Presentation Transcript

1. Short-Term Business Decisions

   Chapter 20
2. How Managers Make Decisions
3. Relevant Information 1. Expected future data 2. Differs among alternatives
4. Relevant and Irrelevant Costs Relevant costs Affect decisions Occur in the future Differ among the alternatives Irrelevant costs Do not affect decisions Sunk costs Occurred in the past Always irrelevant to the decision Cannot be changed
5. Relevant Non-Financial Information Considering qualitative factors in decision-making Impact on employee morale Outsourcing Layoffs Impact on quality Product recall, higher warranty costs Upset customers Customer relations Discounted prices to select customers Use same guidelines as relevant costs Occurs in the future Differs between alternatives
6. Keys to Making Short-Term Special Decisions Relevant information approach Also called the incremental analysis approach How operating income differs under alternatives Irrelevant information is ignored Only relevant data affect decisions
7. S20-1: Describing and identifying information relevant to business decisions You are trying to decide whether to trade in your inkjet printer for a more recent model. Your usage pattern will remain unchanged, but the old and new printers use different ink cartridges. Indicate if the following items are relevant or irrelevant to your decision: The price of the new printer The price you paid for the old printer The trade-in value of the old printer Paper costs The difference between ink cartridges’ costs Relevant Irrelevant Relevant Irrelevant Relevant
8. When to Accept a Special Sales Order Special order When a customer requests a one-time order at a reduced sale price Considerations: Does the company have excess capacity available to fill this order? Will the reduced sales price be high enough to cover the incremental costs of filling the order (the variable costs and any additional fixed costs)? Will the special order affect regular sales in the long run?
9. Special Sales Order
10. Special Sales Order
11. Special Sales Order
12. Incremental Analysis Current cost per DVD 700,000/100,000 = $7.00\ Cost per DVD includes both variable & fixed manufacturing costs
13. Incremental Analysis Focus on relevant data (revenues and costs that will change if it accepts the special order) Use of a contribution margin approach that separates variable costs from fixed costs The special sales order will increase operating income by $2,500. Fixed costs remain the same.
14. Decision Rule
15. Regular Pricing Considerations
16. Price-taker or Price-setter? Examples: Food commodities Natural resources Generic consumer products and services Examples: Original art, jewelry Specially manufactured machinery Patented perfume scents Latest tech gadget
17. Target Pricing Starts with the market price of the product The price customers are willing to pay Subtracts the company’s desired profit Determine the product’s target full cost Full cost to develop, produce, and deliver the product or service
18. Options Accept the lower operating income, not the target return required by stockholders Reduce fixed costs Reduce variable costs Use other strategies Increase capacity to spread the fixed costs are spread over more units Change or add to product mix Differentiate its product (become a price setter)
19. Cost-Plus Pricing Emphasizes a cost-plus approach Opposite of the target-pricing approach Starts with the full costs and adds desired profit to determine a cost-plus price Unique product = more control over pricing
20. Calculating Cost-Plus Pricing Unique products Consider what customers are willing to pay How well has the company been able to differentiate its product?
21. Pricing Decision Rule
22. E20-10: Making special order and pricing decisions Suppose the Baseball Hall of Fame in Cooperstown, New York, has approached Hobby-Cardz with a special order. The Hall of Fame wishes to purchase 57,000 baseball card packs for a special promotional campaign and offers $0.41 per pack, a total of $23,370. Hobby-Cardz’s total production cost is $0.61 per pack, as follows: Hobby-Cardz has enough excess capacity to handle the special order. 1. Prepare an incremental analysis to determine whether Hobby-Cardz should accept the special sales order.
23. E20-10: Making special order and pricing decisions Suppose the Baseball Hall of Fame in Cooperstown, New York, has approached Hobby-Cardz with a special order. The Hall of Fame wishes to purchase 57,000 baseball card packs for a special promotional campaign and offers $0.41 per pack, a total of $23,370. Hobby-Cardz’s total production cost is $0.61 per pack, as follows: Hobby-Cardz has enough excess capacity to handle the special order. 1. Prepare an incremental analysis to determine whether Hobby-Cardz should accept the special sales order. Accept the special order
24. E20-10: Making special order and pricing decisions 2. Now assume that the Hall of Fame wants special hologram baseball cards. Hobby-Cardz will spend $5,900 to develop this hologram, which will be useless after the special order is completed. Should Hobby-Cardz accept the special order under these circumstances? Reject the special order
25. P20-22A: Making special order and pricing decisions Green Thumb operates a commercial plant nursery where it propagates plants for garden centers throughout the region. Green Thumb has $4,800,000 in assets. Its yearly fixed costs are $600,000, and the variable costs for the potting soil, container, label, seedling, and labor for each gallon-size plant total $1.35. Green Thumb’s volume is currently 470,000 units. Competitors offer the same plants, at the same quality, to garden centers for $3.60 each. Garden centers then mark them up to sell to the public for $9 to $12, depending on the type of plant. 1. Green Thumb’s owners want to earn a 10% return on the company’s assets. What is Green Thumb’s target full cost? Revenue at current market price (470,000 units × $3.60 per unit) $1,692,000 Less: Desired profit ($4.8 million × 10%) 480,000 Target full cost $1,212,000
26. P20-22A: Making special order and pricing decisions 2. Given Green Thumb’s current costs, will its owners be able to achieve their target profit? Green Thumb’s actual total full costs of $1,234,500 are higher than its target full cost, therefore Green Thumb will not meet the stockholders’ profit expectations. Current variable cost (500,000 × 1.70) $ 634,500 Current fixed costs 600,000 Total full cost $1,234,500
27. P20-22A: Making special order and pricing decisions 3. Assume Green Thumb has identified ways to cut its variable costs to $1.20 per unit. What is its new target fixed cost? Will this decrease in variable costs allow the company to achieve its target profit? The new target fixed cost is $648,000. Target full cost (from requirement 1) $1,212,000 Less: Reduced level of variable costs (470,000 × $1.20) (564,000) New target fixed costs $ 648,000 Since the company’s actual fixed costs are less than or equal to the new target fixed cost amount, Green Thumb will be able to achieve its target profit without having to take any other cost-cutting measures.
