Professional Documents
Culture Documents
Learning Objectives
Define the decision-making process and identify the
types of cost information relevant for decision making
Use relevant and strategic cost analysis to make
special-order decisions
Use relevant and strategic cost analysis in the makelease-or-buy decision
Use relevant and strategic cost analysis in the decision
to sell before or after additional processing
Blocher,Stout,Cokins,Chen, Cost Management 4e
Fifth: Evaluate
Performance
Blocher,Stout,Cokins,Chen, Cost Management 4e
Equipment-Replacement
Decision Example
Which
Which costs
costs are
are not
not relevant
relevant to
to the
the decision
decision to
to keep
keep an
an old
old
machine
machine or
or replace
replace itit with
with aa new,
new, more
more efficient
efficient one?
one?
Original
Original cost
cost of
of old
old machine,
machine, $4,200
$4,200
Current
Current book
book value
value of
of old
old machine,
machine, $2,100
$2,100
Purchase
Purchase price
price of
of aa new
new machine,
machine, $7,000
$7,000
New
New machine
machine will
will have
have zero
zero salvage
salvage value
value
Repairs
Repairs to
to old
old machine
machine would
would be
be $3,500
$3,500 and
and would
would
allow
allow one
one more
more year
year of
of productivity
productivity
Power
Power for
for either
either machine
machine is
is expected
expected to
to be
be
$2.50/hour
$2.50/hour
New
New machine
machine will
will reduce
reduce labor
labor costs
costs by
by $0.50/hour
$0.50/hour
Expected
Expected level
level of
of output
output for
for next
next year
year is
is 2,000
2,000 units
units
Equipment Replacement
Decision (continued)
The
The relevant
relevant costs
costs are....
are....
Original
Original cost
cost of
of old
old machine,
machine, $4,200
$4,200
Current
Current book
book value
value of
of old
old machine,
machine, $2,100
$2,100
Purchase
Purchase price
price of
of aa new
new machine,
machine, $7,000
$7,000
New
New machine
machine will
will have
have zero
zero salvage
salvage value
value
Repairs
Repairs to
to old
old machine
machine would
would be
be $3,500
$3,500 and
and
would
would allow
allow one
one more
more year
year of
of productivity
productivity
Power
Power for
for either
either machine
machine is
is expected
expected to
to be
be
$2.50/hour
$2.50/hour
New
New machine
machine will
will reduce
reduce labor
labor costs
costs by
by
$0.50/hour
$0.50/hour
Differences in quality
Functionality
Timeliness of delivery
Reliability in shipping
After-sale service level
10
11
12
13
14
15
Therefore.....
Total Cost = $5.05 per unit + $200 per batch + $450,000
Blocher,Stout,Cokins,Chen, Cost Management 4e
16
17
18
Blue
Blue Tone
Tone is
is currently
currently manufacturing
manufacturing the
the
mouthpiece
mouthpiece for
for its
its clarinet,
clarinet, but
but has
has the
the option
option to
to buy
buy
this
this item
item from
from aa supplier.
supplier. Short-term
Short-term fixed
fixed overhead
overhead
costs
costs will
will not
not change
change whether
whether or
or not
not Blue
Blue Tone
Tone
chooses
chooses to
to make
make or
or to
to buy
buy the
the mouthpiece.
mouthpiece.
Blocher,Stout,Cokins,Chen, Cost Management 4e
19
20
Lease-or-Buy Example
Lets say the decision is not whether to make or buy
an item for the firm, but whether to lease or buy that
item (an example follows):
Quick Copy is considering an upgrade to the latest model
copier that is not available for lease but must be purchased
for $160,000. The purchased copier is useful for one year,
after which it could be sold back to the manufacturer for
$40,000. In addition, the new machine has a required annual
service contract of $20,000. Should Quick Copy purchase the
new copier or renew its lease on its old copier?
