CHAPTER 11: DECISION MAKING WITH A STRATEGIC EMPHASIS
QUESTIONS
11-1 Relevant costs are costs to be incurred at some future time and differ for each
option available to the decision maker.
Relevant costs in replacing equipment would include the cost of purchasing and
11-2 Decisions where relevant cost analysis might be used effectively include:
1. The special-order decision
2. Make, lease, or buy
11-3 The only relevant cost is the incremental cost incurred for the additional
processing. In a joint production process these costs are referred to as
11-4 Strategic factors include:
1. The level of capacity usage of the plant
7. Service after the sale
11-5 A well-known problem in business today is the tendency of managers to focus on
short-term goals and neglect the longer-term strategic goals, because their
compensation is based upon short-term accounting measures such as net
income. This issue has been raised by many critics of relevant cost analysis. As
noted throughout the chapter, it is critical that the relevant cost analysis be
other products. The important message for managers is to keep the strategic
concerns in mind, and to start with the strategic objectives in any decision
situation.
11-6 The limitations of relevant cost analysis include:
1. Excessive focus on short-term decisions
2. Tendency to focus on quantitative factors only, and to not include the
11-7 Strategic analysis requires a more integrative focus, as noted in the chapter:
11-8 Some of the behavioral, implementation, and legal issues in using relevant cost
analysis include:
1. The tendency of managers to focus on short term goals, and to not attend
satisfactorily to longer-term strategic goals of the firm. The techniques
in management evaluation (see Chapter 18).
2. If variable costs are given too much focus, as suggested in relevant cost
analysis, managers can tend to ignore fixed costs. Moreover, some managers
evaluation of their unit. The result might be higher overall costs for the firm.
3. Researchers have shown a strong human tendency to rely upon and use
irrelevant factors such as sunk costs in decision making. Thus, the proper use
RELEVANT COST ANALYSIS STRATEGIC COST ANALYSIS
Financial Focus Customer Focus
Not Linked to Strategy Linked to the Firm’s Strategy
Precise and Quantitative Broad and Subjective
explain the techniques and to carefully present the relevant cost reports to
management.
4. Predatory pricing, the lowering of prices to where the effect may be to
11-9 When there is only one production constraint and excess demand it is generally
best to produce only one of products to maximize income, and that is the product
with the highest contribution per unit of scarce resource. When the production
11-10 Relevant cost analysis and cost-volume-profit (CVP) analysis (Chapter 9) are
similar in that they both rely on the distinction of variable versus fixed costs and
BRIEF EXERCISES
11-11 Relevant Costs:
Repair:
Variable Costs:
Labor = $0.50 × 10,000= $5,000
Fixed Costs:
Repair Cost $1,000
Total Cost $6,000
Replace:
Variable Costs:
Labor = $0.25 × 10,000 = $2,500
Fixed Costs:
New Machine = $5,000
11-12 Cost with machine: $200,000 + ($5 × 10,000) = $250,000
Cost without machine: $20 × 10,000 = $200,000
Jackson would recover the cost in 1 and 1/3 years, as follows:
$200,000 + $5Q = $20 Q
11-14 In the longer term, all of these costs are relevant, but in the short term, the only
11-15 The special-order price should cover variable costs (which in this case are the
incremental costs), so it should be greater than $3.50 per meal or $3.50 × 200 =
11-16 The AAA batteries have a higher contribution per unit and since both the AAA and
special order, and reduce the production/sales of AA batteries, if needed.
11-17 The contribution on the order is $3,000 – (10 × $100) = $2,000, or $200 per
sofa. Therefore, Adams should accept the order.
If Adams is at full capacity, then the opportunity cost for lost sales is $500 –
11-18 Wings will make a profit by selling at any price above variable cost of $2.50,
11-19 $35 – ($33 − $5) = $7 per unit
11-20 Total Contribution Margin= $100,000
Jamison should keep the division.
EXERCISES
11-21 Solar Panels: Lease vs. Buy? (60 minutes)
1. Relevant Costs–Leasing vs. Purchasing: Solar Panels
a. Purchase:
(1) Original cost, including installation
(2) Annual maintenance contract?
(3) Annual maintenance expense?
(4) Future repair expense?
(5) Financial incentives:
i. Federal income tax credits (see:
http://www.energysavers.gov/financial/70010.html)
ii. State and local financial incentives (see:
http://www.dsireusa.org)
iii. Financing incentives/subsidies
iv. Utility rebates
v. loan guarantee programs
incentive programs available at both the government [federal
and state] level and at the level of the local utility provider)
b. Lease:
(1) Lease terms:
i. fixed payment plan per month
ii. Variable-cost payment plan (also known as “Power
Purchase Agreements” or PPAs)–generally, these are
slightly below current charges per kilowatt hour by the local
time electric consumption
(2) Cancellation fee/penalty (if lease is terminated before its
expiration date)
11-21 (Continued-1)
(3) Price escalation:
i. what is the annual increase in the contractual rate paid?
2. Other considerations:
a. Individual
i. Risk–by leasing, the basic risk is that the cost of (purchasing)
solar panels would fall in the future and/or the level of
government subsidy for such would increase significantly
would be a worthwhile first step prior to installing solar energy
panels
v. Solar energy could conceivably be used in the future to charge
electric cars
b. Businesses
1. Use of solar-generated power may make businesses more
competitive (due to decreased operating costs
2. A leasing contract would allow the business/organization to more
specified in the lease itself)
11-21 (Continued-2)
3. under a leasing arrangement, capital (that could be used
elsewhere in the organization) is not tied up
4. use of solar (i.e., renewable) energy could help the business
c. Society:
i. Cleaner air/lower levels of pollutants/reduction in level of
Greenhouse Gas Emissions (GGE)
11-22 Special Order; Opportunity Costs (30 minutes)
1. The costs fall from $11 to $10 because of the fixed overhead costs
2. The relevant costs are:
Materials $2 ($80,000 ÷ 40,000)
Labor 3 ($120,000 ÷ 40,000)
Variable Overhead 3 ($300,000 − $240,000) ÷ 20,000
Total $ 8 per unit
CHECK: Is there sufficient capacity so that opportunity cost = zero?
Current Total Capacity (in units) = 80,000 units
3. Other factors to consider:
Is the order likely to lead to further regular business with this
customer?
Is the order in the strategic best interest of the firm, for example, will it
support or undermine Grant Industries’ desired image in the market?
While Grant has enough capacity to complete the special order, will
there be other costs in addition to the variable manufacturing costs in
order to complete the order, that is, special tooling or set-up costs,
etc. Also, are there alternative uses of the capacity which will produce
a greater contribution?