chapter fourteen

management decision making progess

for managers to make good decisions. they look at two kinds of information:

• financial information

• non-financial information

financial information

• all about money

• how much with this cost

• how much money will it bring in

• how will it affect the company’s total profitability

nonfinancial information

• how will this affect the environment

• will it change how often employees quit

• will it make the company look better or worse

incremental analysis approach

the process of finding the financial number that will change if you choose one option over another

• you only care about the differences between the choices

• happens when a manager has two or more choices

example o incremental analysis

you are choosing between walking to the park or taking the bus

• your total revenue (your allowance) stays the same

• the incremental cost is the bus fare, it’s the only cost that changes, so that’s what you compare

relevant costs and revenues

• numbers that matter

• costs and revenues that will happen in the future and change because of your decision

opportunity cost

the benefit you miss out on when you choose one option over the next best one

sunk cost

the cost that has already been paid and cannot be changed by any future decision

are sunk costs relevant in decision making

no, they’re never relevant

incremental costs

the extra costs you take on for a specific option

avoidable costs

costs you can get rid of if you stop a certain activity or choose an alternative

common managerial decisons

1. accept an order at a special price (special orders)

2. make or buy component parts (make or buy)

3. sell products or process them further

4. repair, retain, or replace equipment

5. eliminate an unprofitable business segment

accept an order at a special price

a customer offers to buy a huge number of your product at a very low price

accept an order at a special price decision rule

you should accept the order if the special price is higher than the variable cost per unit

special order rule explanation

• if you have extra capacity, your total fixed costs (like rent), won’t change, so they are irrelevant

• any money you get above the variable cost is good as it helps cover your fixed costs and increases profit

make or buy component parts

should you manufacture a part in your won factory or buy it from an outside supplier

relevant costs in make or buy

• the cost of buying the part from the supplier

• the manufacturing costs that you’ll save by not making the part yourself

• any opportunity cost (if you could use the freed-up factory space to make something else)

sell products or process them further

you have a product that is finished and ready to sell, should you sell it now or spend extra money on more processing to sell it for a higher price?

sell products or process them further rule

process further as long as the incremental revenue (the extra money you get from the higher price) is greater than the incremental processing costs (the extra money you spend on processing further)

relevant costs of repair, retain, or replace equipment

• cost of the new machine

• change in variable manufacturing costs (the new machine is probably more efficent, so this is a savings)

• trade in or cash value you set for the old machine

irrelevant costs of repair, retain, or replace equipment

• the original costs of the old machine and its accumulated depreciation are sunk costs, so they don’t matter

considerations on eliminating an unprofitable business

• if you shut down the product line, you’ll lose the contribution margin (sales - variable costs)

• you’ll only save money if the fixed costs you eliminate (like a manager’s salary) are greater than the contribution margin you lose

• you can’t eliminate fixed costs (like rent), they get spread out to remaining product lines, which could make your profit worse