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Decision Making and Relevant Information. Chapter 11. Overview. Decisions Relevant information Examples of common decisions Opportunity costs Capacity constraints Replace equipment Comprehensive example. Information and the Decision Process. A decision model is a formal method
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Decision Making andRelevant Information Chapter 11
Overview • Decisions • Relevant information • Examples of common decisions • Opportunity costs • Capacity constraints • Replace equipment • Comprehensive example
Information and theDecision Process A decision model is a formal method for making a choice, often involving quantitative and qualitative analysis.
Five-Step Decision Process Historical Costs Other Information Step 1. Gather Information Step 2. Make Predictions Specific Predictions Step 3. Choose an Alternative Feedback Step 4. Implement the Decision Step 5. Evaluate Performance
Differentiate relevant from irrelevant costs and revenues in decision situations.
The Meaning of Relevance Relevant costs and relevant revenues are expected future costs and revenues that differ among alternative courses of action. Historical costs Sunk costs Differential income Differential costs
Quantitative and QualitativeRelevant Information Quantitative factors Financial Nonfinancial Qualitative factors
One-Time-OnlySpecial Order Example Profit is made if the incremental revenue exceeds incremental costs. If excess capacity exists, then relevant cost generally equals variable cost to make special order. Will marketing costs change?
Two Potential Problems inRelevant-Cost Analysis 1 2 Incorrect general assumptions: Misleading unit-cost data: All variable costs are relevant. Include irrelevant costs. All fixed costs are irrelevant. Use same unit costs at different output levels.
Outsourcing versus Insourcing Outsourcing is purchasing goods and services from outside vendors. Insourcing is producing goods or providing services within the organization.
Make-or-Buy Decisions This is a very common (frequent) decision made by most organizations. Purchase managers report three important factors: (1) Quality (2) Supplier dependability (3) Cost
Make-or-Buy Decisions In making a “make-or-buy” decision it is often times useful and quick to compare the cost to outsource versus the costs saved if you outsource.
Opportunity Costs andOutsourcing Opportunity cost is the contribution to income that is forgone (rejected) by not using a limited resource in its next-best alternative use. Generally, opportunity cost is the benefit foregone by not choosing the next best alternative.
Opportunity Costs andOutsourcing Many decisions have an opportunity cost. What is the opportunity cost for making the decision to come to class today? Give an example of a decision that had no or zero opportunity cost.
Capacity Constraints Deciding which products to produce when there are capacity constraints. Answer: Produce/sell product(s) with the highest CM/unit of constraint!
Product-Mix DecisionsUnder Capacity Constraints Per unit Product #2Product #3 Sales price $2.11 $14.50 Variable expenses 0.41 13.90 Contribution margin $1.70 $ 0.60 Contribution margin ratio 81% 4% Bismark Co. has 3,000 machine-hours available.
Product-Mix DecisionsUnder Capacity Constraints One unit of Prod. #2 requires 7 machine-hours. One unit of Prod. #3 requires 2 machine-hours. What is the contribution of each product per machine-hour? Product #2: $1.70 ÷ 7 = $0.24 Product #3: $0.60 ÷ 2 = $0.30
From a company economic Perspective, the book value of equipment is irrelevant in equipment-replacement decisions.
Conflicts can arise between the decision model used by a manager and the performance evaluation model used to evaluate the manager.
Decisions andPerformance Evaluation What is the journal entry to sell the existing machine? Cash $14,000 Accumulated Depreciation 50,000 Loss on Disposal 16,000 Machine $80,000
Decisions andPerformance Evaluation In the real world would the manager replace the machine? An important factor in replacement decisions is the manager’s perceptions of whether the decision model is consistent with how the manager’s performance is judged.
Decisions andPerformance Evaluation Top management faces a challenge – that is, making sure that the performance-evaluation model of subordinate managers is consistent with the decision model.
Anatomy of a Decision: Buy a used versus lease a new car • Example of decision--See spread sheet analysis. • Quantitative and qualitative analysis—you are only part way done with analysis after the quantitative analysis. Use this as a benchmark against the qualitative factors. • What qualitative factors have I missed (left out of) in my quantitative analysis?