28. Considerations for Dropping Products, Departments, or Territories Does the product, department, or territory provide a positive contribution margin? Will fixed costs continue to exist, even if the company drops the product? Are there any direct fixed costs that can be avoided if the company drops the product, department, or territory? Will dropping the product, department, or territory affect sales of the company’s other products? What could the company do with the freed manufacturing capacity?
29. Decision Guidelines Example
30. Dropping Products Under Various Assumptions If product has a negative contribution margin, then drop Unavoidable fixed costs Fixed costs that continue to exist even after a product is dropped—irrelevant Avoidable, direct fixed costs—relevant If costs decrease more than the decrease in revenues, product should be dropped Would dropping the product line, department, or territory hurt other sales? Consider lost contribution margins from other products Will more profitable products be produced with freed capacity?
31. Decision Rule for Dropping Products, Departments or Territories
32. Product Mix: Which Product to Emphasize? Constraints Something that restricts production or sale of product Manufacturers Limitations on labor or machine hours or available materials Merchandisers Amount of display space Stiff competition may limit demand
33. Product Mix Considerations What constraint(s) stop(s) the company from making (or displaying) all the units the company can sell? Which products offer the highest contribution margin per unit of the constraint? Would emphasizing one product over another affect fixed costs? Decision rule: Decision Rule - Which product to emphasize? Emphasize the product with the highest contribution margin per unit of the constraint.
34. S20-4: Making dropping a product and product-mix decisions Deela Fashions operates three departments: Men’s, Women’s, and Accessories. Departmental operating income data for the third quarter of 2012 are as follows: Assume that the fixed expenses assigned to each department include only direct fixed costs of the department: ● Salary of the department’s manager ● Cost of advertising directly related to that department If Deela Fashions drops a department, it will not incur these fixed expenses.
35. S20-4: Making dropping a product and product-mix decisions Under these circumstances, should Deela Fashions drop any of the departments? Give your reasoning. Deela Fashions should drop the Accessories Department because relevant expenses are greater than the revenues which will result in an increase in operating income if the department is dropped.
36. Outsourcing Managers decide whether to buy a component product or service or produce it in-house Cheaper is not always the deciding factor Considerations: How do the company’s variable costs compare to the outsourcing cost? Are any fixed costs avoidable if the company outsources? What could the company do with the freed manufacturing capacity?
37. Avoidable Fixed Costs If fixed costs stay the same—irrelevant If fixed costs change—relevant Differs between alternatives Company can avoid $10,000 in fixed cost if outsourced. However, total costs are more, so do not outsource.
38. Outsourcing Decision Rule
39. Other Factors To Consider Qualitative factors Control over quality Outsourcing considerations Coordination, information exchange, and paperwork problems
40. Sell As Is or Process Further Considerations: How much revenue will the company receive if the company sells the product as is? How much revenue will the company receive if the company sells the product after processing it further? How much will it cost to process the product further?
41. Example
42. Sell As Is or Process Further Decision rule:
43. S20-6: Making outsourcing and sell as is or process further decisions Suppose a Roasted Olive restaurant is considering whether to (1) bake bread for its restaurant in-house or (2) buy the bread from a local bakery. The chef estimates that variable costs of making each loaf include $0.52 of ingredients, $0.24 of variable overhead (electricity to run the oven), and $0.70 of direct labor for kneading and forming the loaves. Allocating fixed overhead (depreciation on the kitchen equipment and building) based on direct labor assigns $0.96 of fixed overhead per loaf. None of the fixed costs are avoidable. The local bakery would charge $1.75 per loaf. 1. What is the unit cost of making the bread in-house (use absorption costing)? 2. Should Roasted Olive bake the bread in-house or buy from the local bakery? Why? 3. In addition to the financial analysis, what else should Roasted Olive consider when making this decision?
44. S20-6: Making outsourcing and sell as is or process further decisions 1. What is the unit cost of making the bread in-house (use absorption costing)?
45. S20-6: Making outsourcing and sell as is or process further decisions 2. Should Roasted Olive bake the bread in-house or buy from the local bakery? Why? Decision: Roasted Olive should bake the bread in-house since the variable cost of making each loaf is less than the cost of outsourcing each loaf. Variable cost to make $ 1.46 vs. cost to buy $1.75 3. In addition to the financial analysis, what else should Roasted Olive consider when making this decision? Roasted Olive should consider the following qualitative factors before making a final decision: Will the local bakery meet their delivery time requirements? How does the quality and freshness of the local bakery bread compare to Roasted Olive bread?