Decision Making

Objectives
Objectives
1. Describe the tactical decision-making model.
After
After studying
studying this
this
2. Explain howchapter,
the activity
resource
usage model
you
should
chapter, you should
is used in assessing
relevancy.
be
be able
able to:
to:
3. Apply tactical decision-making concepts in a
variety of business situations.
4. Choose the optimal product mix when faced
with one constrained resource.
5. Explain the impact of cost on pricing decisions.

Model for Making Tactical Decisions

Step 1. Recognize and define the problem.
Increase capacity for warehousing and production.
Step 2. Identify alternatives as possible solutions to
the problem; eliminate alternatives that are
clearly not feasible.
1. Build new facility
2. Lease larger facility; sublease current facility
3. Lease additional facility
4. Lease warehouse space
5. Buy shafts and brushings; free up needed space
Continued
Continued

Model for Making Tactical Decisions

Step 3. Identify the costs and benefits associated with
each feasible alternative. Classify costs and
benefits as relevant or irrelevant, and eliminate
irrelevant ones from consideration.
Lease warehouse space:
Variable production costs
Warehouse lease
Buy shafts and bushings externally:
Purchase price
Continued
Continued

$345,000
135,000
$460,000

Model for Making Tactical Decisions

Step 4. Total the relevant costs and benefits for each
alternative.
Lease warehouse space:
Variable production costs
$345,000
Warehouse lease
135,000
Total
$480,000
Buy shafts and bushings externally:
Purchase price
$460,000
Differential cost
$ 20,000
Continued
Continued

Model for Making Tactical Decisions

Step 5. Assess qualitative factors.
Quality of shafts
1. Quality of external suppliers
and brushing is
significantly
Not reliablelower
2. Reliability of external suppliers
3. Price stability
4. Labor relations and community image
Step 6. Make the decision.
Continue to produce shafts and bushings internally;
lease warehouse

Relevant
Relevant Costs
Costs Defined
Defined
Relevant
Relevant costs
costs are
are future
future costs
costs that
that differ
differ
across
across alternatives.
alternatives. A
Acost
cost must
must not
not only
only
be
be aa future
future cost
cost but
but most
most also
also differ
differ
between
between alternatives.
alternatives.

Flexible
Flexible resources
resources can
can be
be
easily
easily purchased
purchased in
in the
the amount
amount
needed
needed and
and at
at the
the time
time of
of use
use
like
like electricity.
electricity.

Committed
Committed resources
resources are
are
purchased
purchased before
before they
they are
are used,
used,
such
such as
as salaried
salaried employees.
employees.

Activity
Activity Resource
Resource Usage
Usage Model
Model and
and
Assessing
Assessing Relevancy
Relevancy
Flexible
FlexibleResources
Resources

a. Demand Changes

Relevant

b. Demand Constant

Not Relevant

Activity
Activity Resource
Resource Usage
Usage Model
Model and
and
Assessing
Assessing Relevancy
Relevancy
Committed
CommittedResources
Resources
(Short-Term)
(Short-Term)
Supply Demand = Unused Capacity
a.. Demand Increased < Unused Capacity
Not relevant
b. Demand Increased > Unused Capacity
Relevant
c. Demand Decease (Permanent)
1. Activity Capacity Reduced
Relevant
2. Activity Capacity Unchanged
Not Relevant

Activity
Activity Resource
Resource Usage
Usage Model
Model and
and
Assessing
Assessing Relevancy
Relevancy
Committed
CommittedResources
Resources
(Multiperiod
(MultiperiodCapacity)
Capacity)
Supply Demand = Unused Capacity
a.. Demand Increased < Unused Capacity
Not relevant
b. Demand Decreased (Permanent)
Relevant
c. Demand Increase > Unused Capacity
Capital Decision

Illustrative Examples of
Relevant Cost Applications
Make or Buy
Keep or Drop
Special Order
Sell or Process Further
Product Mix

Important:
Important: Short-term
Short-termPerspective
Perspective

Make
Make or
or Buy
Buy
Swasey Manufacturing currently produces an
electronic component used in one of its printers.
Swasey must produce 10,000 of these parts. The
firm has been approached by a supplier who
offers to build the component to Swaseys
specifications for $4.75 per unit.

Make
Make or
or Buy
Buy
The full absorption cost for the 10,000 parts is
computed as follows:
Total Cost Unit Cost
Rental of equipment
$12,000
$1.20
Equipment depreciation
2,000
0.20
Direct materials
10,000
1.00
Direct labor
20,000
2.00
Variable overhead
8,000
0.80
General fixed overhead
30,000
3.00
Total
$82,000
$8.20
Enough material is on hand to make 5,000 parts.

