
will apply to all 128 components produced. There are no product-
specific fixed costs associated with this new component.
 WTI is going to use a target costing approach for the new component.
Based on the market research it has undertaken, WTI plans to sell the
components for $530 each.WTI requires an average profit margin of
20% of the selling price over the life of this new component.
 Required:
 (a) Calculate the time required to produce the 128th
component
 (b) Calculate the value of any cost gap between the target
cost of 128 components in total and the expected cost of 128
components in total
 (c) Calculate the rate of learning required to close the cost
gap you calculated in part (b) in order to achieve the
required profit margin of 20%
 Cumulative average time for first 128 components
 y = ax^b ,x = 128 a = 25 hours b = -0.152
 Y= 11.96 Hours
 Total time for first 128 components, 11.96 hours * 128 =
1,530.88 hours
 Cumulative average time for first 127 components
 y = ax^b x = 127 a = 25 hours b = -0.152
 y = 11.97 hours
 Total time for 127 Components 11.97*127 =1,520,19
 Time for component 128 = 1,530.88–1,520.19 = 10.69 hours
 Sales 530
 Required margin 20%
 Target Cost 0.80*530 424 *128 54,272
 Expected cost
 Other cost 265 *128 33,920

 Labour cost 11.96*15 179.40 *128 22,963.20

 Expected cost 444.40 *128 56883.20
 Target cost gap 444.40-424 20.40 2611.20
 Cost gap 2611.20
 Target labour cost 22,963-2611,20
20,352
 Target labour hours 20,352/15 =1,356.20
hours
 Target cumulative average time per component: 1,356.8 /
128 components = 10.6 hours
 Target learning rate: 10.6 hours / 25 hours ^(1/7) = 88%
 PBS provides courses for students who are studying for accountancy
examinations. The accountancy education sector is extremely competitive; it is
dominated by a small number of national organisations but there is also a large
number of smaller regional training providers.
 The majority of PBS students are part-time students and fit their studies around
their employment. PBS has developed a reputation for understanding its
students’ needs and delivering a high quality service that meets their
requirements.

