ACCTG 211 1st Edition Lecture 23Outline of Last Lecture I. CVP Analysis Continue a. Contribution Margin Approach II. CVP With Multiple ProductsIII. Examples a. High Low Method b. Single Product CVPOutline 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 mixe. Outsourcing: make vs. buy f. Sell now or process further Current LectureII. 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 costsii. Differs between alternativesc. 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 alternativesd. Example: negotiating to sell your car to a potential buyeri. 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 hereIII. 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.d. Determining the optimal product mixe. Outsourcing: make vs. buy f. Sell now or process further IV. #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: $3.20ii. Customer requests 20,000 units for $35,000 (or $1.75 / unit)iii. Excess capacity exists to produce the special orderd. Assuming the company sold 250,000 units during the period, what is the variablemanufacturing cost per unit for the CM income statement?i. Variable Mfg Costs / units produced1. = $300,000 / 250,000 units = $1.20 per unitii. Accept if there is a positive incremental income and deny if there is a negative incremental income1. Incremental Revenue – Incremental Expenses = Incremental IncomeV. #2 Target Pricing and Cost-Plus Pricinga. Price-Setter vs. Price-Takeri. Apple vs. Samsungb. Price-Taker: Target Pricingi. Start with the expected market priceii. Back out a reasonable profit marginiii. Ask the question: can we produce at or below this cost?c. Price-Setter: Cost-Plus Pricingi. Start with the cost to produceii. Add a reasonable profit marginiii. Set the sales price – remember, you have market power as a price-setter, so the market price is likely reasonabled. Example of price takeri. ACDelco is a price-taker 1. Units sell for $3.00 each in the market2. ACDelco desires a 10% ROA each period3. ACDelco currently has $1,000,000 in total assets4. ACDelco produced and sold 250,000 units last period, and expects to sell 250,000 units this period5. What is ACDelco’s target full cost? a. Target Full Cost = Revenue at Market Price – Desire ROAi. Revenue at Market Price = (3 X 250,000) = 750,000ii. ROA = .10 X 1,000,000 = 100,000iii. Target Full Cost = 750,000 – 100,000 = 650,000iv. Actual TC = COGS + MKTG + Admin Expense = 700,0001. Need to lower TC by 50,0002. ***TC Provided in Example***e. Example of Price Setteri. Here, ACDelco is a price-1. ACDelco desires a 10% ROA each period2. ACDelco currently has $1,000,000 in total assets3. ACDelco produced and sold 250,000 units last period, and expects to sell 250,000 units this periodii. Question: what is ACDelco’s cost-plus price?1. TC + Desired ROA = Total Target Sales / #Units = Cost-plus sales perunit. 2. 700,000 + 100,000 = 800,000/ 250,000 = $3.20 per unitVI. #3 Drop a Product, division, or department example a. Consider if something appears to be generating lossb. Question: Keep or drop air filters?i. Incremental Income = Decrease in TC – Decrease in Revenue 1. If negative: DO NOT DROP2. If positive: DROP 3. Typically FC is not decrease but a special deal may be madeii. 75,000 – 125,000 = -50,0001. Do not drop VII. #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 VIII. #5 Outsourcing: Make or buy?a. Considerationsi. 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. Examplec. 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 outsourceIX. #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 oilii. Bertolli can sell the plain olive oil now for $5.00 per quartiii. Or, Bertolli can incur an additional $0.75 per quart to produce further intogourmet olive oiliv. If produced further, Bertilli can sell for $7.00 per quart.v. Question: should Bertolli sell now or process further?1. Ignore sunk costs2. 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