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CHAPTER

Tactical Decision Making

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Objectives
1. Describe theAfter studying this tactical decision-making model. 2. Explain how the activity should usage chapter, you resource model is used inbe able to:relevancy. assessing 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.

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

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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

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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

$345,000 135,000 $460,000

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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

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Model for Making Tactical Decisions

Step 5. Assess qualitative factors. Quality of shafts 1. Quality of external suppliers and brushing is significantly lower Not reliable 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

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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.

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

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

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Activity Resource Usage Model and Assessing Relevancy

Flexible Resources

a. Demand Changes
b. Demand Constant

Relevant Not Relevant

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Activity Resource Usage Model and Assessing Relevancy

Committed Resources (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 2. Activity Capacity Unchanged Relevant Not Relevant

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Activity Resource Usage Model and Assessing Relevancy

Committed Resources (Multiperiod 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

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Keep or Drop
Special Order

Sell or Process Further

Product Mix

Important: Short-term Perspective

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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 Swaseys specifications for $4.75 per unit.

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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.

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Make or 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 ------------------------$47,500 8,500 $56,000 $12,000 5,000 20,000 8,000 -47,500 - 8,500 $-11,000

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Keep-or-Drop 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

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Keep-or-Drop Decisions
Keep Sales $150 Less: Variable expenses 140 Contribution margin $ 10 Less: Advertising -10 Cost of supervision -35 Total relevant benefit (loss) $- 35 Drop ---------------$ 0 Differential Amount to Keep $150 140 $ 10 -10 -35 $- 35

Preliminary figures indicate that the tile segment should be dropped!

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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!

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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:

Sales Less: Variable expenses Contribution margin Less: Direct fixed expenses Segment margin

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

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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 $1,450 $150 $ 0.60 $50 $64 $870 $140+ $100 $25 $38.40 + Decision: Continue making roof tile! $40

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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.

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Special-Order Decisions
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

Wholesale price = $2.00

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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.

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Special-Order Decisions
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

Which costs are irrelevant?

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Special-Order Decisions
Accept costs: Variable the offer ($0.10 x 2,000,000 = $200,000 Dairy ingredients more 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

Which costs are irrelevant?

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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

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

Grade C 600 lb

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Sell or Further Process

Process Further $450 120 $330 Sell $150 ---$150 Differential Amount to Process Further $300 120 $180

Revenues Processing cost Total

Further process!

Two Approaches to Pricing

1. Cost-Based Pricing

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2. Target Costing and Pricing

Cost-Based Pricing
Revenues Cost of goods sold: Direct materials Direct labor Overhead Gross profit Selling and administrative expenses Operating income $856,500 $489,750 140,000 84,000

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713,750 $142,750 25,000 $117,750

Determining Markup Percentages

Markup on COGS = (S & A expenses + Operating income) COGS = ($25,000 + $117,750) $713,750 = 0.20 Markup on direct materials =

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

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

Determining Markup Percentages

Direct materials (computer components, etc.) Direct labor (100 x 6 hours x $15) Overhead (60 percent of direct labor cost) Estimated cost of goods sold Plus 20 percent markup of COGS Bid price $100,000 9,000 5,400 $114,400 22,880 $137,280

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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.

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This is referred to as price-driven costing.

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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 doesnt cover services and intangibles.

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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

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Linear Programming
Max. Z = $25X x $10Y Subject to: 2X + 0.5Y 40,000 X 15,000 Y 40,000 X0 Y0

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80 75 Machine Hours Constraint 2X + 0.5Y 40,000 70 65 60 Demand Constraint 55 X 15,000 50 45 E D 40 Demand Constraint 35 Y 40,000 30 25 C 20 Feasibility 15 Region 10 5 B A | | | | | 0 5 10 15 20 25

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Linear Programming
Corner Point
A B C D E

X-Value
0 15 15 10 0

Y-Value
0 0 20 40 40

Z = $25X + $10Y
$ 0 375 575 650 400

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

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Chapter Seventeen

The End

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