ACCTG 211 1st Edition Lecture 23 Outline of Last Lecture I CVP Analysis Continue a Contribution Margin Approach II CVP With Multiple Products III Examples a High Low Method b Single Product CVP Outline of Current Lecture I Common Short Term Business Making Decisions a Accepting a special order from a customer b Pricing decisions c Dropping a product department or division d Determining the optimal product mix e Outsourcing make vs buy f Sell now or process further Current Lecture II III Relevant Information in Decision Making a Decision making in business involves making a choice between two or more alternative options b Information is relevant for business decisions if it i Provides information about expected future revenues or costs ii Differs between alternatives c Information is irrelevant for business decisions if it i Provides information about past revenues or costs information about a past cost is dubbed a sunk cost ii Does not differ between alternatives d Example negotiating to sell your car to a potential buyer i Question is the price you paid for the car relevant e Qualitative factors also impact business decisions in reality but we will stick to the quantitative analysis here Common Short Term Business Making Decisions a Accepting a special order from a customer b Pricing decisions c Dropping a product department or division These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute IV V d Determining the optimal product mix e Outsourcing make vs buy f Sell now or process further 1 Accepting a special order from a customer a A customer approaches you and requests that you produce a special order at a reduced sales price b Considerations i Do you have excess capacity to make the order ii Will you be able to make a profit How to measure profit iii Will selling at a reduced price affect future sales c Example i Normal sales price per unit 3 20 ii Customer requests 20 000 units for 35 000 or 1 75 unit iii Excess capacity exists to produce the special order d Assuming the company sold 250 000 units during the period what is the variable manufacturing cost per unit for the CM income statement i Variable Mfg Costs units produced 1 300 000 250 000 units 1 20 per unit ii Accept if there is a positive incremental income and deny if there is a negative incremental income 1 Incremental Revenue Incremental Expenses Incremental Income 2 Target Pricing and Cost Plus Pricing a Price Setter vs Price Taker i Apple vs Samsung b Price Taker Target Pricing i Start with the expected market price ii Back out a reasonable profit margin iii Ask the question can we produce at or below this cost c Price Setter Cost Plus Pricing i Start with the cost to produce VI ii Add a reasonable profit margin iii Set the sales price remember you have market power as a price setter so the market price is likely reasonable d Example of price taker i ACDelco is a price taker 1 Units sell for 3 00 each in the market 2 ACDelco desires a 10 ROA each period 3 ACDelco currently has 1 000 000 in total assets 4 ACDelco produced and sold 250 000 units last period and expects to sell 250 000 units this period 5 What is ACDelco s target full cost a Target Full Cost Revenue at Market Price Desire ROA i Revenue at Market Price 3 X 250 000 750 000 ii ROA 10 X 1 000 000 100 000 iii Target Full Cost 750 000 100 000 650 000 iv Actual TC COGS MKTG Admin Expense 700 000 1 Need to lower TC by 50 000 2 TC Provided in Example e Example of Price Setter i Here ACDelco is a price1 ACDelco desires a 10 ROA each period 2 ACDelco currently has 1 000 000 in total assets 3 ACDelco produced and sold 250 000 units last period and expects to sell 250 000 units this period ii Question what is ACDelco s cost plus price 1 TC Desired ROA Total Target Sales Units Cost plus sales per unit 2 700 000 100 000 800 000 250 000 3 20 per unit 3 Drop a Product division or department example a Consider if something appears to be generating loss b Question Keep or drop air filters VII VIII IX i Incremental Income Decrease in TC Decrease in Revenue 1 If negative DO NOT DROP 2 If positive DROP 3 Typically FC is not decrease but a special deal may be made ii 75 000 125 000 50 000 1 Do not drop 4 Determine the optimal product mix a Happens when we are constrained by a certain resource when producing products i Produce the product with the highest CM per unit 5 Outsourcing Make or buy a Considerations i What are our incremental costs to produce the product internally versus purchase the product externally ii Can we avoid any fixed costs by outsourcing iii How to handle any excess capacity b Example c This is Apple s information and SkullCandy offers to sell Apple headphones for 7 unit i Although the TC per unit for Apple is 8 00 the Fixed Mfg OVHD is a sunk cost and will be paid no matter what 1 The TC per unit without sunk costs is 6 00 per unit a Do not outsource 6 Sell Now or Process Further a Occurs when we have a production process where we can sell a product now for a certain price or produce it further and sell it for a higher price b Example Bertolli i 100 000 has been spent to produce 50 000 quarts of plain olive oil ii Bertolli can sell the plain olive oil now for 5 00 per quart iii Or Bertolli can incur an additional 0 75 per quart to produce further into gourmet olive oil iv If produced further Bertilli can sell for 7 00 per quart v Question should Bertolli sell now or process further 1 Ignore sunk costs 2 For an additional cost of 0 75 per quart Bertolli can make an additional 2 00 per quart in revenue Net profit per quart for processing further 1 25 per quart 3 50 000 quarts further processed x 1 25 quart 62 500 in additional profits for processing further a Process further