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CHAPTER. Tactical Decision Making. Objectives. 1. Describe the tactical decision-making model. 2. Explain how the activity resource usage model is used in assessing relevancy. 3. Apply tactical decision-making concepts in a variety of business situations.

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slide1

CHAPTER

Tactical Decision Making

slide2

Objectives

1. Describe the tactical decision-making model.

2.Explain how the activity resource usage model is used in assessing relevancy.

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 of pricing decisions.

After studying this chapter, you should be able to:

slide3

Objectives

6. Use linear programming to find the optimal solution to a problem of multiple constrained resources. (Appendix)

slide4

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.

  • Build new facility
  • Lease larger facility; sublease current facility
  • Lease additional facility
  • Lease warehouse space
  • Buy shafts and brushings; free up needed space

Continued

slide5

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 $345,000

Warehouse lease 135,000

Buy shafts and bushings externally:

Purchase price $460,000

Continued

slide6

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

slide7

Quality of shafts and brushing is significantly lower

Not reliable

Model for Making Tactical Decisions

Step 5.Assess qualitative factors.

  • Quality of external suppliers
  • Reliability of external suppliers
  • Price stability
  • Labor relations and community image

Step 6. Make the decision.

Continue to produce shafts and bushings internally; lease warehouse

relevant costs defined
Relevant Costs Defined

Relevant costs are future costs that differ across alternatives. A cost must not only be a future cost but most also differ between alternatives.

slide9

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

activity resource usage model and assessing relevancy
Activity Resource Usage Model and Assessing Relevancy

a. Demand Changes

Relevant

b. Demand Constant Not Relevant

Flexible Resources

slide12

a.. Demand Increased < Unused Capacity Not relevant

b. Demand Increased > Unused Capacity Relevant

  • Activity Capacity Reduced Relevant
  • Activity Capacity Unchanged Not Relevant

Activity Resource Usage Model and Assessing Relevancy

Committed Resources

(Short-Term)

Supply – Demand = Unused Capacity

c. Demand Decease (Permanent)

slide13

a.. Demand Increased < Unused Capacity Not relevant

b. Demand Decreased (Permanent) Relevant

c. Demand Increase > Unused Capacity Capital Decision

Activity Resource Usage Model and Assessing Relevancy

Committed Resources

(Multiperiod Capacity)

Supply – Demand = Unused Capacity

illustrative examples of relevant cost applications
Illustrative Examples of Relevant Cost Applications
  • Make or Buy
  • Keep or Drop
  • Special Order
  • Sell or Process Further

Important: Short-term Perspective

slide15

Make or 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 Swasey’s specifications for $4.75 per unit.

slide16

Make or 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.

slide17

Make or Buy

The cost to make or buy 10,000 units follows:

Alternatives Differential

Make Buy Cost to Make

Rental of equipment $12,000 ------- $12,000

Direct materials 5,000 ------- 5,000

Direct labor 20,000 ------- 20,000

Variable overhead 8,000 ------- 8,000

Purchase cost ------- $47,500 -47,500

Receiving Dept. labor ------- 8,500 - 8,500

Total $45,000 $56,000 $-11,000

Make

slide18

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 Decisions

Norton Materials, Inc. produces concrete blocks, bricks, and roofing tile. The controller prepared the following income statements:

slide19

Keep-or-Drop Decisions

Differential

Keep Drop Amount to Keep

Sales $150 ---- $150

Less: Variable expenses 140---- 140

Contribution margin $ 10 ---- $ 10

Less: Advertising -10 ---- -10

Cost of supervision -35---- -35

Total relevant benefit

(loss) $- 35 $ 0 $- 35

Preliminary figures indicate that the tile segment should be dropped!

slide20

Keep-or-Drop 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 Drop Amount to Keep

Sales $1,450 $1,186.0 $264.0

Less: Variable expenses 870 666.6 203.4

Contribution margin $ 580 $ 519.4 $ 60.6

Less: Advertising -30 -20.0 -10.0

Cost of supervision -112 -77.0 -35.0

Total $ 438 $ 422.4 $ 15.6

Keep roofing tile segment!

slide21

Sales $100,000

Less: Variable expenses 40,000

Contribution margin $ 60,000

Less: Direct fixed expenses 55,000

Segment margin $ 5,000

Keep-or-Drop Decisions

Alternate Use of 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:

slide22

Keep-or-Drop Decisions

Alternate Use of Facilities

Drop and Differential

Keep Replace Amount to Keep

Sales $1,450 $1,286.00 $164.00

Less: Variable expenses 870 706.60 163.40

Contribution margin $ 580 $ 579.40 $ 0.60

$1,450 – $150 –$50 – $64 + $100

$870 – $140 – $25 – $38.40 + $40

Decision: Continue making roof tile!