Make
Make or
or Buy
Buy
The cost to make or buy 5,000 units follows:
Alternatives
Differential
Make
Buy Cost to Make
Rental of equipment
Direct materials
Direct labor
Variable overhead
Purchase cost
Receiving Dept. labor
Total

$12,000
5,000
20,000
8,000
------------$45,000
Make
Make

------------------------$47,500
8,500
$56,000

$12,000
5,000
20,000
8,000
-47,500
- 8,500
$-11,000

Keep-or-Drop
Keep-or-Drop Decisions
Decisions
Norton Materials, Inc. produces concrete blocks, bricks, and roofing
tile. The controller prepared the following income statements:
Blocks Bricks Tile
Total
Sales revenue
$500
$800 $150 $1,450
Less: Variable expenses
250
480
140
870
Contribution margin
$250
$320 $ 30 $ 580
Less direct fixed expenses:
Advertising
$ 10
$ 10 $ 10 $ 30
Salaries
37
40
35
112
Depreciation
53
40
10
103
Total
$100
$ 90 $ 55 $ 245
Segment margin
$150
$230 $- 45 $ 335
Less: Common fixed exp.
125
Operating income
$ 210

Keep-or-Drop
Keep-or-Drop Decisions
Decisions
Differential
Keep
Sales
$150
Less: Variable expenses 140
Contribution margin
$ 10
Less: Advertising
-10
Cost of supervision -35
Total relevant benefit
(loss)
$- 35

Drop
---------------$ 0

Amount
$150to Keep
140
$ 10
-10
-35
$- 35

Preliminary
Preliminary figures
figuresindicate
indicatethat
thatthe
thetile
tile
segment
segment should
should be
be dropped!
dropped!

Keep-or-Drop
Keep-or-Drop Decisions
Decisions
Tom Blackburn determines that dropping the tile section will
reduce sales in all sections as follows: $50,000 for blocks,
$64,000 for bricks, and $150,000 for roofing tile. His
summary in thousands is shown below:
Differential
Keep
Sales
$1,450
Less: Variable expenses
870
Contribution margin
$ 580
Less: Advertising
-30
Cost of supervision -112
Total
$ 438

Drop Amount
to Keep
$1,186.0
$264.0
666.6
203.4
$ 519.4
$ 60.6
-20.0
-10.0
-77.0
-35.0
$ 422.4
$ 15.6

Keep
Keeproofing
roofingtile
tilesegment!
segment!

Keep-or-Drop
Keep-or-Drop Decisions
Decisions
Alternate
AlternateUse
Useof
ofFacilities
Facilities
The marketing manager sees the market for floor tile as
stronger and less competitive than roof tile. He submits the
following figures for floor tile sales:
Sales
Less: Variable expenses
Contribution margin
Less: Direct fixed expenses
Segment margin

$100,000
40,000
$ 60,000
55,000
$ 5,000

Keep-or-Drop
Keep-or-Drop Decisions
Decisions
Alternate
AlternateUse
Useof
ofFacilities
Facilities
Drop and

Differential

Keep $1,286.00
Replace Amount
to Keep
Sales
$1,450
$164.00
Less: Variable expenses
870
706.60
163.40
Contribution margin $ 580
$ 579.40
$ 0.60
$1,450
$150
$50$140
$64 +
$870
$25 $100
$38.40 +
Decision:
roof
Decision: Continue
Continue making
making
roof tile!
tile!
$40

Special-Order
Special-Order Decisions
Decisions
An ice cream company is
operating at 80 percent of its
productive capacity (20 million
half gallon units). The unit costs
associated with producing and
selling 16 million units are shown
on the next slide.

Special-Order
Special-Order Decisions
Decisions

Wholesale
price =
$2.00

Variable costs:
Dairy ingredients
Sugar
Flavoring
Direct labor
Packaging
Commissions
Distribution
Other
Total variable costs
Total fixed costs
Total costs

$ 0.70
0.10
0.15
0.25
0.20
0.02
0.03
0.05
$ 1.50
0.097
$1.597

Special-Order
Special-Order Decisions
Decisions
An ice cream distributor from a
geographic region not normally
served by the company has offered
to buy two million units at $1.55 per
unit, provided its own label can be
attached to the product. The
distributor has agreed to pay the
transportation cost.

Special-Order
Special-Order Decisions
Decisions

Which costs
are irrelevant?

Variable costs:
Dairy ingredients
Sugar
Flavoring
Direct labor
Packaging
Commissions
Distribution
Other
Total variable costs
Total fixed costs
Total costs

$0.70
0.10
0.15
0.25
0.20
0.02
0.03
0.05
$1.50
$1.45
0.097
$1.45
$1.597

Special-Order
Special-Order Decisions
Decisions

Which costs
are irrelevant?

Accept
the
Acceptcosts:
the offer
offer ($0.10
($0.10
Variable
xxDairy
2,000,000
==$200,000
2,000,000
$200,000
ingredients
more
more profit).
profit).
Sugar
Flavoring
Direct labor
Packaging
Commissions
Distribution
Other
Total variable costs
Total fixed costs
Total cost

$ 0.70
0.10
0.15
0.25
0.20
0.02
0.03
0.05
$$1.45
1.50
0.097
$1.45
$1.597

Sell or Further Process

Yield at Split-Off

Further Processing

Grade A
800 lb
Sell for $0.40 lb
Joint Cost
$300

Grade B
600 lb

Bagged
120 Bags
Cost $0.05/Bag
Sell for $1.30/Bag

Grade C
600 lb

Applesauce
500 16-oz Cans
Cost $0.10/lb
Sell for $0.75 can

Sell or Further Process

Revenues
Processing cost
Total

Process
Further
$450
120
$330

Sell
$150
---$150

Further
Further process!
process!

Differential Amount
to Process Further
$300
120
$180