Professional Documents
Culture Documents
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Decision Making
Strategic, Operational, and Financial Planning
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McGraw-Hill/Irwin
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Colorado Spring Break Drive/Fly Analysis Cost Motel Eating out costs Kennel cost Car insurance Gasoline Airfare/rental car
McGraw-Hill/Irwin
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Costs do not differ, so they are not relevant to decision. Also, car insurance is not relevant to the decision as it is a past cost.
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
16-7
Colorado Spring Break Drive/Fly Analysis Cost Motel Eating out costs Kennel cost Car insurance Gasoline Airfare/rental car
McGraw-Hill/Irwin
Are the two extra days in Colorado worth the $500 extra cost to fly?
Transportation costs differ between the two alternatives, so they are relevant to your decision
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Irrelevant
Allocated Cost -- a common cost that has been arbitrarily assigned to a product or activity. Sunk Cost -- has already been incurred and will not change.
McGraw-Hill/Irwin
16-9
Opportunity Cost
Example: If you were not attending college, you could be earning $20,000 per year. Your opportunity cost of attending college for one year is $20,000.
Opportunity costs are not recorded in the accounting records, but are relevant to decisions because they are a real sacrifice.
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
16-10
McGraw-Hill/Irwin
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$ $ $
Based on capacity of 5,000 units: $2,500,000 5,000 units = $500 per unit.
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
16-12
MicroTech receives an offer to purchase 500 of its laptop computers for $1,800 each. If MicroTech accepts the offer, total fixed overhead will not increase and a selling commission will not be paid on the computers in the special order. Should MicroTech accept the offer?
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
16-13
Our manufacturing cost is $2,000 per unit. I cant sell for $1,800 per unit.
McGraw-Hill/Irwin
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5
McGraw-Hill/Irwin
new units 8
= 4
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5
McGraw-Hill/Irwin
new units
5 =
5,
2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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McGraw-Hill/Irwin
16-18
We can reach the same results more quickly like this: Special order contribution margin = $1,800 $1,500 = $300 Change in income = $300 500 units = $150,000.
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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osts
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McGraw-Hill/Irwin
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MicroTech should not pay $305 per unit to an outside supplier to avoid the $270 per unit differential cost of making the part ($35 disadvantage).
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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McGraw-Hill/Irwin
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The real question to answer is, What is the best use of MicroTechs facilities?
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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McGraw-Hill/Irwin
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Selling price per unit Less: variable expenses per unit Contribution margin per unit Processing time required (hours)
If 120 hours of processing time are available, which product should be produced?
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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McGraw-Hill/Irwin
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Product 2 should be emphasized. It is the more valuable use of processing time, yielding a contribution margin of $100 per hour as opposed to $75 per hour for Product 1.
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
16-30
If there are no other considerations, the best plan would be to produce to meet current demand for Product 2 and then use any time that remains to make Product 1.
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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McGraw-Hill/Irwin
16-32
Capital Budgeting
How managers plan significant outlays on projects that have long-term implications such as the purchase of new equipment and introduction of new products.
McGraw-Hill/Irwin
16-33
Capital Budgeting
Outcome is uncertain. Large amounts of money are usually involved.
Capital budgeting: Analyzing alternative long term investments and deciding which assets to acquire or sell. ecision may be difficult or impossible to reverse.
McGraw-Hill/Irwin
16-34
Plant Expansion
?
Limited Investment Funds
? ?
New Equipment
Office Renovation
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
16-35
Business investments extend over long periods of time, so we must recognize the time value of money. Investments that promise returns earlier in time are preferable to those that promise returns later in time.
2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
McGraw-Hill/Irwin
16-36
Cost of Capital
The firms cost of capital is usually regarded as the most appropriate choice for the discount rate to determine the present value of the investment proposal being analyzed. The cost of capital is the average rate of return the company must pay to its longterm creditors and stockholders for the use of their funds.
2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
McGraw-Hill/Irwin
16-37
Methods that do not use present value analysis: Payback. Accounting rate of return.
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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McGraw-Hill/Irwin
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NP =
McGraw-Hill/Irwin
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Zero . . .
Negative . . .
McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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Present Value of Cash Flows $ 3,571 3,348 2,989 2,796 2,724 2,027 1,719 2,262 $ 21,436 (16,000) $ 5,436
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McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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The higher the profitability index, the more desirable the project.
McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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$ 16,600
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Payback Period
The payback period of an investment is the number of years it will take to recover the amount of the investment.
Managers prefer investing in projects with shorter payback periods.
McGraw-Hill/Irwin
16-60
Payback Period
Cumulative et Cash lows $ 1 ,000 1 ,000 , 00 ,000 , 00 1,000 , 00 , 00 10, 00
TexCo wants to install a machine that costs $1 ,000 and has an 8 year useful life with $1,000 salvage value. Annual net cash flows are:
Year 0 1
8
McGraw-Hill/Irwin
Includes salvage
16-61
Payback Period
T x c h 1 , p ch p ic b w y 4 d , b 4. y f h p yb ck p i d.
4.
A Y
N hF w 4 3, 3, 3, 3, 3, 3, 3,
N F w 3, ( , ( , ( , 1, 4, , 1 ,
3 4
) ) ) )
McGraw-Hill/Irwin
16-62
Payback Period
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Payback Period
Consider two projects, each with a five-year life and each costing $6,000.
Proj t Net I flow , , , , , Proj t wo Net I flow , , , , , ,
Year
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McGraw-Hill/Irwin
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McGraw-Hill/Irwin
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$1 ,000 + $1,000 2
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
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McGraw-Hill/Irwin
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End of Chapter 16
McGraw-Hill/Irwin