Decision Making and Relevant Information

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# Decision Making and Relevant Information - PowerPoint PPT Presentation

Decision Making and Relevant Information. Chapter 11. Overview. Decisions Relevant information Examples of common decisions Opportunity costs Capacity constraints Replace equipment Comprehensive example. Information and the Decision Process. A decision model is a formal method

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### Decision Making andRelevant Information

Chapter 11

Overview
• Decisions
• Relevant information
• Examples of common decisions
• Opportunity costs
• Capacity constraints
• Replace equipment
• Comprehensive example
Information and theDecision Process

A decision model is a formal method

for making a choice, often involving

quantitative and qualitative analysis.

Five-Step Decision Process

Historical Costs

Other Information

Step 1.

Gather Information

Step 2.

Make Predictions

Specific Predictions

Step 3.

Choose an Alternative

Feedback

Step 4.

Implement the Decision

Step 5.

Evaluate Performance

Differentiate relevant

from irrelevant

costs and revenues in

decision situations.

The Meaning of Relevance

Relevant costs and relevant revenues are

expected future costs and revenues that

differ among alternative courses of action.

Historical costs

Sunk costs

Differential income

Differential costs

Quantitative and QualitativeRelevant Information

Quantitative factors

Financial

Nonfinancial

Qualitative factors

One-Time-OnlySpecial Order Example

Profit is made if the incremental revenue exceeds incremental costs.

If excess capacity exists, then relevant cost generally equals variable cost to make special order.

Will marketing costs change?

Two Potential Problems inRelevant-Cost Analysis

1

2

Incorrect general

assumptions:

unit-cost data:

All variable costs

are relevant.

Include

irrelevant costs.

All fixed costs

are irrelevant.

Use same unit

costs at different

output levels.

Outsourcing versus Insourcing

Outsourcing is

and services from

outside vendors.

Insourcing is

producing goods

or providing services

within the organization.

This is a very common (frequent) decision made by most organizations.

Purchase managers report three important factors:

(1) Quality

(2) Supplier dependability

(3) Cost

In making a “make-or-buy” decision it is often times useful and quick to compare the cost to outsource versus the costs saved if you outsource.

Opportunity Costs andOutsourcing

Opportunity cost is the contribution to income

that is forgone (rejected) by not using a

limited resource in its next-best alternative use.

Generally, opportunity cost is the benefit foregone by not choosing the next best alternative.

Opportunity Costs andOutsourcing

Many decisions have an opportunity cost.

What is the opportunity cost for making the decision to come to class today?

Give an example of a decision that had no or zero opportunity cost.

Capacity Constraints

Deciding which

products to produce when there

are capacity constraints.

Answer: Produce/sell product(s) with the highest CM/unit of constraint!

Product-Mix DecisionsUnder Capacity Constraints

Per unit Product #2Product #3

Sales price \$2.11 \$14.50

Variable expenses 0.41 13.90

Contribution margin \$1.70 \$ 0.60

Contribution margin ratio 81% 4%

Bismark Co. has 3,000 machine-hours available.

Product-Mix DecisionsUnder Capacity Constraints

One unit of Prod. #2 requires 7 machine-hours.

One unit of Prod. #3 requires 2 machine-hours.

What is the contribution of each product

per machine-hour?

Product #2: \$1.70 ÷ 7 = \$0.24

Product #3: \$0.60 ÷ 2 = \$0.30

From a company economic

Perspective, the book value

of equipment is irrelevant in

equipment-replacement decisions.

Conflicts can arise

between the decision model

used by a manager and the

performance evaluation model

used to evaluate the manager.

Decisions andPerformance Evaluation

What is the journal entry to sell the existing machine?

Cash \$14,000

Accumulated Depreciation 50,000

Loss on Disposal 16,000

Machine \$80,000

Decisions andPerformance Evaluation

In the real world would the manager

replace the machine?

An important factor in replacement decisions

is the manager’s perceptions of whether the

decision model is consistent with how the

manager’s performance is judged.

Decisions andPerformance Evaluation

Top management faces a challenge – that is,

making sure that the performance-evaluation

model of subordinate managers is consistent

with the decision model.

Anatomy of a Decision: Buy a used versus lease a new car
• Example of decision--See spread sheet analysis.
• Quantitative and qualitative analysis—you are only part way done with analysis after the quantitative analysis. Use this as a benchmark against the qualitative factors.
• What qualitative factors have I missed (left out of) in my quantitative analysis?