Docstoc

s12

Document Sample
s12 Powered By Docstoc
					1                                              2


              CHAPTER 13                                   Decision Making




3                                              4
• Steps in decision making:
  –Define problem                                  • Focus only on relevant costs
  –Identify alternatives                             & benefits
  –Identify costs / benefits of alternatives         –Everything else is irrelevant
  –Compare relevant costs / benefits
  –Select alternative with:
     • Greatest benefit
     • Lowest cost




5
                                               6

      Relevant Costs & Benefits                • Relevant costs & benefits are
                                                 different between alternatives




                                                                                      1
7 • Assume you rent boat for                  8 • Rent is same for both alternatives
         $1,000/month                             • You get same result if you ignore
                                                    Rent
       • Harbor tour business vs
         fishing business:                                  Fishing      Tour Difference
                                              Revenue        $8,000   $10,000    -$2,000
              Fishing    Tour    Difference
                                              Expenses       -1,000    -4,000      3,000
Revenue        $8,000 $10,000       -$2,000   Profit         $7,000    $6,000     $1,000
Expenses       -1,000   -4,000       3,000
Rent           -1,000   -1,000       ____0          • Rent is not relevant
Profit         $6,000   $5,000      $1,000




 9                                             10
                                              • E.g., Assume you own large
• No need to consider costs /                   painting for home
  benefits that are same                         – Paid $10,000
   – May mislead you                          • Moving & no room
• Also    Relevant costs & benefits           • Only offer is $8,000
  are future costs & benefits                 • Fact that you originally paid
   – Not sunk or historical costs               $10,000 is irrelevant
                                                 – Original price is sunk cost




11                                             12
                                              • Opportunity Costs
            Opportunity Costs                    – Other revenue
                                                     • Only available if one of
                                                       alternatives is selected
                                                 – Treated as cost of alternative
                                                   that closes off additional
                                                   revenue




                                                                                           2
 13                                          14
• E.g., Assume you rented retail space
• Choice: CD store vs Comic Book store        • Lost revenue from vending
• With Comic Book store only:                   machine sublease ($200)
  – Can sublease part of space to vending       – Opportunity Cost of CD
     machine operators                            store
      • Additional $200 a month
                                                – Added to other costs of CD
  – This sublease not available with CD
     store alternative                            store




15                                           16
 • Lost sublease rent shown as                • Can also show Opportunity as
   cost for CD Store Alternative                additional revenue
   – Opportunity Cost
               CD      Comic    Difference                  CD      Comic    Difference
             Store Book Store                             Store Book Store
Revenue    $10,000     $7,000      $3,000    Revenue    $10,000     $7,000      $3,000
Expenses    -5,000     -2,000      -3,000    Expenses    -5,000     -2,000      -3,000
Sublease      -200    _____0     ____-200    Sublease    ______    ___200       __-200
Profit      $4,800     $5,000       -$200    Profit      $5,000     $5,200       -$200




 17                                           18
                                             • We focus on quantitative
       Other Important Factors                 – Qualitative factors
                                             • E.g., Should we outsource?
                                               – Supplier reliability
                                               – Quality control
                                               – Workforce morale
                                               – Robustness
                                               – Ability to resume production




                                                                                          3
19                                              20

 • Time-value of money relevant
                                                           General Example
   – Ignore for now




21
• Assume you own Catalina cruise ship          • 2 alternate uses for unused ½ of ship
  –Original Cost    $4,000,000                   –Figures exclude depreciation ($100K)
  –20-year life                                • Freight business
  –S/L Depreciation                              –Annual revenue = $70,000
  –Depreciation = $200,000/year                  –Annual expenses = $10,000
  –Operating Profit of $500,000/year           • Floating disco
  –½ of ship not used for cruise business        –Annual rents = $90,000
  –Potential contract    transport Scouts to     –Annual expenses = $20,000
   Catalina for camping trips                    –Boy Scouts      will not patronize ship
    • Additional $15,000                           used as disco
                                                                                        22




