Chapter 8 Short Term Business Decisions 1 How do Managers Make Decisions a Follow These Steps i Define Business Goals ii Identify Alternative Courses of Action iii Gather and Analyze Relevant Information Compare Alternatives iv Choose the Best Alternative v Implement Decisions vi Follow Up Compare Actual Results with the Results Anticipated b Relevant Information Expected future data that differs among alternatives i These costs are relevant because they affect one s decision about what to purchase c Sunk Costs irrelevant costs towards decision making costs that are incurred in the past and cannot change regardless of your decision making d Keys to Making Short Term Special Decisions i Relevant Information Approach or Incremental Analysis Approach 1 Look at how operating income would change or differ under each alternative 2 Consider Special sales orders pricing dropping products departments and territories product mix outsourcing make or buy selling as is or processing further 2 How do Managers Make Special Order and Regular Pricing Decisions a Special Order Decisions Occurs when a customer requests a one time order at a reduced sales price usually in large quantities i Do we have excess capacity available to fill this order ii Will the reduced sales price be high enough to cover the incremental costs of filling the order Variable costs and any additional fixed costs 1 MUST provide a positive contribution margin iii Will the special order affect regular sales in the long run i If expected increase in revenues exceeds expected increase in variable and fixed costs ii If expected increase in revenues is less than expected increase in variable and fixed costs b Accept special order accept the special order reject the special order c Regular Pricing Decisions i What is our target profit ii How much will customers pay iii Are we a price taker or price setter for this product 1 Price Takers Product lacks uniqueness heavy competition pricing approach 2 Price Setters Product is more unique less competition pricing approach emphasizes target costing emphasizes cost plus pricing iv Target Costing Starts with the market price of the product or the price that customers are willing to pay and subtracts the company s desired price of the product 1 Target Full Cost Revenues at market price desired profit 2 Target Fixed Cost Target Total Cost Current Variable Costs 3 Target Unit Variable Cost Target Total Cost Current fixed costs target total variable costs number of units v Cost Plus Pricing Starts with products total costs as given and adds its desired profit 1 Total Cost Desired Profit 2 Cost Plus Price Per Unit Current Variable Costs Current Fixed Costs Current total costs Desired Revenue Target Revenue Number of Units 3 How do Managers Make Other Special Business Decisions a Decisions to Drop Products Departments or Territories i Does the product provide a positive contribution margin ii Will fixed costs continue to exist even if we drop the product iii Are there any direct fixed costs that can be avoided if we drop the product iv Will dropping the product affect sales of the company s other products v What could we do with the free capacity vi WHEN DROPPING A PRODUCT 1 Does the product provide a positive contribution margin 2 Will total fixed costs continue to exist even if the product line is dropped a If so they are called unavoidable fixed costs These costs are irrelevant to the decision of weather or not to drop the product b Find the decrease in operating income Expected decrease in revenue expected decrease in expenses 3 Can any direct fixed costs be avoided if the product line is dropped b If lost revenues from dropping a product department or territory exceed the cost savings from c If total cost savings exceed the lost revenues from dropping a product department or territory dropping DO NOT DROP PRODUCT DROP THE PRODUCT d Constraints Restrict production or sale of a product and vary from company to company i What constraints stops us from making or displaying all of the units we can sell ii Which products offer the highest C M per unit of the constraint iii Would emphasizing one product over another affect fixed costs iv Emphasize the product with the highest C M per unit of the constraint e Outsourcing Make or Buy Managers must decide whether to buy a product or service or produce it in house i How best to use available resources ii How do our variable costs compare to the outsourcing cost iii Are any fixed costs avoidable if we outsource iv What could we do with the freed capacity f Opportunity Cost The benefit forgone by not choosing an alternative course of action i Alternative with the lowest net cost is the best use of a company s facilities g Sell As Is or Process Further Conside rations i How much revenue will we receive if we sell the product as is ii How much revenue will we receive if we sell the product after processing it further iii How much will it cost to process the product further
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