1、Decision Making LESSON4Topic Outline and Required Reading Topic 1:Operation Decisions(Chapter 11)Topic 2:Pricing Decisions(Chapter 12)Topic 1：Operating decisions 1 Relevant Costs 2 Incremental Analysis in Common Business Decisions SpecialorderdecisionsProductmixdecisionsMakeor buydecisionsJointprodu
2、ctdecisionsl Product markets can change quickly due to competitor pricecuts,changing customer preferences,and introduction ofnew products by competitors.l Managers must make short-run decisions,with a fixed setof resources,to react to the changing market place.The Challenge ofChanging Markets51:Rele
3、vant costLearning objective Distinguish relevant from irrelevant information in decisions situations.Required reading Chapter 11,pages 299-303l Costs that are applicableto a particular decision.l Costs that should have a bearing on which alternative a manager selects.l Costs that are avoidable.l Fut
4、ure costs that differbetween alternatives.12Relevant Costs Will you drive or fly to Florida for spring break?You have gathered the following information to help you with the decision.lMotel cost is$80 per night.lMeal cost is$20 per day.lYour car insurance is$100 per month.lKennel cost for your dog i
5、s$5 per day.lRound-trip cost of gasoline for your car is$200.lRound-trip airfare and rental car for a week is$500.Driving requires two days,with an overnight stay,cutting your time in Florida by two days.The Concept ofRelevant Cost InformationFlorida Spring BreakDrive/Fly AnalysisCostDriveFlyMotel64
6、0$640$Eating out costs160 160 Kennel cost40 40 Car insurance100 100 Gasoline200 -Airfare/rental car-500 8 days$808 days$208 days$5The Concept ofRelevant Cost InformationFlorida Spring BreakDrive/Fly AnalysisCostDriveFlyMotel640$640$Eating out costs160 160 Kennel cost40 40 Car insurance100 100 Gasoli
7、ne200 -Airfare/rental car-500 Costs do not differ,so they are notrelevant to decision.Also,car insuranceis not relevant tothe decision as itis a past cost.The Concept ofRelevant Cost InformationTransportationcosts differ betweenthe two alternatives,so they are relevantto your decisionAre the extra t
8、wodays in Floridaworth the$300extra cost to fly?Florida Spring BreakDrive/Fly AnalysisCostDriveFlyMotel640$640$Eating out costs160 160 Kennel cost40 40 Car insurance100 100 Gasoline200 -Airfare/rental car-500 The Concept ofRelevant Cost Information Information that varies among the possible courses
9、of action being considered.Incremental costs and revenues Important cost concepts forbusiness decisions.Differential Costs and RevenueslDifferential Costs and RevenueslOpportunity costs.lSunk costs.lOut-of-pocket costs.12Relevant Informationin Business DecisionsDifferential Costs and RevenuesCosts a
10、nd revenues that differ among alternatives.Example:You have a job paying$1,500 per month in your hometown.You have a job offer in a neighboring city that pays$2,000 per month.The commuting cost to the city is$300 per month.Differential revenue is:$2,000$1,500=$500Differential cost is:$300The benefit
11、 that could have been attained by pursuing an alternative course of action.Example:If you were notattending college,you couldbe earning$20,000 per year.Your opportunity cost ofattending college for oneyear includes the$20,000.Opportunity costs are not recorded in the accounting records,but are relev
12、ant to decisions because they are a real sacrifice.Opportunity Cost All costs incurred in the past that cannot be changed by any decision made now or in the future.Sunk costs should not be considered in decisions.Example:You bought an automobile that cost$10,000 two years ago.The$10,000 cost is sunk
13、 because whether you drive it,park it,trade it,or sell it,you cannot change the$10,000 cost.Sunk Costs VersusOut-of-Pocket CostsCost=$10,000two years agoCost=$25,000todayThe dealer will trade for$20,000 plus your car.What amount is relevant to your decision,the$10,000 sunk cost of your car or the$20
14、,000 out-of-pocket cash differential?Trade?Sunk Costs VersusOut-of-Pocket Costs162:Different types of operating decisionsLearning objective Using Incremental Analysis in different operating decisions.Required reading Chapter 11,pages 301-318Five-Step Decision-Making Process：We will now examine sever
15、al different types of managerial decisions.Different types of operating decisions The decision to accept additional business should be based on incremental costs and incremental revenues.Incremental amounts are those that occur if the company decides to acceptthe new business.Accepting Additional Bu
16、siness The decision to accept additional business should be based on incremental costs and incremental revenues.Incremental amounts are those that occur only if the company decides to acceptthe new business.1.Special Order DecisionsJamCo currently sells 100,000 units of its product.The company has r
17、evenue and costs as shown below:Per Unit Total Sales10.00$1,000,000$Direct materials3.50 350,000 Direct labor2.20 220,000 Factory overhead1.10 110,000 Selling expenses1.40 140,000 Administrative expenses0.80 80,000 Total expenses9.00$900,000$Operating income1.00$100,000$Special Order Decisions JamCo