23                                             24
                    Freight Disco Difference                       Freight Disco Difference
Revenue               $70K $90K        -$20K   Revenue               $70K $90K        -$20K
Cash Expenses        -$10K -$20K         10K   Cash Expenses          -$10K -$20K       10K
Opportunity Cost    ______ -$15K         15K   Opportunity Cost        $15K _____       15K
Operating Profit      $60K $55K          $5K   Operating Profit        $75K $70K        $5K

• Cruise net profit irrelevant
                                               • Boy Scout contract     Additional Revenue
• Depreciation is irrelevant                     for Freight
• Loss Boy Scout contract      Opportunity
  Cost for Disco




                                                                                              4
 25                                                26
                                                      • Special Orders
               Special Orders                           –Approached by potential
                                                         customer
                                                          •In area not normally served
                                                            –Avoids cannibalization
                                                            –Avoids price discrimination
                                                        –Offers to buy product/service at
                                                         price below your cost




      • Overall cost is irrelevant
27                                                  28
        – Already in business
        – Focus on effect of special order on OP
                                                      • E.g.,
         Don’t Take          Take Difference             –Assume small airline takes
Rev:              A            (A + a)      a             passengers to resort island with
VCs:             -B            -(B+b)      -b             deluxe conference center & hotel
FCs      _______-C          __(C+c?) _____-c?            –Normal tourists take ferry for
Profit    A – (B+C) (A+a)-(B+b+C+c?) a-(b+c?)             $50/passenger
                                                         –Conference attendees take your jet
• A, B, & C   irrelevant
                                                          & pay $700/passenger
• FC don’t change if sufficient capacity
• VC could be different




                                             29                                                   30
                                                     • $300/passenger cost irrelevant
• Passengers cost you $300/person
                                                        – Make $1,200 on each flight ($4,200 -
  –Trip costs you $3,000                                  $3,000)
  –Jet can carry 10 passengers                     `
                                                     • Will special order hurt OP?
  –Typical trip    sell 6 seats                      • Accept if OP increases
    • 4 seats empty                                                Take Don’t Take       Difference
• Motel offers to buy empty seats for $100          Revenue        $400         $0             $400
  –Purchase on “Stand-By” basis                     Expenses      ___-0         -0               -0
  –Won’t affect your current business               Profit         $400         $0             $400




                                                                                                       5
                                                     31                                                         32
• With special orders, pay attention to                     • If
  capacity.                                                    – you don’t have enough current capacity, and
  – If you have excess capacity, taking special order          – you can’t buy extra capacity,
    does not cost you extra FC                              • Then you have to give up a current sale in order
  – If you don’t have enough current capacity, can you        to take special order.
    buy some extra capacity. That cost is a relevant
                                                            • If you do this, your costs are the same whether
    cost.
                                                              you take the special order, but your revenue is
                                                              different.
                                                               – You are trading the current sales revenue for the
                                                                 lower special order sales revenue.




• E.g. Assume                                        33     34
  – Every unit has variable costs of $10 per unit, and
    fixed costs of $3 per unit.
  – You have no excess capacity.                                              Keep or Drop
  – You currently sell units for $20, and you get special
    order for 1,000 units at $15.
• If you take the special order your costs are the
  same, you are trading sales prices. Costs are
  irrelevant. Only difference is:
  – 1,000 units x $20 = $20,000, and
  – 1,000 units x $15 = $15,000
• You lose $5,000




35                                                          36

• Keep or drop division/product                                            Barbie    GI Joe     Gumby     Total
                                                            Revenue        $600K     $350K       $250K $1,200K
• Firms prepare income statements                           VCs             -200K    -100K       -150K   -450K
  –Include all costs of products /                          FCs             -300K    -200K       -150K   -650K
   divisions                                                Profit         $100K      $50K       -$50K   $100K

  –But, some FCs are not relevant                           • Looks like dropping Gumby will save $50K
     •They don’t change                                     • What are FCs?




