Professional Documents
Culture Documents
Decisions
A decision model is a formal method of making a choice, often involving both quantitative and qualitative analyses
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Relevance
Relevant Information has two characteristics:
It occurs in the future It differs among the alternative courses of action
Relevant Costs expected future costs Relevant Revenues expected future revenues
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Irrelevance
Historical costs are past costs that are irrelevant to decision making
Also called Sunk Costs- cost that has already been incurred and that cannot be avoided regardless of what a manager decides to do
Types of Information
Quantitative factors are outcomes that can be measured in numerical terms Qualitative factors are outcomes that are difficult to measure accurately in numerical terms, such as satisfaction
Are just as important as quantitative factors even though they are difficult to measure
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Terminology
Incremental Cost the additional total cost incurred for an activity Differential Cost the difference in total cost between two alternatives Incremental Revenue the additional total revenue from an activity Differential Revenue the difference in total revenue between two alternatives
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Types of Decisions
One-Time-Only Special Orders Insourcing vs. Outsourcing Make or Buy Product-Mix Customer Profitability Branch / Segment: Adding or Discontinuing Equipment Replacement
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Special Orders
Acki Company receives a one-time order that is not considered part of its normal ongoing business. Acki Company only produces one type of silver key chain with a unit variable cost of TL 16. Normal selling price is TL 40 per unit. A company in KKTC offers to purchase 3,000 units for TL 20 per unit. Annual capacity is 10,000 units, and annual fixed costs total TL78,000, but Acki company is currently producing and selling only 5,000 units.
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Special Orders
Acki Company Contribution Income Statement Revenue (5,000 TL40) TL200.000 Variable costs: Direct materials TL40.000 Direct labor 10.000 Manufacturing overhead 20.000 Marketing costs 10.000 Total variable costs 80.000 Contribution margin 120.000 Fixed costs: Manufacturing overhead TL78.000 Marketing costs 25.000 Total fixed costs 103.000 Net income TL17.000
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Special Orders
If Acki accepts the offer, net income will increase by TL 12.000.
Increase in revenue (3,000 TL20) Increase in costs (3,000 TL16 variable cost) Increase in net income TL60.000 48.000 TL12.000
Using the incremental approach: Special order contribution margin = TL20 TL 16 = TL 4 Change in income = TL 4 3,000 units = TL 12.000.
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70 27 15 3 9 6 30 90
Cost of 20,000 Units Buy Make 1.400.000 540.000 300.000 60.000 0 120.000 0 1.020.000
1.400.000
Not avoidable and is irrelevant. If the product is dropped, it will be reallocated to other products.
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Product-Mix Decisions
The decisions made by a company about which products to sell and in what quantities Decision Rule (with a constraint): choose the product that produces the highest contribution margin per unit of the constraining resource
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Product 2 should be emphasized. Provides more valuable use of the constrained resource machine A1, yielding a contribution margin of TL 30 per minute as opposed to TL 24 for Product 1.
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If there are no other considerations, the best plan would be to produce to meet current demand for Product 2 and then use remaining capacity to make Product 1.
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Weekly demand for Product 2 Time required per unit Total time required to make Product 2 Total time available Time used to make Product 2 Time available for Product 1 Time required per unit Production of Product 1
2.200 units 0,50 min. 1.100 min. 2.400 1.100 1.300 1,00 1.300 min. min. min. min. units
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Production and sales (units) Contribution margin per unit Total contribution margin
Managing Constraints
Finding ways to process more units through a resource bottleneck
Eliminate waste.
Streamline production process.
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Decision is based on profitability of the customer, not how much revenue a customer generates
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Decision is based on profitability of the branch or segment, not how much revenue the branch or segment generates
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Adding/Dropping Segments
Digital Musical Instruments Income Statement for 2007 Sales 1.000.000 Less: variable expenses Variable mfg. costs 240.000 Variable shipping costs 10.000 Commissions 150.000 400.000 Contribution margin 600.000 Less: fixed expenses General factory overhead 120.000 Salary of line manager 180.000 Depreciation of equipment 100.000 Advertising - direct 200.000 Should the company drop digital instruments Rent - factory space 140.000 division? General admin. expenses 60.000 800.000 Net loss (200.000)
General Factory Overhead and General Administrative Expenses are unavoidable costs.
Assume that the equipment used in manufacturing digital instruments has no resale value or alternative use.
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Incremental Approach
DECISION RULE UM should drop the digital instruments division only if the avoided fixed costs of the division exceed lost contribution margin of this division.
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Incremental Approach
Contribution Margin Solution Contribution margin lost if digital instrument division is dropped Less fixed costs that can be avoided Salary of the line manager 180.000 Advertising - direct 200.000 Rent - factory space 140.000 Net disadvantage
(600.000)
520.000 (80.000)
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Sales Less variable expenses: Mfg. expenses Freight out Commissions Total variable expenses Contribution margin Less fixed expenses: General factory overhead Salary of line manager Depreciation Advertising - direct Rent - factory space General admin. expenses Total fixed expenses Net loss
1.000.000 240.000 10.000 150.000 400.000 600.000 120.000 180.000 100.000 200.000 140.000 60.000 800.000 (200.000)
Difference (1.000.000) 240.000 10.000 150.000 400.000 (600.000) 0 90.000 0 100.000 70.000 0 260.000 (340.000)
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Joint Products
Joint Costs
Joint Input Common Production Process Oil
Gasoline
Chemicals
Split-Off Point
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Joint Products
Joint Costs
Common Production Process Oil Separate Processing Final Sale
Joint Input
Gasoline
Final Sale
Chemicals
Separate Processing
Final Sale
Split-Off Point
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Sales value at the split-off point Sales value after further processing Allocated joint product costs Cost of further processing
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Sales value after further processing Sales value at the split-off point Incremental revenue Cost of further processing Profit (loss) from further processing
TL50 40 10 20 (TL10)
Should Kere process the lumber further and sell the sawdust as is?
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Behavioral Implications
Despite the quantitative nature of some aspects of decision making, not all managers will choose the best alternative for the firm Managers could engage in selfserving behavior such as delaying needed equipment maintenance in order to meet their personal profitability quotas for bonus consideration
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