18、 is approached by an overseas company that offers to purchase 10,000 units at$8.50 per unit.If JamCo accepts the offer,total factory overhead will increase by$5,000;total selling expenses will increase by$2,000;and total administrative expenses will increase by$1,000.Should JamCo accept the offer?Sp
19、ecial Order DecisionsFirst lets look at incorrect reasoningthat leads to an incorrect decision.Our cost is$9.00per unit.I cant sell for$8.50 per unit.Special Order Decisions Current Business Additional Business Combined Sales1,000,000$85,000$1,085,000$Direct materials350,000$35,000$385,000$Direct la
20、bor220,000 22,000 242,000 Factory overhead110,000 5,000 115,000 Selling expenses140,000 2,000 142,000 Admin.expenses80,000 1,000 81,000 Total expenses900,000$65,000$965,000$Operating income100,000$20,000$120,000$This analysis leads to the correct decision.Special Order Decisions Current Business Add
21、itional Business Combined Sales1,000,000$85,000$1,085,000$Direct materials350,000$35,000$385,000$Direct labor220,000 22,000 242,000 Factory overhead110,000 5,000 115,000 Selling expenses140,000 2,000 142,000 Admin.expenses80,000 1,000 81,000 Total expenses900,000$65,000$965,000$Operating income100,0
22、00$20,000$120,000$10,000 new units$8.50 selling price=$85,000Special Order Decisions Current Business Additional Business Combined Sales1,000,000$85,000$1,085,000$Direct materials350,000$35,000$385,000$Direct labor220,000 22,000 242,000 Factory overhead110,000 5,000 115,000 Selling expenses140,000 2
23、,000 142,000 Admin.expenses80,000 1,000 81,000 Total expenses900,000$65,000$965,000$Operating income100,000$20,000$120,000$10,000 new units$3.50=$35,000Special Order Decisions Current Business Additional Business Combined Sales1,000,000$85,000$1,085,000$Direct materials350,000$35,000$385,000$Direct
24、labor220,000 22,000 242,000 Factory overhead110,000 5,000 115,000 Selling expenses140,000 2,000 142,000 Admin.expenses80,000 1,000 81,000 Total expenses900,000$65,000$965,000$Operating income100,000$20,000$120,000$10,000 new units$2.20=$22,000Special Order Decisions Current Business Additional Busin
25、ess Combined Sales1,000,000$85,000$1,085,000$Direct materials350,000$35,000$385,000$Direct labor220,000 22,000 242,000 Factory overhead110,000 5,000 115,000 Selling expenses140,000 2,000 142,000 Admin.expenses80,000 1,000 81,000 Total expenses900,000$65,000$965,000$Operating income100,000$20,000$120
26、,000$Even though the$8.50 selling price is less than thenormal$10 selling price,JamCo should accept theoffer because net income will increase by$20,000.Special Order DecisionsWe can also look at this decisionusing contribution margin.Per Unit Total Special order revenue8.50$85,000$Direct materials3.
27、50 35,000 Direct labor2.20 22,000 Contribution margin2.80$28,000$Increase in fixed costs:Factory overhead5,000$Selling expenses2,000 Administrative expenses1,000 Special order profit20,000$Special Order Decisions Managers often face the problem of deciding how scarce resources are going to be utiliz
28、ed.Usually,fixed costs are not affected by this particular decision,so management can focus on maximizing total contribution margin.Lets look at the Kaser Company example.2.Production Constraint DecisionsKaser Company produces two products and selected data is shown below:Products12Selling price per
29、 unit$60$50 Less:variable expenses per unit36 35 Contribution margin per unit24$15$Current demand per week(units)2,000 2,200 Contribution margin ratio40%30%Processing time required on machine A1 per unit1.00 min.0.50 min.Production Constraint Decisions Machine A1 is the scarce resource because there
30、 is excess capacity on other machines.Machine A1 is being used at 100%of its capacity.Machine A1 capacity is 2,400 minutes per week.Should Kaser focus its efforts on Product 1 or 2?Production Constraint DecisionsLets calculate the contribution margin per unit of the scarce resource,machine A1.Produc
31、ts12Contribution margin per unit$24$15 Time required to produce one unit1.00 min.?min.Contribution margin per minute24$?Production Constraint DecisionsProduct 2 should be emphasized.It is the more valuable use of the scarce resource,machine A1,yielding a contribution margin of$30 per minute as oppos
32、ed to$24 for Product 1.Products12Contribution margin per unit$24$15 Time required to produce one unit1.00 min.0.50 min.Contribution margin per minute24$30$Production Constraint DecisionsLets calculate the contribution margin per unit of the scarce resource,machine A1.If there are no other considerat
33、ions,the best plan would be to produce to meet current demand for Product 2 and then use any capacity that remains to make Product 1.Products12Contribution margin per unit$24$15 Time required to produce one unit1.00 min.0.50 min.Contribution margin per minute24$30$Production Constraint DecisionsLets
