10-1 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Tactical Decision Making 12...

10-1Copyright © 2004 by Nelson, a division of Thomson Canada Limited.

Tactical Tactical Decision Decision MakingMaking

1212

PowerPresentation® prepared by PowerPresentation® prepared by

David J. McConomy, Queen’s UniversityDavid J. McConomy, Queen’s University


Describe the tactical decision- making model.

Explain how the activity resource usage model is used in assessing relevancy.

Learning ObjectivesLearning Objectives


Apply the tactical decision-making concepts in a variety of management situations.

Choose the optimal product mix when faced with one constrained resource.

Learning ObjectivesLearning Objectives (continued) (continued)


Learning Objectives (continued)Learning Objectives (continued)

Explain the impact of cost on pricing decisions.

Use linear programming to find the optimal solution to a problem of multiple constrained resources. (Appendix)


Decision-Making ProcessDecision-Making Process

Recognize and define the problem. Identify alternatives as possible solutions

to the problem; eliminate alternatives that are clearly not feasible.

Identify the costs and benefits associated with each feasible alternative. Classify costs and benefits as relevant or irrelevant and eliminate irrelevant ones from consideration.


Decision-Making Process Decision-Making Process (continued)(continued)

Total the relevant costs and benefits for each alternative.

Assess the qualitative factors. Select the alternative with the greatest overall

benefit.


Relevant Costs DefinedRelevant Costs Defined

Costs that differ across alternatives Costs that deal with future courses of action


Important: Short-term Perspective

Some Types of Decisions Some Types of Decisions IllustratedIllustrated

Make or Buy Keep or Drop Special Order Sell or Process Further Product Mix


Activity Resource Usage Model Activity Resource Usage Model and Assessing Relevancy and Assessing Relevancy

a. Demand Changes

b. Demand Constant

Relevant

Not Relevant

Flexible Resources

Resources Acquired as Needed



(continued)(continued)

Committed Resources

Acquired in Advance (Short Term)

a. Demand Increase < Unused Capacity

b. Demand Increase > Unused Capacity

c. Demand Decrease (Permanent)

1. Activity Capacity Reduced

2. Activity Capacity Unchanged

Not Relevant

Relevant

Relevant

Not Relevant




Committed Resources

Resources Acquired in Advance (Multiperiod Capacity)

a. Demand Increase < Unused Capacity

b. Demand Decrease (Permanent)

c. Demand Increase > Unused Capacity

Not Relevant

Not Relevant

Capital Decision


Solution to Exercise 10-10Solution to Exercise 10-10Keep-or-Drop: A Segment DecisionKeep-or-Drop: A Segment Decision

1. Segmented income statement

Product A Product B Total Sales $`100,000 $250,000 $350,000Less: Variable exp. 50,000 145,000 195,000Contribution margin $ 50,000 $105,000 $155,000Less: Direct fixed exp.* 60,000 60,000 120,000Segment margin $ (10,000) $ 45,000 $ 35,000Less: Common fixed exp. 70,000Operating income (loss) $ (35,000)

=======

*Product A: 100,000/350,000 x $70,000 = $20,000;$80,000 - $20,000 = $60,000

Product B: 250,000/350,000 x $70,000 = $50,000$110,000 - $50,000 = $60,000


Solution to Exercise 10-10Solution to Exercise 10-10Keep-or-Drop: A Segment Decision Keep-or-Drop: A Segment Decision


2. Alternatives Keep Drop Drop A Drop B

Both Both Keep B Keep A

Sales $350,000 $ 0 $275,000 $150,000

Less: Variable exp. 195,000 0 159,500 75,000

Contribution margin $155,000 $ 0 $115,500 $ 75,000

Less: Direct fixed exp. 120,000 0 60,000 60,000

Segment margin $ 35,000 $ 0 $ 55,500 $ 15,000

Less: Common fixed exp. 70,000 70,000 70,000 70,000

Operating income (loss) $ (35,000 ) $(70,000 ) $ (14,500 ) $ (55,000 )======= ====== ======= =======

Willem should drop product A unless the common fixed costs can be avoided if both products

are dropped


Solution to Exercise 10-11Solution to Exercise 10-11Special Order DecisionSpecial Order Decision

1. The company should not accept the offer because the additional revenue is less than the additional costs (assuming fixed overhead is allocated and will not increase with the special order):

Incremental revenue per box$4.20

Incremental cost per box 4.25

Loss per box$0.05

Total loss: $0.05 x 5,000 = $250


Solution to Exercise 10-11Solution to Exercise 10-11Special Order Decision (continued)Special Order Decision (continued)

2. Costs associated with the layoff:Increase state UI premiums (0.01 x $1,460,000)

$14,600Notification costs ($25 x 20)

500Rehiring and retraining costs ($150 x 20)

3,000Total

$18,100======

The order should be accepted. The loss of $250 on the order is more than offset by the $18,100 savings by not laying off employees.


