for
Decision Making
McGrawHill/Irwin
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1
2
3
4
5
6
Annual Cost
of Fixed Items
$
2,800
1,380
360
Cost per
Mile
$
0.280
0.050
0.138
0.065
0.036
$
0.569
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
1
2
3
4
5
6
7
8
9
10
11
12
13
McGrawHill/Irwin
Annual Cost
of Fixed Items
$
2,800
1,380
360
Cost per
Mile
$
0.280
0.050
0.138
0.065
0.036
$
0.569
$ 0.026
$
104
????
$
40
????
????
$
25
Copyright2006,TheMcGrawHillCompanies,Inc.
Copyright2006,TheMcGrawHillCompanies,Inc.
The monthly
school parking
fee is not
relevant because
it must be paid if
Cynthia drives or
takes the train.
Copyright2006,TheMcGrawHillCompanies,Inc.
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$ 23.00
29.90
11.96
50.00
$ 114.86
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
Current
Situation
$
200,000
Situation
With New
Machine
$
200,000
Differential
Costs and
Benefits
-
70,000
40,000
10,000
120,000
80,000
70,000
25,000
10,000
105,000
95,000
15,000
15,000
62,000
62,000
18,000
62,000
3,000
65,000
30,000
(3,000)
(3,000)
12,000
Copyright2006,TheMcGrawHillCompanies,Inc.
Current
Situation
$
200,000
Situation
With New
Machine
$
200,000
Differential
Costs and
Benefits
-
70,000
40,000
10,000
120,000
80,000
70,000
25,000
10,000
105,000
95,000
15,000
15,000
62,000
3,000
65,000
30,000
(3,000)
(3,000)
12,000
McGrawHill/Irwin
$
$
15,000
(3,000)
12,000
Copyright2006,TheMcGrawHillCompanies,Inc.
Copyright2006,TheMcGrawHillCompanies,Inc.
Adding/Dropping Segments
One of the most important decisions
managers make is whether to add or
drop a business segment such as a
product or a store.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
Adding/Dropping Segments
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
DECISION
DECISION RULE
RULE
Lovell
Lovell should
should drop
drop the
the digital
digital watch
watch segment
segment only
only
ifif its
its profit
profit would
would increase.
increase. This
This would
would only
only
happen
happen ifif the
the fixed
fixed cost
cost savings
savings exceed
exceed the
the lost
lost
contribution
contribution margin.
margin.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
Adding/Dropping Segments
Segment Income Statement
Digital Watches
Sales
Less: variable expenses
Variable manufacturing costs
Variable shipping costs
Commissions
Contribution margin
Less: fixed expenses
General factory overhead
Salary of line manager
Depreciation of equipment
Advertising - direct
Rent - factory space
General admin. expenses
Net operating loss
McGrawHill/Irwin
$ 500,000
$ 120,000
5,000
75,000
$ 60,000
90,000
50,000
100,000
70,000
30,000
200,000
$ 300,000
400,000
$ (100,000)
Copyright2006,TheMcGrawHillCompanies,Inc.
Adding/Dropping Segments
Segment Income Statement
Digital Watches
Sales
$ 500,000
Less: variable expenses
Investigation
has
Investigation
has revealed
revealed
that
total fixed
fixed general
general
Variable manufacuring
coststhat
$ total
120,000
Variablefactory
shippingoverhead
costs
5,000
and
factory
overhead
and general
general
Commissions expenses would not
75,000
200,000
administrative
be
affected
ifif
administrative
expenses
would
not
be
affected
Contribution margin
$ 300,000
the
digital
watch
the
digital
watch line
line is
is dropped.
dropped. The
The fixed
fixed
Less:
fixed
expenses
general
factory
overhead
general
General
factory
overhead
$ and
60,000
general
factory
overhead
and
general
Salary of line manager
90,000
administrative
expenses
to
administrative
expenses assigned
assigned
to this
this product
product
Depreciation of equipment
50,000
would
to
product
would be
be -reallocated
reallocated
to other
other100,000
product lines.
lines.
Advertising
direct
Rent - factory space
70,000
General admin. expenses
30,000
400,000
Net operating loss
$ (100,000)
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
Adding/Dropping Segments
Segment Income Statement
Digital Watches
Sales
$ 500,000
Less: variable expenses
Variable
manufacturing
costs
$ 120,000
The
equipment
used
manufacture
The
equipment
used to
to
manufacture
Variable shipping costs
5,000
digital
digital watches
watches has
has no
no resale
resale
Commissions
75,000
200,000
value
or
Contribution
margin
$ 300,000
value
or alternative
alternative use.
use.
Less: fixed expenses
General factory overhead
$ 60,000
Salary of line manager
90,000
Depreciation of equipment
50,000
Should
retain or drop
Should Lovell
Lovell
Advertising - direct
100,000 retain or drop
the
watch
Rent - factory space
the digital
digital70,000
watch segment?
segment?