 PBS has grown in recent years from a small regional company to a position
where it now has colleges in several of the country’s large cities. The company
directors now wish PBS to grow further and have implemented a strategy to
achieve the objective of becoming “the largest accountancy study provider in
the country”.
 PBS’s board of directors currently uses financial reports to monitor the
company’s performance but are thinking about implementing a Balanced
Scorecard approach to performance management
 a) Explain the disadvantages of using financial performance
indicators alone to assess performance.
 (b) Explain TWO non-financial performance measures, each
from a different perspective of the Balanced Scorecard,
which PBS could use to measure the performance of the
business against the new strategy. (You must state the
perspectives that your measures relate to and explain why the
measures would be effective.)
 Financial performance indicators are ‘lag’ indicators. The financial
impact, in terms of sales revenue or profitability, of a decision
taken at an organisation will be reported some time after that
decision has been made
 Many financial performance indicators provide little insight into
the business as they could be said to be the product of decisions
made and actions taken possibly long before the period in which
they are reported and/or considered.They provide very little
linkage to the strategy of the business and may invoke ‘short
termism’ and overlook motivation, quality, efficiency and other
drivers of success.
 Financial performance indicators are vulnerable to manipulation
and to the choice of accounting policies (such as depreciation and
inventory valuation)
 Customer perspective: The primary purpose of the training
courses that PBS provides is to help students pass their
examination papers. Student examination pass rate is a key
measure that will attract and retain students. Students passing
exams will result in those students continuing their
professional education with that college. Students passing
exams will also generate advocates for that college as
successful students tell their friends and colleagues about
their experience. This in turn will attract further students to
the college, thus delivering on PBS’s stated strategic
objective.
 Learning and growth perspective: The success of new
innovations in teaching and learning at PBS is a determinant
of student satisfaction and exam success. If students are
finding these new learning resources valuable this will likely
lead to an increase in the effectiveness of the learning
delivery at PBS and in turn the students’ satisfaction with
their experience. A measure to assess the success of the new
innovations introduced by PBS is the number of times a
student has logged in to their account and used the software
provided.
 PTP produces two products from different combinations of the same
resources. Details of the selling price and costs per unit for each product
are shown below:
 Product E
Product
 Selling price
175 125
 Material A ($12/Kg) 60
24
 Material B ($5/Kg) 10
15
 Labour ($20/hr)
40 20
 Variable Overhead $7/ machine/hr 14
28
 The fixed costs of the company are $50,000 per month.
 PTP aims to maximise profits from production and sales. The
production plan for June is currently under consideration.
 The following resources are available in June:
 Material A 4,800kg
 Material B 3,900kg
 Labour 2,500 hours
 Machine hours 5,000 hours
 Required
 (a) Identify the objective function and the constraints to be used in
a linear programming model to determine the optimum
production plan for June.
 The solution to the linear programming model shows that the only
binding constraints in June are those for Material A and Material
B.
 (ii) Produce, using simultaneous equations, the optimum
production plan and resulting profit for June. (You are NOT
required to draw or sketch a graph.)
 Based on the optimal production plan for June, the management
accountant at PTP has determined that the shadow price for
Material A is $7 per kg.
 (b) Explain the meaning of the shadow price for Material A.
Solution
 Let E = the number of units of Product E produced and sold in
June.
 Let M = the number of units of Product M produced and sold in
June.
 Material A: 5E + 2M ≤ 4,800
 Constraints:
 Material B: 2E + 3M ≤ 3,900
 Labour: 2E + M ≤ 2,500
 Machine hours: 2E + 4M ≤ 5,000
 Non-negativity: E,M ≥ 0
 Objective function:To maximise 51E + 38M
 5E + 2M = 4,800 Equation (1)
 2E + 3M = 3,900 Equation (2)
 Equation (1) x 2 = Equation (3)
 Equation (2) x 5 = Equation (4)
 10E + 15M = 19,500 Equation (4)
 10E + 4M = 9,600
 11M = 9,900 Equation (4) – Equation (3) Equation (3)
 M = 900
 Substitute into Equation (1)
 E = 600
 Substitute values into the objective function:
 Contribution: (51 x 600) + (38 x 900) = $64,800 Less fixed costs
$50,000 Profit = $14,800
 If one more kg of material A were available at the normal
cost of $12, this would generate an additional $7 of
contribution for PTP. Therefore, the shadow price of $7 for
material A represents the maximum premium PTP should
pay to acquire one more kg of material A
 Dragon Ltd manufactures three products: the Ego, the Bling and the Out. Currently, sales, cost
 and selling price details and processing time requirements are as follows:
 n Ego Bling
Out
 Annual Sales (units) 6,000 6,000 750
 Selling Price in $ 20.00 31.00
39.00
 Maximum demand at current selling price 11,000 8,000 2,000
 Total Unit cost (*) 18.00 24.00 30.00
 Processing time required per unit (hours) 1 1 2
 (*) Fixed manufacturing overheads are absorbed into unit costs by a charge of 200% of variable
 cost.
 Dragon Ltd is working at full capacity (13,500 processing
hours per year), and this procedure fully absorbs the fixed
manufacturing overhead. Processing time can be switched
from one product line to another, and selling prices (on a
cost-plus basis) are not to be altered.
 In what order should the products be manufactured, assuming that the company wants to
maximize profits
 C Ego Bling
Out
 Variable cost a third of total cost 1/3 × $18= $6.00 1/3 × $24 = $8.00 1/3 × $30=
$10.00
 V Ego Bling
Out
 S
 Selling price 20 31 39
 Variable cost 6 8 10
 Contribution 14 23 29
 Processing time 1 1 2
 Contribution per hour 14 23
14.50
 Rank 3 1 2
 Which of the following statements regarding shadow prices are correct?
 (1) With shadow prices, we are trying to work out how much better off we
would be as a result of having one more unit of a particular scarce resource
(materials or labour, for example).
 (2) A shadow price analysis helps management in deciding whether a struggle to
uplift a constraint is worthwhile or not.
 (3) With a shadow price analysis, improvement does not only mean an increase
in revenue or contribution, but can also mean a decrease in costs.
 (4) Non-critical constraints will have zero shadow prices as slack exists already.
 A (1) and (2) only
 B (1), (2) and (3) only
 C (1) and (4)
 D (1), (2), (3) and (4)
 All statements are correct
Selling price of go
 The best selling prices are those that maximise profit. Profit is
maximised when Marginal
 Revenue = Marginal cost and the equation for the optimum Price
and quantity demanded
 will take the form:
 P = a + bQ
 Where ‘b’ is the gradient of the line and calculated as follows for
all three products:
 b = change in price/change in quantity
 1/2000 = 0.0005
 ‘a’ is the price at which nothing will be sold and can be established
as follows:
 Ego
 $25.50 nothing is sold
 We need to double the gradient to find the marginal revenue:
MR = a – 2bQ and equate MR
 and MC to find Q.
 MR = $25.50 – 0.001Q
 MC 6
 6=25.50-0.001Q Optimum quantity 19,500
 Price 15.75
 bling