Week 7Ch8Identifying Relevant Information:Must be both; 1- must occur in the future 2- must differ between the alternativesAvoidable costs- RELEVANT, costs that are incurred under one alternative but not under the other alternativeUnavoidable costs- costs incurred under all alternativesSunk costs- costs that have already been incurred in the pastSpecial Order Pricing:Purchases of large quantity but wanting to pay less than the regular sales price. (The company must decide whether to accept or reject the proposal)EX. Normal price of meal is $20, the Seminole club wants to buy 100 meals at $14 per meal. Sales $20 per meal-Cost of Goods SoldDirect Materials $3Direct Labor $3Variable Over $4 Fixed Over $1Gross Margin $9-Selling & AdminFixed $2Variable $2 Operating Income $5 Costs Total: $15Direct Materials, Direct Labor, Variable Overhead, & Variable S&A are all RELEVANT Fixed Overhead, & Fixed S&A are both IRRELEVANT----Add Relevant costs to find whether they add up to MORE or LESS than the proposed sales price. If more, reject. If less, accept.In this case, the relevant costs are $3 + 3 + 4 + 2 = $12So we ACCEPT the offer, as we will get $2 profit per meal sold at the proposed $14 a meal. Increasing our GP by $200. If operating at Full Capacity:If at full capacity we would NOT accept the offer, b/c we would be giving up 100 meals at $20 per meal, giving up $6 per meal, losing $600 (the opportunity cost)Outsourcing:aka “make” or “buy”Outsourcing transfers the production of goods to a provider outside the company.EX. A company can supply for $0.35 a gallonOur Costs-Direct Materials $0.15 RELEVANTDirect Labor $0.05 RELEVANTVariable Overhead $0.10 RELEVANTFixed Overhead $0.20 IrrelevantTotal Manufacturing $0.50Pumped 300,000 gallonsMAKE – (300,000 * .15) + (300,000 * .05) + (300,000 * .10) = $90,000- ( 45,000 + 15,000 + 30,000 ) = $90,000BUY – (300,000 * .35) = $105,000In this case it would be $15,000 better to MAKE EX Continued…Suppose the space that would open up as a result of stopping the production, and starting buying the product would result in space to generate an additional $20,000 profit in total? Should the company continue to produce the product still?MAKE - $45,000 + $15,000 + $30,000 + $20,000 = $110,000BUY – (300,000 * .35) = $105,000In this case we would want to BUY the product, as it would save us $5,000.For any OUTSOURCING example one must consider QUALITATIVE factors as well, such as:1- Quality of the product provided2- Reliability of the supplier3- Stability of the price offered 4- Theft of intellectual propertyAllocating Constrained Resources:How can we work around constraints while still earning max income? A constrained resource is anything that limits a company’s ability to produce products. (Ex. Cash, Machine Hours, Facilities, Labor Hours.)Bottleneck- the most constrained resource that a company has to deal with.Deciding which service to undergo at full capacity is dictated by the service that generates the largest CONTRIBUTION MARGIN. EX. If only 1,200 hours are available, how many of each service should be provided?Contribution Margin = Sales Price – Variable Expense/CostRequired Hours = constraintFishing: CM $70, Hours 8, Demand 95=$8.75 CM/perhour (2)Priority RankScuba : CM $30, Hours 6, Demand 55=$5.00 CM/perhour (3)Island : CM $40, Hours 4, Demand 65=$10.00 CM/perhour(1)Prioritize by greatest CM per hour (the main constraint)Island : 65 (demand) * 4 hours = 260 total hours Fishing: 95 (demand) * 8 hours = 760 total hoursScuba: (1,200 – 1,020=180) = 180 / 6(hours) = 30 (new demand)Notice the Scuba service only gets to serve 30 people, with the leftover 180 hours (divided by 6 hour per service)Week 8 NotesCh 8Managerial DecisionsKeeping or Eliminating Operations:Segment Margin- Contribution Margin of a particular segment less (minus) and direct fixed costs.Direct Fixed Costs- Fixed Cost that can be directly attributed to one specific segment. If that segment is eliminated, these fixed costs will too be eliminated. (AVOIDABLE)Common Fixed Costs- Fixed Cost that are shared by all segments. If that segments is eliminated. (UNAVOIDABLE)A company begins to consider whether or not to continue running a segment based on whether the segment is still profitable, or as profitable as wanted. If the segment is not profitable then it will be considered for elimination.If a segment has a +positive segment margin then keep it.EX. Segment ARevenue $255,000Variable Exp 195,000Contr Margin 60,000Fixed Exp 40,000Segment Margin $20,000If the company stops running Segment A, they will be worse off by $20,000.If there is “Common Fixed Exp”, it is allocated to all segments based on percent of total sales. For instance;EX. $200,000 Common Fixed Exp, four operating segments.For an operating segment that had $340,000 Sales, out of total $1,700,000 Sales (20% of sales) $40,000 Common Fixed Exp would be allocated to this segment. (20% of total Sales, so 20% of common fixed exp.Suppose that if Segment A is eliminated, we would expect a 15% increase in sales for Segment B. Segment B has Sales of $340,000, and Variable Costs of $95,000. EX. (340,000 * .15) = $51,000 gain (95,000 * .15) = $14,250 lossWe would be $20,000 worse off based solely on eliminating Segment A. There would be a $36,750 increase in sales revenue with the 15% increase in sales. This would NOW make eliminating Segment A a better course of action. So, eliminating Segment A, and causing a 15% increase in sales for Segment B, would make the company better off by $16,750 overall.Sell or Process Further:Some products may be sold “as is” or “processed further” into a product that can be sold for a higher amount. Additional costs will be incurred to “process further”, so the company must decide if the costs are worth the gain. EX. A cruise intends to start selling a dinner cruise instead of the traditional sunset cruise.Sunset Cruise Dinner Cruise Sales Price $50 $75 Direct Materials 15 28Direct Labor 8 15Variable Overhead 6 8Fixed Overhead 4 4 Unit Cost $33 $55 To calculate whether to sell “as is” or “process further”
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