Busines Management

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    Decision Making 1

    Learning objective

    In this chapter we will check different types decision making problems as faced by topmanagement on day-to-day operation basis. Management has to consider the best alternative

    situations so that the profit of the organisation will increase. Some of these are as follows1. product sales pricing & mix2. limiting factors3. multiple scare resource problem ( Ref chapter 10a)4. make or buy5. selection of products, etc etc

    Introduction:

    Decision making are of 2 types.

    (1) Long term decision making :For this purpose we generally apply capital budgeting technique.

    (2) Short term decision making ( i.e. generally in one financial year)(a) Pricing decision for the particulars period for which we apply different pricing

    techniques.(b) Other than pricing decision such as-

    (i) Except or reject an offer(ii) Make or buy the product or slab component(iii) Sale or process(iv) Exploring new foreign market.

    (v) Discontinue of a product(vi) Shut down of a factory etc.

    In this way there may be different type of heading.However, the solution technique are limited to four only :

    (1) Problem of limiting factor or limiting factor approach ( for common process applicable for morethan 1 product).

    (1) Differential cost & incremental Revenue analysis where the production & sales will continue tillMarginal Revenue > Marginal costs.

    (3) Indifference cost approach

    (4) Relevant cost approach i.e. considered only those cost & revenues which are related to thepurpose or decision. Generally we considered the following 3 items for this purpose.

    (a) Variable cost of the proposal(b) Discretionary Fixed cost(c) Opportunity cost

    If the price offered by the customer is more than the total relevant cost, then the offer isaccepted.

    In case of problem where minimum sale price is to be quoted then total relevant cost = Totalminimum sales price.

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    Decision Making 2

    Limiting Factor Problems

    When many products are produced from a single resource & total resources requirementof the product is greater then resource available, then it known as limiting factor ofproduction.

    Objective of the management maximization of contribution or contribution-DiscretionaryFixed cost.

    Step-1:Compute contribution p.u. & identify the nature of fixed cost.

    Step-2:Identify the limiting factor

    (a) Where demand is given(b) Where demand is not given (apply the concept of bottle neck)

    Step-3:Computation of contribution/limiting factor & give rank.

    Step-4:Allotment of resource from highest rank onward. In case of minimum productionequipment for all products 1st allot the limiting resource to fulfill the minimum productioncondition & then allot it on the basis of rank.

    Step-5:Prepare the profit statement & determine the best product mix.

    Problem 1Universe Ltd. manufactures two products X and Y. It is facing severe competition in the market.The monthly sales potential in units at different selling prices as anticipated by the Sales Mangerare as under:

    Product-X______________ Product-YSelling price Sales potential selling price Sales potentialPer unit (Rs.) (in units) per unit (Rs.) (in units)110 5,000 78 30,000108 7,500 77 32,000107 8,000 75 35,000103 8,400 72 40,00096 9,000 69 45,000

    The total costs as disclosed by the budgets of the company are as follows:Product X Product-Y

    Output and sales per month (units) 5,000 9,000 30,000 45,000Total costs per month (Rs. In lakhs) 5 6.6 18 25.5Labour hours needed per month 20,000 36,000 60,000 90,000

    You are required to find out the selling price and units to be sold to earn maximum profit where(a) labour hours are available without any restriction and (b) only 95,000 hours are available.

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    Decision Making 3

    SolutionWorking Notes:1. Computation of variables cost p.u. and fixed cost (p.m.)

    of two products X and Y of Universe Ltd.Products X Y

    Rs. Rs.Variable cost per unit 40 50

    -----------------------------------------------

    units

    Rs

    000,4

    000,60,1.

    units

    Rs

    000,15

    000,50,7.

    Fixed cost 3,00,000 3,00,000(Total cost-variable cost) (Rs. 5,00,000- (Rs. 18,00,000

    Rs. 2,00,000) Rs. 15,00,000)

    2. Selling price and sales level of maximum contributionProduct-X Product-Y

    Selling contribution units Total selling contribution units total

    Price p.u.per unit contribution price p.u (SP-VC) contributionRs. Rs. (Rs. Lakhs) Rs. Rs. (Rs. Lakhs)110 70 5,000 3.5 78 28 30,000 8.4108 68 7,500 5.1 77 27 32,000 8.64107 67 8,000 5.36 75 25 35,000 8.75103 63 8,400 5.292 72 22 40,000 8.8096 56 9,000 5.04 69 19 45,000 8.55

    Maximum contribution of two products X and Y are Rs. 5.36 (Lakhs) and Rs. 8.80 (Lakhs) atselling prices Rs. 107 and Rs. 72 respectively.

    3. Incremental contribution per labour hour of products X and Y(Refer to working note 2)

    Product-X Product YSellingincremental incremental contribution selling incremental incremental contributionPricecontribution labour hrs per hour price contribution labour hrs per hour Per unit per unit

    Rs. Rs. Lakhs units4 hrs Rs. Rs. Rs. Lakhs (Units2 hrs) Rs.

