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Short-Term Business Decisions. Chapter 8. Making Decisions. Define goals Identify alternative courses of action Gather and analyze relevant information Compare alternatives Choose best alternative. Objective 1. Describe and identify information relevant to business decisions. - PowerPoint PPT Presentation
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Copyright © 2007 Prentice-Hall. All rights reserved1
Short-Term Business Decisions
Chapter 8
Copyright © 2007 Prentice-Hall. All rights reserved2
Making Decisions
• Define goals• Identify alternative courses of action• Gather and analyze relevant information• Compare alternatives• Choose best alternative
Copyright © 2007 Prentice-Hall. All rights reserved3
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
Copyright © 2007 Prentice-Hall. All rights reserved5
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
Copyright © 2007 Prentice-Hall. All rights reserved6
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
Copyright © 2007 Prentice-Hall. All rights reserved10
Qualitative Factors
Will special order affect regular sales in the long run?
Copyright © 2007 Prentice-Hall. All rights reserved11
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
Copyright © 2007 Prentice-Hall. All rights reserved12
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)
Copyright © 2007 Prentice-Hall. All rights reserved13
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
Copyright © 2007 Prentice-Hall. All rights reserved16
Price Setters
• Product is more unique• Less competition• Pricing approach emphasizes cost-plus
pricing
Copyright © 2007 Prentice-Hall. All rights reserved17
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
Copyright © 2007 Prentice-Hall. All rights reserved19
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?
Copyright © 2007 Prentice-Hall. All rights reserved23
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
Copyright © 2007 Prentice-Hall. All rights reserved25
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)
Copyright © 2007 Prentice-Hall. All rights reserved27
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
Copyright © 2007 Prentice-Hall. All rights reserved30
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
Copyright © 2007 Prentice-Hall. All rights reserved39
End of Chapter 8