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Chapter 15

Chapter 15. Short-term Planning Decisions. What are Relevant Costs & Revenues?. They are future costs & revenues. They are included in making decisions. Past (sunk) costs are always irrelevant. Other cost terms:. Incremental Costs: Cost increases resulting from a change of activity.

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Chapter 15

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  1. Chapter 15 Short-term Planning Decisions

  2. What are Relevant Costs & Revenues? • They are future costs & revenues. • They are included in making decisions. • Past (sunk) costs are always irrelevant.

  3. Other cost terms: • Incremental Costs: Cost increases resulting from a change of activity. • Avoidable Costs: A cost which can be reduced or eliminated. • Opportunity Cost: Forgone profits when one activity is chosen over another.

  4. Relevant costs/revenues are used to make the following types of decisions: • Whether to accept a special order. • How many units of inventory to buy. • Whether to drop (or add) a product.

  5. Relevant costs/revenues are used to make the following types of decisions: • Whether to make or buy a product or part. • Whether to sell a product as is or to process it further. • What product mix to sell.

  6. Economic Order Quantity (EOQ) • Inventory costs include: • Carrying Costs: storage, handling, insurance, opportunity costs • Order Costs: costs of placing and receiving an order.

  7. Carrying costs • increase as the amount of inventory on hand increases

  8. Ordering costs • increase when more orders are placed.

  9. EOQ for a merchandiser: • take the square root of: • 2SO • C

  10. EOQ for a manufacturer: • take the square root of: • 2UO • C

  11. Legend: • S = total annual sales • O = order cost per order • C = carrying cost per unit • U = total annual raw materials used

  12. How to decide to drop a product: • Drop only if avoidable costs are > revenue produced from the product. • Put another way - total profit would increase if product were dropped.

  13. Should a part/product be purchased or made? • Many factors to consider: • If making, must have the “know-how”. • How will the decision affect current business relationships? • How reliable is the supplier? Is quality an issue? • Basically, determine relevant costs of each alternative.

  14. Sell “as is” or process further? • Process further if incremental revenues >incremental costs of processing further.

  15. Product Mix decisions: • What combination of products should a company produce/sell?

  16. Where should advertising dollars go: • Using the assumptions in the book: basically, “push” that item which has the highest contribution margin per unit. • Remember, CM per unit is sales price minus variable costs.

  17. How many units should be produced? • When there a constraints (scarce resources), produce the unit which provides the greatest CM per the constraint.

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