slide23

Special-Order 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.

slide24

Special-Order Decisions

Variable costs:

Dairy ingredients $ 0.70

Sugar 0.10

Flavoring 0.15

Direct labor 0.25

Packaging 0.20

Commissions 0.02

Distribution 0.03

Other 0.05

Total variable costs $ 1.50

Wholesale price = $2.00

Total fixed costs 0.097

Total costs $1.597

slide25

Special-Order 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.

slide26

$1.45

$1.45

Special-Order Decisions

Variable costs:

Dairy ingredients $0.70

Sugar 0.10

Flavoring 0.15

Direct labor 0.25

Packaging 0.20

Commissions 0.02

Distribution 0.03

Other 0.05

Total variable costs $1.50

Which costs are irrelevant?

Total fixed costs 0.097

Total costs $1.597

slide27

$1.45

$1.45

Special-Order Decisions

Accept the offer ($0.10 x 2,000,000 = $200,000 more profit).

Variable costs:

Dairy ingredients $ 0.70

Sugar 0.10

Flavoring 0.15

Direct labor 0.25

Packaging 0.20

Commissions 0.02

Distribution 0.03

Other 0.05

Total variable costs $ 1.50

Which costs are irrelevant?

Total fixed costs 0.097

Total cost $1.597

slide28

Bagged

120 Bags

Cost $0.05/Bag

Sell for $1.30/Bag

Applesauce

500 16-oz Cans

Cost $0.10/lb

Sell for $0.75 can

Sell or Further Process

Yield at Split-Off

Further Processing

Grade A

800 lb

Sell for $0.40 lb

Grade B

600 lb

Joint Cost $300

Grade C

600 lb

slide29

Sell or Further Process

Process Differential Amount

Further Sell to Process Further

Revenues $450 $150 $300

Processing cost 120 ---- 120

Total $330 $150 $180

Further process!

two approaches to pricing
Two Approaches to Pricing

1. Cost-Based Pricing

2. Target Costing and Pricing

cost based pricing
Cost-Based Pricing

Revenues $856,500

Cost of goods sold:

Direct materials $489,750

Direct labor 140,000

Overhead 84,000 713,750

Gross profit $142,750

Selling and administrative expenses 25,000

Operating income $117,750

determining markup percentages
Determining Markup Percentages

Markup on COGS =

(S & A expenses + Operating income) ÷ COGS

= ($25,000 + $117,750) ÷ $713,750

= 0.20

Markup on direct materials =

(DL + OH + S & A expenses + Oper. income) ÷ Direct mater. =

($140,000 + $84,000 + $25,000 + $117,750) ÷$489,750 = 0.749

slide33

Determining Markup Percentages

Direct materials (computer components, etc.) $100,000

Direct labor (100 x 6 hours x $15) 9,000

Overhead (60 percent of direct labor cost) 5,400

Estimated cost of goods sold $114,400

Plus 20 percent markup of COGS 22,880

Bid price $137,280

target costing and pricing
Target Costing and Pricing

Target costing is a method of determining the cost of a product or service based on the price (target price) that customers are willing to pay.

This is referred to as price-driven costing.

slide35

Legal Aspects of Pricing

Predatory pricing.The practice of setting prices below cost for the purpose of injuring or eliminating competitors.

Price discrimination. Charging different prices to different customers for essentially the same product.

The Robinson-Patman Act is the most potent weapon against price discrimination, but it doesn’t cover services and intangibles.

slide36

Linear Programming

The maximum demand for Gear X is 15,000 units and the maximum demand for Gear Y is 40,000 units. The contribution margin for X is $25 and for Y is $10.

Z = $25X x $10Y

Two machine hours are used for each unit of Gear X, and 0.5 machine hour is used for a unit of Gear Y.

2X + 0.5Y  40,000

slide37

Subject to:

2X + 0.5Y  40,000

X  15,000

Y  40,000

X  0

Y  0

Linear Programming

Max. Z = $25X x $10Y

slide38

E

D

C

Feasibility Region

B

A

80 –

75 –

70 –

65 –

60 –

55 –

50 –

45 –

40 –

35 –

30 –

25 –

20 –

15 –

10 –

5 –

0 –

Machine Hours Constraint

2X + 0.5Y  40,000

Demand Constraint X  15,000

Demand Constraint Y  40,000

| | | | |

5 10 15 20 25

slide39

Linear Programming

Corner Point X-Value Y-Value Z = $25X + $10Y

A 0 0 $ 0

B 15 0 375

C 15 20 575

D 10 40 650

E 0 40 400

Manufacture 10,000 units of Gear X and 40,000 of Gear Y.