CH 12 13 Chapter 12 Differential Analysis the Key to Decision Making Managerial Accounting Final Exam Relevant Cost a future cost that differs between choice alternatives Never relevant to the decision sunk cost future costs that don t differ Keep Drop Adding Dropping Segments Sales Variable Expenses Manufacturing expenses Shipping Commissions Total Variable Expenses Contribution Margin Fixed Expenses Gen Factory Overhead Salary of Line Manager Depreciation Advertising Direct Rent on Factory Space General Admin Expenses Total Fixed Expenses Net Operating Loss Make or Buy Decision Outside Purchase Price Direct Materials Direct Labor Variable Overhead Depreciation of Equip Supervisor s Salary General Factory Overhead Total Cost Make Buy Opportunity Cost the benefits that are 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 Special Orders Contribution Income Statement Revenue Variable Costs Direct Materials Direct Labor Manuf Overhead Marketing Costs Total Variable Costs Contribution Margin Fixed Costs Manuf Overhead Marketing Costs Total Fixed Costs Net Operating Income Special Orders Increase in Revenues Increase in Costs Increase in Net Incomes Utilization of a Constrained Resource Selling price per unit Variable expense per unit Contribution Margin per unit Current Demand per week units Contribution Margin ratio Processing time required on machine per unit Utilization of Cons Resource the key is the contribution margin per unit of the constrained resource 1 calculate contribution margin per unit 2 scarce resource per unit 3 calculate CM per scarce resource Managing Constraints produce only what can be sold don t produce units that your don t have demand for At the bottleneck itself Improve the process Add overtime or another shift Hire new workers or acquire more machines Subcontract production Eliminate waste Streamline production process Joint Products 2 or more products produced from a common input Split off Point the point in the manufacturing process where each joint product can be recognized as a separate product Joint Input Common Production Process Joint Costs split off point Oil Separate Processing Final Sale Gas Final Sale Chemicals Separate Processing Final Sale Problems of Allocation Joint costs are really common costs incurred to simultaneously produce a variety of end Joint costs are often allocated to end products on the basis of the relative sales value of each products product or on some other basis Sell or Process Further 1 It will always be profitable to continue processing a joint product after the split off point so long as the incremental revenue exceeds the incremental processing costs incurred after the split off point Sell or Process Further Sales value after further processing Sales value at the split off point Incremental Revenue Cost of further processing Profit loss from further processing Yes Process further if Positive Value No Sell at Split Off if Negative Chapter 13 Capital Budgeting Decisions Managers invest today to realize profit in the Future Two Broad Categories of Capital Budgeting Screening decision does this project meet some minimum threshold for acceptance Preference decision select from the screened alternatives Capital Budgeting planning for significant outlays on long term projects such as the purchase on new equipment and introduction of new products example plant expansion new plant equipment selection equipment replacement lease or buy cost reduction Interest and the Time Value of Money FV PV 1 r n PV FV 1 r n PV Annuity Annuity PV Annuity Factor PVAF The present value of any sum to be received in the future can be computed by turning the interest formula around and solving for P Time Value of Money an investment that involves a series of identical cash flows at the end of each year is called an Annuity social security car payment etc Cash Outflows repairs and maintenance initial investment incremental operating costs additional working capital need current assets current liabilities working capital Cash Inflows incremental revenues salvage values reduction in costs released working capital Time Value Techniques only consider cash flows Net Present Value Method Internal Rate of Return Payback Method Simple Rate of Return Recovery of the Original Investment Net Present Value Item Initial Investment now Annual Cash Inflow 1 Net Present Value Years of Flow 10 Factor PV of Cash Flows 1 0 0 Now 1 Net PV of 0 or Greater ACCEPT Depreciation is not deducted in computing the present value of a project because it is not a current cash outflow Discounted cash flow methods automatically provide for return of the original investment Choosing a Discount Rate the firms cost of capital is usually regarded as the most appropriate choice for the discount rate the cost of capital is the average rate of return the company must pay to its long term creditors and stockholders for the use of their funds use cost of capital to choose discount rate The Net Present Value Method 1 Calculate the present value of cash inflows 2 Calculate the present value of cash outflows 3 Subtract the present value of the outflows from the present values of the inflows If Net PV is Positive Zero Negative Then the Project is Acceptable return is than the req ROR Acceptable return is to the req ROR Not Acceptable return is than the req ROR Annual net cash inflows from operations Sales revenue Cost of parts sold Salaries shipping etc Annual net cash inflows The Net Present Value Method Years Flow Investment in equipment Working Capital needed Annual Cash Inflow Relining of Equipment Salvage Value Working Capital Net Present Value 10 Factor PV Internal Rate of Return Method The internal rate of return is the rate of return promised by an investment project over its useful life Find the discount rate that makes NPV 0 The internal rate of return is computed by finding the discount rate that will cause the net present value to be zero PV Factor for Internal Rate of Return Investment Required Net annual cash flows Least Cost Decisions In decisions where revenues are not directly involved managers should choose the alternative that has the least total cost from the present value perspective Flows 10 Factor PV Calculate PV Factor Choose table to use single or annuity Find factor at year of project Value Internal Rate of Return Year Buy Purchase Price Annual Operating