Chapter 11 Relevant Costs for DecisionMaking

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Chapter 11 - Relevant Costs for Decision-Making

• Prior to class
• Fill in the BLANKS
• Answer any questions, complete HW assignments
  and turn in ONLY what is asked for in appropriate
  format, (EXCEL, WORD NOTHING HAND WRITTEN will
  be accepted) with headers footers, on the due
  date
• Make a copy of all work to be turned in
• (keep in mind, any HW assignment may be graded or
  taken up. So make sure that you complete the
  assignments PRIOR TO CLASS)

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Cost Concepts for Decision Making
A __________________ is a cost that differs
between alternatives. _____________ are avoidable
the cost will be eliminated in whole or in part
by choosing one alternative over another.

• Unavoidable costs are never relevant
• ______________
• ______________ that do not differ between the
  alternatives.

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Identifying Relevant Costs
______________ -- a cost that has already been
incurred and that cannot be avoided regardless of
what a manager decides to do.
Well, I have identified all the costs associated
with the alternatives we are considering.
Great! Now all we have to do is eliminate all the
__________.
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Quick Check ?

• In a decision of whether to buy a new car and
  trade-in your old car or just keep your old car,
  which of the following are sunk costs?
• a. The cost of licensing the new car.
• b. The cost of licensing your old car next year
  if you keep it.
• c. The amount you paid for your old car.
• d. The amount you paid to repair your old car
  last month in case you wanted to sell it.

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Quick Check ?

• In a decision of whether to buy a new car and
  trade-in your old car or just keep your old car,
  which of the following are future costs that
  dont differ between the alternatives?
• a. Monthly parking fees.
• b. Auto insurance.
• c. Theater tickets.
• d. Drivers license renewal fee.

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Different Costs for Different Purposes
Costs that are relevant in one decision situation
are not necessarily relevant in another. In each
decision situation the manager must examine the
data at hand and isolate the ______________.
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Identifying Relevant Costs and Benefits

• A manager at White Co. wants to replace an old
  machine with a new, more efficient machine.

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Identifying Relevant Costs and Benefits

• Whites sales are 200,000 per year.
• Fixed expenses, other than depreciation, are
  70,000 per year.
• Should the manager purchase the new machine?

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Identifying Relevant Costs and Benefits
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Relevant Cost Analysis
Lets look at a more efficient way to
analyze this decision bylooking at thecosts
that differ inthe two alternatives.
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Relevant Cost Analysis
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Why Isolate Relevant Costs? (To be turned in)
Isolating relevant costs is desirable for at
least two reasons. Write a short description
(3-5 sentences) of two reasons.
Due MWF 4/17 TR 4/18
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Adding/Dropping Segments

• One of the most important decisions managers make
  is whether to add or drop a business segment such
  as a product or a store.Due to the declining
  popularity of digital watches, Lovell Companys
  digital watch line has not reported a profit for
  several years. An income statement for last year
  is shown on the next screen.

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Adding/Dropping Segments
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Adding/Dropping Segments
Investigation has revealed that total fixed
general factory overhead and general
administrative expenses would not be affected if
the digital watch line is dropped. The fixed
general factory overhead and general
administrative expenses assigned to this product
would be reallocated to other product lines.
Should Lovell retain or drop the digital watch
segment?
The equipment used to manufacture digital watches
has no resale value or alternative use.
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A Contribution Margin Approach

• Should Lovell retain or drop the digital watch
  segment?

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A Contribution Margin Approach
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Comparative Income Approach

• The Lovell solution can also be obtained by
  preparing comparative income statements showing
  results with and without the digital watch
  segment.
• Lets look at this second approach.

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(No Transcript)
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Beware of Allocated Fixed Costs
Should we keep the digital watch segment when
its showing a loss?
Write a short paragraph (3-5 sentences) answering
this question. To be turned in MWF 4/17, TR 4/18
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Homework

• Brief Exercise
• 2, p. 480
• Due
• MWF 4/17
• TR 4/18

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The Make or Buy Decision

• A decision concerning whether an item should be
  produced internally or purchased from an outside
  supplier is called a _________________ decision.
• Lets look at the Essex Company example.

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The Make or Buy Decision

• Essex manufactures part 4A that is currently used
  in one of its products.
• The cost per unit of this part is

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The Make or Buy Decision

• The special equipment used to manufacture part 4A
  has no resale value.
• The total amount of general factory overhead,
  which is allocated on the basis of direct labor
  hours, would be unaffected by this decision.
• The 30 total cost per unit is based on 20,000
  parts produced each year.
• An outside supplier has offered to provide the
  20,000 parts at a cost of 25 per part.Should we
  accept the suppliers offer?

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The Make or Buy Decision
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Homework

• Brief Exercise
• 3, p. 480
• Due
• MWF 4/19
• TR 4/18

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• Benefits that are foregone as a result of
  pursuing some course of action.
• __________________ are not actual dollar outlays
  and are not recorded in the accounts of an
  organization.