    (1) (2) (3) (2)/(3)=(4) (5) (6) (7) (6)/(7) = (8)110 3.5 20,000 17.50 78 8.40 60,000 14.00108 1.6 10,000 16.00 77 0.24 4,000 6.00107 0.26 2,000 13.00 75 0.11 6,000 1.83103 (-0.068) 1,600 (-4.25) 72 0.05 10,000 0.5096 (-0.252) 2,400 (-10.50) 69 (-0.25) 10,000 (-2.50)

    4. Ranking of products X and Y based on the incrementalContribution per hour as per working note 3

    Sl No. selling price Incremental Product RankingContribution per hour

    Rs. Rs.1. 110 17.50 X I2. 108 16.00 X II3. 78 14.00 Y III4. 107 13.00 X IV5. 77 6.00 Y V6. 75 1.83 Y VI

    7. 72 0.50 Y VII

    (a) Statement of selling price and units to earn maximum profit

    Change in total cost of a productChange in the output of the product

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    Decision Making 4

    (No restriction on the availability of labour hours)Products X Y TotalOutput and sales (in units) ofOptimum contribution per month (1) 8,000 40,000(Refer to working note 2)Selling price p.u. (Rs.) 107 72Contribution (Rs./units) (2) 67 22(Refer to working note 2)

    Total contribution (Rs.) (1)(2) 5,36,000 8,80,000 14,16,000

    Less: Fixed cost (Rs.) 3,00,000 3,00,000 6,00,000(Refer to working note 1) _________ Profit 8,16,000

    (b) Statement of selling price and units to earnMaximum profit when only 95,000 labour hours are available

    Products selling incremental incremental Labour TotalPrice contribution units hours contribution

    Per labour in (Lakhs)Hour

    Rs. Rs. Rs.

    (1) (2) (3) (4) (5) (3)(5) = (6)

    X 110 17.50 5,000 20,000 3.50X 108 16.00 2,500 10,000 1.60Y 78 14.00 30,000 60,000 8.40X 107 13.00 500 2,000 0.26Y 77 6.00 1,500* 3,000* ___0.18

    95,000 13.94Less: Fixed costs __6.00Profit 7.94

    Balancing figure

    Problem 2A Company produces three products from an imported material. The cost structure per unitof the products are as under:Products A B C

    Rs. Rs. Rs.Sales value 200 300 250Direct materials 50 80 60Direct wages Rs. 6 per hour 60 120 108Variable overheads 30 60 54

    Out of Direct material 80% is of the imported material @ Rs. 10 per kg.

    Prepare a statement showing comparative profitability of the three products under thefollowing scenarios:

    (i) Imported material is in restricted supply.(ii) Production capacity is limiting factor.(iii) When maximum sales potential of products A and B are 1,000 units each and that of

    product C is 500 units for specific requirement, availability of imported material is restrictedto 10,000 kgs per month, how the profit could be maximized?

    SolutionWorking Notes:

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    Decision Making 5

    Value of imported and indigenous material and quantity of imported material consumed P.u..:Products A B CValue of imported material p.u. (Rs.) 40 64 48Value of indigenous material p.u. (Rs.) 10 16 12Quantity of imported material consumed p.u. (Kg.) 4 6.4 4.8

    Statement of profitabilityProducts A B CSales value p.u. (Rs.) : (X) 200 300 250Direct material (Rs.) 50 80 60Direct wages (Rs.) 60 120 108

    (10 hrs (20 hrs.(18 hrs

    Rs. 6) Rs. 6) Rs. 6)Variable overheads (Rs.) __30 __60 __54Total variable cost (Rs.) : (Y) 140 260 222Contribution p.u. (Rs.): (X-Y) 60 40 28

    P/V ratio:

    100x

    S

    C30% 13.33% 11.2%

    Contribution per kg. Of imported materials (Rs.)(Refer to working note) 15 6.25 5.83Contribution per hour of production (Rs.) 6 2 1.6

    (60/10 hrs.) (40/20 hrs)(28/18 hrs)

    When imported material is in restricted supply then product A is most profitable one.(ii) Even when production capacity is limited, product A is the most profitable one.

    (iii) Statement for maximized profitProducts A B CMaximum sales (units) 1,000 1,000 500Requirement of imported material p.u. (kg) 4 6.4 4.8Total requirement of imported material forMaximum sales (kg.) 4,000 6,400 2,400Contribution per kg. (Rs.) 15 6.25 5.83For maximizing profit 10,000 kg. Of importedMaterial is to be used for manufacturing thoseProducts where contribution per kg is maximum.But 500 units of C must be produced to meetSpecific requirement. Hence the materialUtilized will be (Kg.) 4,000 3,600 2,400No. of units 1,000 562 500

    Maximum profit (Rs.) 60,000 22,480 14,000

    Problem 3On a turnover of Rs. 20 crores in 1997, a large