General admin. expenses
30,000
400,000
Net operating loss
$ (100,000)
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
$ (300,000)
260,000
$ (40,000)
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
margin.
margin.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
Difference
$ (500,000)
120,000
5,000
75,000
200,000
(300,000)
90,000
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
Difference
$ (500,000)
120,000
5,000
75,000
200,000
(300,000)
90,000
100,000
70,000
260,000
$ (40,000)
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
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Smoother flow of
parts and materials
Better quality
control
Realize profits
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9
5
1
3
2
10
$ 30
Copyright2006,TheMcGrawHillCompanies,Inc.
Copyright2006,TheMcGrawHillCompanies,Inc.
$ 25
Direct materials
Direct labor
Variable overhead
Depreciation of equip.
Supervisor's salary
General factory overhead
Total cost
9
5
1
3
2
10
$ 30
$ 500,000
Copyright2006,TheMcGrawHillCompanies,Inc.
$ 25
Direct materials
Direct labor
Variable overhead
Depreciation of equip.
Supervisor's salary
General factory overhead
Total cost
9
5
1
3
2
10
$ 30
$ 500,000
The
The special
special equipment
equipment has
has no
no resale
resale
value
value and
and is
is aa sunk
sunk cost.
cost.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
$ 25
Direct materials
Direct labor
Variable overhead
Depreciation of equip.
Supervisor's salary
General factory overhead
Total cost
9
5
1
3
2
10
$ 30
$ 500,000
Not
Not avoidable;
avoidable; irrelevant.
irrelevant. IfIf the
the product
product is
is
dropped,
dropped, itit will
will be
be reallocated
reallocated to
to other
other products.
products.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
$ 25
Direct materials
Direct labor
Variable overhead
Depreciation of equip.
Supervisor's salary
General factory overhead
Total cost
9
5
1
3
2
10
$ 30
$ 500,000
Copyright2006,TheMcGrawHillCompanies,Inc.
Opportunity Cost
An opportunity cost is the benefit that is foregone as a
result of pursuing some course of action.
Opportunity costs are not actual dollar outlays and
are not recorded in the formal accounts of an
organization.
How would this concept potentially relate to the Essex
Company?
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
Special Orders
Jet, Inc. makes a single product whose normal selling
price is $20 per unit.
A foreign distributor offers to purchase 3,000 units for $10
per unit.
This is a one-time order that would not affect the
companys regular business.
Annual capacity is 10,000 units, but Jet, Inc. is currently
producing and selling only 5,000 units.
Copyright2006,TheMcGrawHillCompanies,Inc.
Special Orders
$8 variable cost
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
Special Orders
If Jet accepts the offer, net operating income will
increase by $6,000.
Increase
Increase
Increase
$ 30,000
24,000
$ 6,000
Copyright2006,TheMcGrawHillCompanies,Inc.
Quick Check
Northern Optical ordinarily sells the X-lens for $50.
The variable production cost is $10, the fixed
production cost is $18 per unit, and the variable
selling cost is $1. A customer has requested a
special order for 10,000 units of the X-lens to be
imprinted with the customers logo. This special
order would not involve any selling costs, but
Northern Optical would have to purchase an
imprinting machine for $50,000.
(see the next page)
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
Quick Check
What is the rock bottom minimum price below which
Northern Optical should not go in its negotiations
with the customer? In other words, below what
price would Northern Optical actually be losing
money on the sale? There is ample idle capacity to
fulfill the order and the imprinting machine has no
further use after this order.
a. $50
b. $10
c. $15
d. $29
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
Quick Check
What is the rock bottom minimum price below which
Northern Optical should not go in its negotiations
with the customer? In other words, below what
price would Northern Optical actually be losing
money on the sale? There is ample idle capacity to
fulfill the order and the imprinting machine has no
further use after this order.
Variable production cost
$100,000
a. $50
Additional fixed cost
50,000
b. $10
Total relevant cost
$150,000
c. $15 Number of units
10,000
d. $29 Average cost per unit
$15
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
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Copyright2006,TheMcGrawHillCompanies,Inc.
Quick Check
How many units of each product can be
processed through Machine A1 in one minute?
a.
b.
c.
d.
McGrawHill/Irwin
Product 1
1 unit
1 unit
2 units
2 units
Product 2
0.5 unit
2.0 units
1.0 unit
0.5 unit
Copyright2006,TheMcGrawHillCompanies,Inc.
Quick Check
How many units of each product can be
processed through Machine A1 in one minute?
a.
b.
c.
d.
Product 1
1 unit
1 unit
2 units
2 units
Product 2
0.5 unit
2.0 units
1.0 unit
0.5 unit
Copyright2006,TheMcGrawHillCompanies,Inc.
Quick Check
What generates more profit for the company,
using one minute of machine A1 to process
Product 1 or using one minute of machine A1
to process Product 2?
a. Product 1
b. Product 2
c. They both would generate the same profit.
d. Cannot be determined.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
Quick Check
With one minute of machine A1, we could
makegenerates
1 unit of Product
1, with
contribution
What
more profit
for athe
company,
margin
$24, orof2 machine
units of Product
2, each
using
oneofminute
A1 to process
with a contribution margin of $15.