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Quick Check ?

• Which of the following are opportunity costs of
  attending the university?
• a. Tuition.
• b. Books.
• c. Lost wages.
• d. Not enough time for other interests.

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Special Orders

• Jet, Inc. makes a single product whose normal
  selling price is 20 per unit.
• A foreign distributor offers to purchase 3,000
  units for 10 per unit.
• This is a one-time order that would not affect
  the companys regular business.
• Annual capacity is 10,000 units, but Jet, Inc. is
  currently producing and selling only 5,000 units.

Should Jet accept the offer?
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Special Orders
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Special Orders

• If Jet accepts the offer, net income will
  increase by ________.

Note This answer assumes that fixed costs are
unaffected by the order and that variable
marketing costs must be incurred on the special
order.
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Quick Check ?

• NorOp ordinarily sells the X-lens for 50. The
  variable production cost is 10, the fixed
  production cost is 18 per unit, and the variable
  selling cost is 1. A customer has requested a
  special order for 10,000 units of the X-lens to
  be imprinted with the customers logo. This
  special order would not involve any selling
  costs, but NorOp would have to purchase an
  imprinting machine for 50,000.
• (see the next screen)

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Quick Check ?

• What is the rock bottom minimum price below
  which NorOp should not go in its negotiations
  with the customer? In other words, below what
  price would NorOp actually be losing money on the
  sale? There is ample idle capacity to fulfill the
  order.
• a. 50
• b. 10
• c. 15
• d. 29

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Homework

• Brief Exercise
• 4, pp. 480-481
• Due
• MWF 4/19
• TR 4/20

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Managing Constrains

• Firms often face the problem of deciding how to
  best utilize a constrained resource.
• Usually fixed costs are not affected by this
  particular decision, so management can focus on
  maximizing ____________________________.
• Lets look at the Ensign, Inc. example.

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Managing Constraints

• Ensign, Inc. produces two products and selected
  data is shown below

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Managing Constraints

• Machine A1 is the constrained resource and is
  being used at 100 of its capacity.
• There is excess capacity on all other machines.
• Machine A1 has a capacity of 2,400 minutes per
  week.

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Should Ensign focus its efforts on 1 or 2? (to
be turned in - MWF 4/21, TR 4/20)

• How many units of each product can be processed
  through Machine A1 in one minute?
• What generates more profit for the company, using
  one minute of machine A1 to process Product 1 or
  using one minute of machine A1 to process Product
  2?
• Make sure your answers are descriptive and use
  the following 3 slides (diagrams) in your answer
  (use EXCEL)

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Managing Constraints

• The key is the __________________ per unit of the
  constrained resource.

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Managing Constraints
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Managing Constraints

• According to the plan, we will produce ________
  units of Product 2 and ________ of Product 1.
  Our contribution margin looks like this.

The total contribution margin for Ensign is
________.
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Quick Check ?

• Colonial Heritage makes reproduction colonial
  furniture from select hardwoods.
• The companys supplier of hardwood will only be
  able to supply 2,000 board feet this month. Is
  this enough hardwood to satisfy demand?
• a. Yes
• b. No

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Quick Check ?

• The companys supplier of hardwood will only be
  able to supply 2,000 board feet this month. What
  plan would maximize profits?
• a. 500 chairs and 100 tables
• b. 600 chairs and 80 tables
• c. 500 chairs and 80 tables
• d. 600 chairs and 100 tables

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Quick Check ?

• As before, Colonial Heritages supplier of
  hardwood will only be able to supply 2,000 board
  feet this month. Assume the company follows the
  plan we have proposed. Up to how much should
  Colonial Heritage be willing to pay above the
  usual price to obtain more hardwood?
• a. 40 per board foot
• b. 25 per board foot
• c. 20 per board foot
• d. Zero

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Quick Check ?

• As before, Colonial Heritages supplier of
  hardwood will only be able to supply 2,000 board
  feet this month. Assume there is unlimited demand
  for chairs. Up to how much should Colonial
  Heritage be willing to pay above the usual price
  to obtain more hardwood?
• a. 40 per board foot
• b. 25 per board foot
• c. 20 per board foot
• d. Zero

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Internet Exercise MWF 4/21 TR 4/20

• (To be turned in)
• A consulting company that provides software and
  services designed to help manufacturing companies
  maximize cash flow and return on assets includes
  a library of case studies on its website. Read
  the U.S. Steel, Inc. case study, which may be
  downloaded from http//www.maxager.com/images/MAXA
  GER_USSTEEL_CASE.pdf, and answer the following
  questions
• How did the consulting companys software enable
  U.S. Steel to significantly improve its cash flow
  and overall profitability?
• What was the secret to maximizing
  profitability?
• How do steelmakers tend to think of profits? How
  has U.S. Steel changed its thinking in this
  regard?

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End of Chapter 11