Copyright © 2007 Prentice-Hall. All rights reserved 1 Short-Term Business Decisions Chapter 8
Mar 15, 2016
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Short-Term Business Decisions
Chapter 8
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Making Decisions
• Define goals• Identify alternative courses of action• Gather and analyze relevant information• Compare alternatives• Choose best alternative
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Objective 1
Describe and identify information relevant to business decisions
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Relevant Information
• Affects the future and• Differs among alternative courses of action• Quantitative and qualitative
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Relevant Information Approach
• Incremental analysis - how operating income differs under each alternative
• Two keys– Focus on relevant revenues, costs, and profits– Use contribution margin approach
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Irrelevant Costs
• Costs that do not differ between alternatives
• Sunk costs – incurred in past and cannot be changed
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Objective 2
Make special order and pricing decisions
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Special Sales Order
Is there excess capacity?
Yes
Consider further
No
Reject the special order
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Special Sales Order
DECISION RULE: Accept special order?
Increase in revenues > increase in variable & fixed
costs?
Accept the special order
Increase in revenues < increase in variable & fixed
costs?
Reject the special order
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Qualitative Factors
Will special order affect regular sales in the long run?
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E8-16 (1)Sports-Cardz
Incremental Analysis of Special Sales OrderExpected increase in revenues
(50,000 packs $0.40) $ 20,000Expected increase in expenses:
Variable manufacturing cost:(50,000 $0.35) (17,500)
Expected increase in operating income $ 2,500
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E8-16 (2)Sports-Cardz
Incremental Analysis of Special Sales OrderExpected increase in revenues
(50,000 packs $0.40) $ 20,000Expected increase in expenses:
Variable manufacturing cost:(50,000 $0.35) $(17,500)Fixed manufacturing costs (5,000)(22,500)
Expected decrease in operating income $(2,500)
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Setting Regular Prices
• What is our target profit?• How much will customers pay?• Are we a price-taker or a price-setter for
this product?
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Price Taker
• Product lacks uniqueness• Heavy competition• Pricing approach emphasizes target
pricing
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Target Pricing
Revenue at market price- Desired profit Target full cost
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Price Setters
• Product is more unique• Less competition• Pricing approach emphasizes cost-plus
pricing
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Cost-Plus Pricing
Full cost+ Desired profit Cost-plus price
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Pricing Decisions
DECISION RULE: How to Approach Pricing?
Is company a price-taker for the product?
Emphasize target pricing approach
Is company a price-setter for the product?
Emphasize cost-plus pricing approach
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E8-18
Req 2 Revenue at market price $200,000- Desired profit ($182,000 x 15%) (27,300) Target full cost $172,700 Actual current variable cost 182,000 Shortfall $9,300
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E8-18
Req 3 Full cost $202,000+ Desired profit ($202,000 X 15%) 30,300 Cost-plus price $232,300
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Objective 3
Make dropping a product and product-mix decisions
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Dropping Products, Departments or Territories
• Does product provide positive contribution margin?
• Will dropping the product affect sales of the company’s other products?
• What can be done with the freed capacity?
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Dropping Products, Departments or Territories
• Are there unavoidable fixed costs?– Unavoidable fixed costs continue even if the
product line is dropped• Are there avoidable fixed costs?
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DECISION RULE: Drop a product,
department, or territory?
Are lost revenues > its relevant costs?
Do not drop
Are lost revenues < its relevant costs?
Drop
Dropping Products, Departments or Territories
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E8-19Video Avenue
Analysis of Dropping VCR-Tape LineExpected decrease in revenues $ (120,000)Expected decrease in expenses:
Variable costs 80,000Expected decrease in operating
income $(40,000)
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E8-20Video Avenue
Analysis of Dropping VCR-Tape LineExpected decrease in revenues $ (120,000)Expected decrease in expenses:
Variable costs 80,000Fixed costs 30,000
Expected decrease in operating income $(10,000)
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Product Mix
• What constraint(s) stops us from making (or displaying) all the units we can sell?
• Which products offer the highest contribution margin per unit of the constraint?
• Would emphasizing one product over another affect fixed costs?
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Product Mix
DECISION RULE: Which product to
emphasize?
The product with the highest contribution margin per unit of
constraint
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E8-22 Designer Moderate
Contribution margin per unit $115.00 $60.00Units displayed per sq ft.
300/10,000 x .030650/10,000 x.065
Contribution margin per sq ftof display space $3.45 $3.90
Capacity – sq ft of display space x10,000 x10,000 Total contribution margin at
capacity $34,500 $39,000
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Objective 4
Make outsourcing and “sell as is or process further” decisions
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Outsourcing (Make or Buy)
• How do our variable costs compare to the outsourcing cost?
• Are any fixed costs avoidable if we outsource?
• What could we do with the freed capacity?
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OutsourcingDECISION RULE:
Should the company outsource?
Are relevant costs to make > relevant costs to buy?
Outsource
Are relevant costs to make < relevant costs to buy?
Do not outsource
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E8-24 Make Buy DifferenceIncremental cost per unit:
Direct materials $9.00 $0$9.00Direct labor 1.50 01.50Variable overhead 2.00 02.00Purchase price $14 (14.00)
Incremental cost per unit $12.50 $14$(1.50)
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E8-25MakeIncremental cost per unit: $12.50Number of switches x 80,000Total incremental costs $1,000,000
Buy and leave facilities idleIncremental cost per unit: $14.00Number of switches 80,000Total incremental costs $1,120,000
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E8-22
Buy and use facilities for other productIncremental cost per unit: $14Number of switches 80,000Total incremental costs to buy $1,120,000Expected profit contribution from
other product (220,000)
Expected net cost$900,000
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Sell As-Is or Process Further
• How much revenue is generated if we sell the product as is?
• How much revenue is generated if we sell the product after processing it further?
• How much will it cost to process the product further?
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Sell As-Is or Process Further
DECISION RULE: Sell as is or process further?
Are extra revenues from processing further > extra cost
to process further?
Process further
Are extra revenues from processing further < extra cost
to process further?
Sell as is
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8-27Process
Sell As Is FurtherExpected revenue/unit $6.00 $0.50Extra packaging costs/unit (0.10) (0.08)Extra cost for fruit (0.10)Expected net revenue/unit $5.90 $0.32Number of units per batch x 500 x 10,667Net benefit per batch $2,950 $3,413
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End of Chapter 8