                                                                                                                     6
37                                              38
     • Rent is Common FC                        • Rent is not relevant
     • Manager salary is Direct FC              • Will make $50K more if you don’t drop Gumby

           Barbie   GI Joe Gumby   Total                      Don’t Drop       Drop Difference
Revenue    $600K    $350K $250K $1,200K         Revenue           $250K          $0      $250K
VCs         -200K   -100K   -150K -450K
                                                VCs                -150K          -0     -150K
Salary      -100K     -50K   -50K -200K
                                                Salary              -50K          -0      -50K
Rent        -200K   -150K   -100K -450K
Profit     $100K     $50K   -$50K $100K
                                                Profit              $50K         $0       $50K




39                                                                                             40
                                                • With following set up not misleading
 • Operating Profit drops from $100K to         • Can see Gumby produces $50K
   $50K if you drop Gumby:                      • Rent shown under Total because common FC

              Barbie      GI Joe        Total                Barbie    GI Joe Gumby   Total
Revenue     $600,000    $350,000     $950,000   Revenue      $600K     $350K $250K $1,200K
VCs         -200,000    -100,000     -300,000   VCs           -200K    -100K   -150K -450K
Salary      -100,000     -50,000     -150,000   Salary        -100K      -50K   -50K -200K
Rent        -257,143    -192,857     -450,000   Profit       $300K     $200K    $50K
Profit       $42,857      $7,143      $50,000   Rent                                 -450K
                                                Profit                               $100K




41                                              • Make or Buy      outsourcing decisions
                                                • Assume National Parks Service runs restaurant at
                                                  Statue of Liberty
                                                • Meals are prepared by Service at nearby kitchen
             Make or Buy                          facility
                                                • During month, Service prepares 12,000 meals
                                                • Receive offer from business willing to cater meals
                                                • Each in-house meal costs Service $35:
                                                          Direct Materials            $ 5
                                                          Direct Labor                 15
                                                          Variable Overhead            10
                                                          Fixed Overhead              __5
                                                 42                                   $35




                                                                                                       7
43                                                       44
• Outsider offers to provide each meal for $33             • FO/H is irrelevant
                                                                 – It won’t go away
• Fixed O/H is part of supervisors’ salaries.
  – Supervisors will stay on payroll
  – They still supervise the Statue’s operations                      Buy Meals        Make Meals       Difference
                                                        DM:            0              $60K   (5x12K)         -$60K
                                                        DL:            0              180K (15x12K)          -180K
                                                        VO/H:          0              120K (10x12K)          -120K
                                                        Price:      396K   (33x12K) ______                    396K
                                                        Total:     $396K             $360K                    $36K




                                                        46
 45
                                                           • Sell or Process Further
          Sell or Process Further                            – If you produce raw or
                                                               intermediate good
                                                             – You could:
                                                                • Sell good or
                                                                • Process it further & sell
                                                             – E.g., oil wells




47                                                       48
• Own diamond mine                                      Grade A:               Jewelers   DeBeers      Difference
• Produces 2 grades of diamonds: A & B                  Revenue:                  $900       $700            $200
• You sell diamonds to DeBeers:
                                                        Additional Costs:          -100      ____             -100
   – $700/carat for Grade A
                                                        Operating Profit:         $800       $700            $100
   – $500/carat for Grade B
• You could process diamonds further & sell them        Grade B:                 Jewelers DeBeers Difference
  directly to jewelers:                                 Revenue:                   $1,200    $500         700
   – $900/carat for Grade A                             Additional Costs:            -750    ____        -750
      • Additional processing & marketing costs: $100
        for Grade A                                     Operating Profit:           $450     $500        -$50
   – $1,200/carat for Grade B
      • Additional processing & marketing costs: $750      • You should sell Grade A directly to jewelers
        for Grade B                                        • You should sell Grade B to DeBeers




                                                                                                                     8

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:6
posted:10/8/2011
language:English
pages:8