Blocher,Stout,Cokins,Chen, Cost Management 4e
21
Lease-or-Buy
Example (continued)
Quick Copy Lease or Buy Information
Annual lease
Charge per copy
Purchase cost
Annual service contract
Value at end of period
Expected number of copies per year
Lease
$ 40,000
0.02
N/A
N/A
N/A
6,000,000
Purchase
N/A
N/A
$ 160,000
20,000
40,000
6,000,000
22
Lease-or-Buy
Example (continued)
Lease cost = Purchase cost
Annual fee
$40,000 + ($0.02 Q)
Q
=
=
=
=
The
The indifference
indifference point,
point, 5,000,000
5,000,000 copies,
copies, is
is lower
lower than
than the
the
expected
expected annual
annual machine
machine usage
usage of
of 6,000,000
6,000,000 copies.
copies. So,
So, Quick
Quick
Copy
Copy should
should purchase
purchase the
the machine
machine ifif strategic
strategic factors,
factors, such
such as
as
quality
quality of
of the
the copy,
copy, reliability
reliability of
of the
the machine,
machine, and
and benefits
benefits and
and
features
features of
of the
the service
service contract,
contract, are
are favorable
favorable
Blocher,Stout,Cokins,Chen, Cost Management 4e
23
Cost
$140,000
Net cost to Purchase Copier
$40,000
Q = 5,000,000
Number of Copies per Year
Blocher,Stout,Cokins,Chen, Cost Management 4e
24
TTS
TTS has
has suffered
suffered an
an equipment
equipment malfunction
malfunction causing
causing
400
400 T-shirts
T-shirts not
not to
to be
be acceptable.
acceptable. The
The shirts
shirts can
can be
be
sold
sold as-is
as-is for
for $4.50
$4.50 each
each or
or run
run through
through the
the printing
printing
process
process again.
again. The
The cost
cost of
of running
running the
the T-shirts
T-shirts through
through
the
the printer
printer aa second
second time
time is
is variable
variable cost
cost of
of $1.80
$1.80 per
per
shirt
shirt and
and the
the cost
cost of
of one
one setup.
setup.
Blocher,Stout,Cokins,Chen, Cost Management 4e
25
The net advantage to reprinting the T-shirts is $880 ($2,680 $1,800). TTS would need to consider the effect of selling to discount
stores were the cost analysis in favor of that option.
Blocher,Stout,Cokins,Chen, Cost Management 4e
26
Profitability Analysis
Profitability analysis addresses issues such as:
Which product lines are most profitable?
Are the products priced properly?
Which products should be promoted and advertised more
aggressively?
Which product-line managers should be rewarded?
An example follows:
Windbreakers, Inc. manufactures three jackets.
Management is concerned about the low profitability of the
Gale jacket and is thinking about dropping the product. If
the jacket is dropped, there will be no change in total fixed
costs for the coming year.
Blocher,Stout,Cokins,Chen, Cost Management 4e
27
28
Profitability Analysis
(continued)
The company is $15,000 ($147,000 $132,000) better off retaining rather
than deleting the Gale jacket.
Windbreakers, Inc. should also
consider strategic factors in this
decision, such as whether dropping one
product line would affect sales of
another and whether employee morale
would be affected by the decision.
Blocher,Stout,Cokins,Chen, Cost Management 4e
29
30
31
36,000
24,000
Units of
Sales
for Gale
Units of Sales
for Windy
The McGraw-Hill Companies 2008
32
33
34
35
36
Units of
Sales
for Gale
22,400
24,000
36,000
Units of
Sales for
Windy
The McGraw-Hill Companies 2008
Behavioral and
Implementation Issues
Managers must be sure to keep the firms strategic
objectives in the forefront in any decision situation to
avoid focusing solely on short-term gains
Predatory pricing occurs when a company has set
prices below average variable cost with a plan to raise
prices later to recover losses from these lower prices
Courts have found in favor of the defendants time after
time in cases involving predatory pricing
U.S. congressional leaders are considering revising the
laws related to predatory pricing to promote competition
in previously uncompetitive industries
Blocher,Stout,Cokins,Chen, Cost Management 4e
37
38
39
Chapter Summary
A relevant cost is a future cost that differs between
decision alternatives
It is important to consider strategic factors when
performing a relevant cost analysis
Focusing solely on short-term profits could potentially
lead to long-term losses
Blocher,Stout,Cokins,Chen, Cost Management 4e
40
41