Decision making

Decision making process

First: Determine Organization’s First: Determine Organization’s Competitive Environment and Strategy; Second: Specify the Criteria and Identify the Alternative Actions; Third: Relevant Cost Analysis and Strategic Analysis; Fourth: Select and Implement a Course of Action; Fifth: Evaluate Performance

Relevant cost

a future cost that differs between the decision alternatives

Features of relevant cost

Both characteristics must be present for a cost to be relevant; Relevant costs can be variable or fixed, but variable costs are generally relevant while fixed costs are not; Relevant cost analysis and total cost analysis produce the same results

Sunk cost

is a cost that has been incurred in the past or committed for the future

Opportunity cost

the benefit lost when one chosen option precludes the benefits from an alternative option, should also be considered in the analysis of alternative options

When depreciation is included in the relevant cost?

when considering tax implications

When time value of money is relevant?

When deciding among alternatives with cash flows over two or more years

Importance of qualitative factors

Differences in quality; Functionality; Timeliness of delivery; Reliability in shipping; After-sale service level

What are the features of Relevant Cost Analysis?

short-term focus, not linked to a strategy, product cost focus, focused on individual decision

What are the features of strategic analysis?

long-term focus, linked to the firm's strategy, customer focus, considers all customer factors

This decision framework can be used to address common management decisions such as:

The special-order decision; The make-lease-or-buy decision; The decision to sell before or after additional processing; The short-term product-mix decision; Profitability analysis

What is special-order decision?

when a firm has a one-time opportunity to sell a specified quantity of its product or service; these orders are generally non-recurring

What would happen if X were producing near full capacity?

it would have to consider opportunity costs

What would happen if Special order decisions were on the regular basis?

can erode profitability

Lease cost is the same as...?

Purchase cost

Profitability analysis addresses issues such as:

Which product lines are most profitable?; Are the products priced properly?; Which products should be promoted and advertised more aggressively?; Which product-line managers should be rewarded?; Which product-line managers should be rewarded?;

What should be the management's goal?

To maximize contribution margin while minimizing fixed costs

What should be managers careful about?

Managers must be careful not to include irrelevant, including sunk, costs in their decision making; When fixed costs are shown as cost per unit, many managers tend to improperly classify them as relevant