Copyright2006,TheMcGrawHillCompanies,Inc.
Copyright2006,TheMcGrawHillCompanies,Inc.
IfIf there
there are
are no
no other
other considerations,
considerations, the
the best
best
plan
plan would
would be
be to
to produce
produce to
to meet
meet current
current
demand
demand for
for Product
Product 22 and
and then
then use
use remaining
remaining
capacity
capacity to
to make
make Product
Product 1.
1.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
2,200
2,200
0.50
0.50
units
units
min.
min.
1,100
1,100 min.
min.
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
2,200
2,200
0.50
0.50
units
units
min.
min.
1,100
1,100 min.
min.
2,400
2,400
1,100
1,100
1,300
1,300
min.
min.
min.
min.
min.
min.
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
2,200
2,200
0.50
0.50
units
units
min.
min.
1,100
1,100 min.
min.
2,400
2,400
1,100
1,100
1,300
1,300
1.00
1.00
1,300
1,300
min.
min.
min.
min.
min.
min.
min.
min.
units
units
Copyright2006,TheMcGrawHillCompanies,Inc.
Product 1
1,300
$
24
$ 31,200
Product 2
2,200
$
15
$ 33,000
Copyright2006,TheMcGrawHillCompanies,Inc.
Quick Check
Colonial Heritage makes reproduction colonial
furniture from select hardwoods.
Chairs
Selling price per unit
$80
Variable cost per unit
$30
Board feet per unit
2
Monthly demand
600
Tables
$400
$200
10
100
Copyright2006,TheMcGrawHillCompanies,Inc.
Quick Check
Colonial Heritage makes reproduction colonial
furniture from select hardwoods.
Chairs
Selling price per unit
$80
Variable cost per unit
$30
Board feet per unit
2
Monthly demand
600
Tables
$400
$200
10
100
Copyright2006,TheMcGrawHillCompanies,Inc.
Quick Check
Chairs
Selling price per unit
$80
Variable cost per unit
$30
Board feet per unit
2
Monthly demand
600
Tables
$400
$200
10
100
Copyright2006,TheMcGrawHillCompanies,Inc.
Quick Check
Chairs Tables
Selling price
$ 80 $ 400
Variable cost
200
Chairs Tables 30
Selling price per
unit
$80
Contribution
margin $400
$ 50 $ 200
Variable cost per unit
$200
Board feet $30
2
10
Board feet per unit
2
10
CM per board
foot
$ 25 $ 20
Monthly demand
600
100
Copyright2006,TheMcGrawHillCompanies,Inc.
Quick Check
As before, Colonial Heritages supplier of
hardwood will only be able to supply 2,000
board feet this month. Assume the company
follows the plan we have proposed. Up to how
much should Colonial Heritage be willing to pay
above the usual price to obtain more hardwood?
a. $40 per board foot
b. $25 per board foot
c. $20 per board foot
d. Zero
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
Quick Check
As before,
Colonial
Heritages
supplier
of make
The
additional
wood
would be
used to
hardwood
onlyuse,
be able
to board
supplyfoot
2,000
tables. will
In this
each
of
board feetwood
this month.
Assume
the company
additional
will allow
the company
to earn
follows the plan we have proposed. Up to how
an additional $20 of contribution margin and
much should Colonial Heritage be willing to pay
profit.
above the usual price
to obtain more hardwood?
a. $40 per board foot
b. $25 per board foot
c. $20 per board foot
d. Zero
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
Managing Constraints
Finding ways to
process more units
through a resource
bottleneck
McGrawHill/Irwin
Joint Costs
In some industries, a number of end
products are produced from a single raw
material input.
Two or more products produced from a
common input are called joint products.
products
The point in the manufacturing process
where each joint product can be
recognized as a separate product is
called the split-off point.
point
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
Joint Products
Oil
Joint
Input
Common
Production
Process
Gasoline
Chemicals
Split-Off
Point
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
Joint Products
Joint
Costs
Joint
Input
Common
Production
Process
Oil
Gasoline
Chemicals
Split-Off
Point
McGrawHill/Irwin
Separate
Processing
Final
Sale
Final
Sale
Separate
Processing
Final
Sale
Separate
Product
Costs
Copyright2006,TheMcGrawHillCompanies,Inc.
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
Per Log
Lumber
Sawdust
$
140
$
40
270
176
50
50
24
20
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
270
140
130
Sawdust
50
40
10
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
270
140
130
50
80
Sawdust
50
40
10
20
(10)
Copyright2006,TheMcGrawHillCompanies,Inc.
270
140
130
50
80
Sawdust
50
40
10
20
(10)
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.
End of Chapter 13
McGrawHill/Irwin
Copyright2006,TheMcGrawHillCompanies,Inc.