Solution to Exercise 10-12Solution to Exercise 10-12Sell or Process FurtherSell or Process Further

1. Sales $263,000

Costs 223,000

Operating income $ 40,000=======

ProcessSell Further Difference

2. Revenues $40,000 $75,000 $35,000

Process cost 0 23,900 23,900

Operating income $40,000 $ 51,100 $ 11,100======= ======= ======

The company should process Delta further as gross profit would increase by $11,100. (Note: Joint costs are irrelevant to this decision, as the company will incur them whether or not Delta is processed further.)


One Constrained ResourceOne Constrained Resource

Jorgenson Company produces two types of gears: X and Y.

Gear X has a contribution margin of $25 per unit and Gear Y has a unit contribution margin of $10.

Each Gear must be notched by a special machine. The Company owns eight of these machines which can produce a total of 40,000 hours of machine time per year.

The company can sell all that it produces of either model.

The machine time required for Gear X is two hours per unit and for Gear Y is one half an hour per unit.

How many of each model should be produced?


One Constrained Resource One Constrained Resource (continued)(continued)

Answer:

To maximize total contribution margin, select the product that yields the highest contribution margin per unit of scarce resource:

Gear X: $25/2 = $12.50 per hour

Economy: $10/.5 = $20.00 per hour

Contribution for Gear X: 40,000 hours @ $12.50 = $500,000

Contribution for Gear Y: 40,000 hours @ $20.00 = $800,000

The Gear Y yields the highest CM per unit of scarce resource.

Thus, 40,000/.5 = 80,000 units of Gear Y should be produced and none of Gear X.


Two Approaches to PricingTwo Approaches to Pricing

1. Cost-Based Pricing

2. Target Costing and Pricing


A Product Pricing ExampleA Product Pricing Example

Revenues$856,500

Cost of goods sold:Direct materials $489,750Direct labour 140,000Overhead 84,000

713,750Gross profit

$142,750Selling and administrative expenses

25,000Operating income

$117,750=======


Markup on COGS= (S & A expenses + Operating income) / COGS= ($25,000 + $117,750) / $713,750

= 0.20

Markup on direct materials =

(DL + OH + S & A expenses + Oper. income) / Direct mater. =

($140,000 + $84,000 + $25,000 + $117,750) / $489,750

= 0.749

Determining Markup Determining Markup PercentagesPercentages


Target Costing and PricingTarget Costing and Pricing

Target costing is a method of determining the cost of a product or service based on the price (target price) that customers are willing to pay.

This is also referred to as price-driven costing.


Legal Aspects of PricingLegal Aspects of Pricing

There are certain issues that we must be aware of whenever we make pricing decisions:

• Predatory pricing

• Price Discrimination

• Price Gouging


Multiple Constrained ResourceMultiple Constrained Resource

To the Jorgenson Company example for a one constrained resource, add the following additional constraint: the market limits sales of GEAR Y to 60,000 units. Formulate the linear programming problem and solve using the graphical method

Let X1 = GEAR X, and

X2 = GEAR Y

Formulation: Max CM = 25X1 + 10X2

Subject to: 2X1 + .5X2 < 40,000

X2 < 60,000


Multiple Constrained Resource Multiple Constrained Resource (continued)(continued)

80,000

60,000

A 20,000

D

C

B

X

X

2X +.5X < 20,000

X < 60,000

1

1

2

2

2


Multiple Constrained Resource Multiple Constrained Resource (continued)(continued)

Corner Point X1 X2 CM = 25X1 + 10X2

A 0 0 0

B 20,000 0 $500,000

C* 5,000 60,000 $725,000

D 0 60,000 $600,000

* Point C is optimal

The X1 value of point C is found by substituting the second equation into the first one like

so:

2X1 + .5 (60,000) = 40,000

2X1 +30,000 = 40,000

2X1 = 10,000

X1 = 5,000

10-1 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Tactical Decision Making 12...

Documents

Transcript of 10-1 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Tactical Decision Making 12...