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Short-Term Business Decisions

Short-Term Business Decisions. Chapter 8. Making Decisions. Define goals Identify alternative courses of action Gather and analyze relevant information Compare alternatives Choose best alternative. Objective 1. Describe and identify information relevant to business decisions.

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Short-Term Business Decisions

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  1. Short-Term Business Decisions Chapter 8

  2. Making Decisions • Define goals • Identify alternative courses of action • Gather and analyze relevant information • Compare alternatives • Choose best alternative

  3. Objective 1 Describe and identify information relevant to business decisions

  4. Relevant Information • Affects the future and • Differs among alternative courses of action • Quantitative and qualitative

  5. Relevant Information Approach • Incremental analysis - how operating income differs under each alternative • Two keys • Focus on relevant revenues, costs, and profits • Use contribution margin approach

  6. Irrelevant Costs • Costs that do not differ between alternatives • Sunk costs – incurred in past and cannot be changed

  7. Objective 2 Make special order and pricing decisions

  8. Special Sales Order

  9. Special Sales Order

  10. Qualitative Factors Will special order affect regular sales in the long run?

  11. E8-16 (1) Sports-Cardz Incremental Analysis of Special Sales Order Expected increase in revenues (50,000 packs  $0.40) $ 20,000 Expected increase in expenses: Variable manufacturing cost:(50,000  $0.35) (17,500) Expected increase in operating income $ 2,500

  12. E8-16 (2) Sports-Cardz Incremental Analysis of Special Sales Order Expected increase in revenues (50,000 packs  $0.40) $ 20,000 Expected increase in expenses: Variable manufacturing cost:(50,000  $0.35) $(17,500) Fixed manufacturing costs (5,000) (22,500) Expected decrease in operating income $(2,500)

  13. Setting Regular Prices • What is our target profit? • How much will customers pay? • Are we a price-taker or a price-setter for this product?

  14. Price Taker • Product lacks uniqueness • Heavy competition • Pricing approach emphasizes target pricing

  15. Target Pricing Revenue at market price - Desired profit Target full cost

  16. Price Setters • Product is more unique • Less competition • Pricing approach emphasizes cost-plus pricing

  17. Cost-Plus Pricing Full cost + Desired profit Cost-plus price

  18. Pricing Decisions

  19. E8-18 Req 2 Revenue at market price $200,000 - Desired profit ($182,000 x 15%) (27,300) Target full cost $172,700 Actual current variable cost 182,000 Shortfall $9,300

  20. E8-18 Req 3 Full cost $202,000 + Desired profit ($202,000 X 15%) 30,300 Cost-plus price $232,300

  21. Objective 3 Make dropping a product and product-mix decisions

  22. Dropping Products, Departments or Territories • Does product provide positive contribution margin? • Will dropping the product affect sales of the company’s other products? • What can be done with the freed capacity?

  23. Dropping Products, Departments or Territories • Are there unavoidable fixed costs? • Unavoidable fixed costs continue even if the product line is dropped • Are there avoidable fixed costs?

  24. Dropping Products, Departments or Territories

  25. E8-19 Video Avenue Analysis of Dropping VCR-Tape Line Expected decrease in revenues $ (120,000) Expected decrease in expenses: Variable costs 80,000 Expected decrease in operating income $(40,000)

  26. E8-20 Video Avenue Analysis of Dropping VCR-Tape Line Expected decrease in revenues $ (120,000) Expected decrease in expenses: Variable costs 80,000 Fixed costs 30,000 Expected decrease in operating income $(10,000)

  27. Product Mix • What constraint(s) stops us from making (or displaying) all the units we can sell? • Which products offer the highest contribution margin per unit of the constraint? • Would emphasizing one product over another affect fixed costs?

  28. Product Mix

  29. E8-22 Designer Moderate Contribution margin per unit $115.00 $60.00 Units displayed per sq ft. 300/10,000 x .030 650/10,000 x.065 Contribution margin per sq ftof display space $3.45 $3.90 Capacity – sq ft of display space x10,000 x10,000 Total contribution margin atcapacity $34,500 $39,000

  30. Objective 4 Make outsourcing and “sell as is or process further” decisions

  31. Outsourcing (Make or Buy) • How do our variable costs compare to the outsourcing cost? • Are any fixed costs avoidable if we outsource? • What could we do with the freed capacity?

  32. Outsourcing

  33. E8-24 Make Buy Difference Incremental cost per unit: Direct materials $9.00 $0 $9.00 Direct labor 1.50 0 1.50 Variable overhead 2.00 0 2.00 Purchase price $14 (14.00) Incremental cost per unit $12.50 $14 $(1.50)

  34. E8-25 Make Incremental cost per unit: $12.50 Number of switches x 80,000 Total incremental costs $1,000,000 Buy and leave facilities idle Incremental cost per unit: $14.00 Number of switches 80,000 Total incremental costs $1,120,000

  35. E8-22 Buy and use facilities for other product Incremental cost per unit: $14 Number of switches 80,000 Total incremental costs to buy $1,120,000 Expected profit contribution fromother product (220,000) Expected net cost $900,000

  36. Sell As-Is or Process Further • How much revenue is generated if we sell the product as is? • How much revenue is generated if we sell the product after processing it further? • How much will it cost to process the product further?

  37. Sell As-Is or Process Further

  38. 8-27 Process Sell As Is Further Expected revenue/unit $6.00 $0.50 Extra packaging costs/unit (0.10) (0.08) Extra cost for fruit (0.10) Expected net revenue/unit $5.90 $0.32 Number of units per batch x 500 x 10,667 Net benefit per batch $2,950 $3,413

  39. End of Chapter 8

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