34、 calculate the contribution margin per unit of the scarce resource,machine A1.Allotting Our Scarce Resource(Machine A1)Weekly demand for Product 2 2,200 unitsTime required per unit0.50 min.Total time required to make Product 21,100 min.Lets see how this plan would work.Production Constraint Decision
35、sAllotting Our Scarce Resource(Machine A1)Weekly demand for Product 2 2,200 unitsTime required per unit0.50 min.Total time required to make Product 21,100 min.Total time available2,400 min.Time used to make Product 21,100 min.1,300 Production Constraint DecisionsLets see how this plan would work.All
36、otting Our Scarce Resource(Machine A1)Weekly demand for Product 2 2,200 unitsTime required per unit0.50 min.Total time required to make Product 21,100 min.Total time available2,400 min.Time used to make Product 21,100 min.Time available for Product 11,300 min.Time required per unit1.00 min.Productio
37、n of Product 11,300 unitsProduction Constraint DecisionsLets see how this plan would work.According to the plan,we will produce 2,200 units of Product 2 and 1,300 of Product 1.Our contribution margin looks like this.Product 1Product 2Production and sales(units)1,300 2,200 Contribution margin per uni
38、t24$15.00$Total contribution margin31,200$33,000$The total contribution margin for Kaser is$64,200.Production Constraint DecisionsShould Icontinue to makethe part,or shouldI buy it?I suppose Ishould comparethe outside purchaseprice with the additionalcosts to manufacturethe part.What will I do with
39、myidle facilities ifI buy the part?3.Make or Buy Decisions Incremental costs also are important in the decision to make a product or buy it from a supplier.The cost to produce an item must include(1)direct materials,(2)direct labor and(3)incremental overhead.We should not use the predetermined overh
40、ead rate to determine product cost.Make or Buy Decisions Exitel makes computer chips used in one of its products.Unit costs,based on production of 20,000 chips per year,are:Unit CostsDirect Material9.00$Direct Labor5.00 Variable Overhead1.00 Fixed Overhead13.00 Total28.00$Make or Buy Decisions An ou
41、tside supplier has offered to provide the 20,000 chips at a cost of$25 per chip.Fixed overhead costs will not be avoided if the chips are purchased.Exitel has no alternative use for the facilities.Should Exitel accept the offer?Make or Buy DecisionsDifferential costs of making(costs avoided if bough
42、t from outside supplier)Unit CostDirect Material9.00$Direct Labor5.00 Variable Overhead1.00 Total15.00$Exitel should not pay$25 per unit to an outside supplier to avoid the$15 per unit differential cost of making the part.Fixed costs are irrelevant to decision.Make or Buy Decisions If Exitel buys th
43、e chips from the outside supplier,the idle facilities could be leased to another company for$250,000 per year.Should Exitel buy the chips and lease the facilities?Make or Buy DecisionsThe real question to answer is,“What is the best use of Exitels facilities?”Disadvantage of buying 20,000 units ($25
44、-$15)200,000$Opportunity cost of facilities:The lease revenue250,000 Advantage of buying partand leasing facilities50,000$The opportunity cost of facilities changes the decision.Make or Buy Decisions Costs incurred in manufacturing units of product that do not meet quality standards are sunk costs a
45、nd cannot be recovered.As long as rebuild costs are recovered through sale of the product,and rebuilding does not interfere with normal production,we should rebuild.4.Sell,Scrap,or Rebuild Decisions OserCo has 10,000 defective units that cost$1.00 each to make.The units can be scrapped now for$.40 e
46、ach or rebuilt at an additional cost of$.80 per unit.If rebuilt,the units can be sold for the normal selling price of$1.50 each.Rebuilding the 10,000 defective units will prevent the production of 10,000 new units that would also sell for$1.50.Should OserCo scrap or rebuild?Sell,Scrap,or Rebuild Dec
47、isions Scrap Now Rebuild Sale of defects4,000$15,000$Less rebuild costs-Less opportunity cost-Net return4,000$10,000 units$1.50 per unit10,000 units$0.40 per unitSell,Scrap,or Rebuild Decisions Scrap Now Rebuild Sale of defects4,000$15,000$Less rebuild costs-(8,000)Less opportunity cost-(5,000)Net r
48、eturn4,000$2,000 10,000 units$0.80 per unit10,000 units ($1.50-$1.00)per unitSell,Scrap,or Rebuild Decisions Scrap Now Rebuild Sale of defects4,000$15,000$Less rebuild costs-(8,000)Less opportunity cost-(5,000)Net return4,000$2,000 OserCo should scrap the units now.If OserCo fails to include the opp
49、ortunity cost,the rework option would show a return of$7,000,mistakenly making rebuild appear more favorable.Sell,Scrap,or Rebuild DecisionsProduct 2Joint CostsProduct 1Product 3Two or more products produced from acommon input are called joint products.The split-off point is the point in a process w
50、here joint products can be recognized as separate products.Joint costs arethe costs ofprocessing prior to the split-off point.5.Joint Product Decisions Businesses are often faced with the decision to sell partially completed products at the split-off point or to process them to completion.General ru
