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Chapter 11 - Decision Making with a Strategic Emphasis
11-1
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
decision.
11-2 Decisions where relevant cost analysis might be used effectively include:
1. The special-order decision
6. Profitability analysis: evaluating programs
7. Determining the optimum short-term product (or service) mix
11-3 The only relevant cost is the incremental cost incurred for the additional
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
Chapter 11 - Decision Making with a Strategic Emphasis
firm's image in the marketplace, and perhaps a negative effect on sales of the
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
and then to perhaps not find the strategically correct analysis
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
described in relevant cost analysis can have the effect of encouraging this
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
Focused on Individual Integrative;
Product or Decision Considers all Customer-related
Situation Factors
Short-term Focus Long-term Focus
Chapter 11 - Decision Making with a Strategic Emphasis
11-3
3. Researchers have shown a strong human tendency to rely upon and use
provisions of the Robinson-Patman Act.
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
technique.
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
they both use the contribution margin (price less unit variable cost) as the focal
Chapter 11 - Decision Making with a Strategic Emphasis
11-4
BRIEF EXERCISES
11-11 $35 – ($33 − $5) = $7
11-12 The contribution on the order is $3,000 – (10 × $100) = $2,000, or $200 per
sofa. Therefore, Adams should accept the order.
batch, which would be a relevant cost for the special order. Setup costs are
ignored in the above volume-based solution.
11-13 Wings will make a profit by selling at any price above variable cost of $2.50,
which in this case is the incremental cost.
11-14 Relevant Costs:
Repair:
Variable Costs:
Labor = $0.50 × 10,000= $5,000
Fixed Costs:
Total Costs $7,500
Relevant Cost Difference = $7,500 − $6,000= $1,500 more to replace than repair
Decision: Williams should repair the existing machine
11-15 Contribution Margin= $100,000
Overhead that can be eliminated= $90,000
Chapter 11 - Decision Making with a Strategic Emphasis
11-5
11-16 The AAA batteries have a higher contribution per unit and since both the AAA
and AA batteries require the same processing time, ElecPlus should accept the
11-17 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:
11-18 [($0.10 − $0.05) × 100,000] − $1,000 = $4,000
11-19 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 =
Chapter 11 - Decision Making with a Strategic Emphasis
11-6
EXERCISES
11-21 Special Order; Opportunity Costs (20-30 min)
1. The costs fall from $11 to $10 because of the fixed overhead costs
which are the same at each level of production, so that the unit fixed costs
decrease as production level increases.
2. The relevant costs are:
Materials $2 ($80,000 ÷ 40,000)
Labor 3 ($120,000 ÷ 40,000)
× ($9 − $8) = $20,000
CHECK: Is there sufficient capacity so that opportunity cost = zero?
Current Total Capacity (in units) = 80,000 units
Current Capacity Usage (in units) = 40,000 units
Available Capacity (in units) = 40,000 units
Are opportunity costs = zero? Yes--there is sufficient excess capacity to
accept the special order
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
Chapter 11 - Decision Making with a Strategic Emphasis
11-7
etc. Also, are there alternative uses of the capacity which will produce
a greater contribution?
11-21 (Continued)
4. Opportunity cost incurred if sales of 5,000 units to regular customers are
lost by accepting the special sales order:
Lost contribution margin, sales to regular customers:
Selling price per unit =
$20.00
Variable cost per unit:
Direct materials =
$2.00
Direct labor =
$3.00
Contribution margin per unit =
$15.00
× Lost sales (in units) =
5,000
Total opportunity cost =
$75,000
Chapter 11 - Decision Making with a Strategic Emphasis
11-8
11-22 Special Order (30-35 min)
1. Current Special Order
Revenue per unit $ 45 $ 35
Variable costs per unit:
Direct materials $ 9 $ 9
Direct labor $ 8 $ 8
Variable factory overhead $ 4 $ 4
Variable nonmanufacturing costs $ 8 29 $ 4 25
Contribution margin per unit $ 16 $ 10
Alternatively, the following relevant cost analysis can be used:
to produce the special order is based on the comparison of current
and special-order production. If there were additional capacity, the
proper decision would be to accept the special order since it has a
positive contribution of $50,000.
2. The minimum price would be $28.20.
At 16,000 units of current output and 20,000 units of capacity, Alton
does not have enough capacity to produce the entire order for SHC.
Revenue from the special sales order (@ $35 per unit offering price) = $175,000
Less: Relevant cost to fill the special sales order:
Out-of-pocket costs ($9 + $8 + $4 + $4 = $25 per unit) = $125,000
Opportunity costs:
# units of lost sales (to regular customers) = 5,000
cm per unit on regular sales ($45.00 - $29.00) =
$16.00 $80,000
Impact on operating income, accepting the special order = ($30,000)
Chapter 11 - Decision Making with a Strategic Emphasis
11-9
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
get an order for 4,000 units. Then the special order could be
accepted without a loss of regular sales.
11-22 (Continued-1)
If SHC insists on the full order of 5,000 units, then Alton must figure
the contribution margin on lost sales ($16.00 × 1,000 units =
$16,000). This loss of contribution margin is less than the contribution
margin on the special order ($50,000), so the special order would still
In general, the minimum selling price = relevant cost = out-of-
pocket costs + opportunity cost, as shown below:
Out-of-Pocket Costs:
Direct materials
$9.00
Direct labor
$8.00
Variable manufacturing overhead
$4.00
Variable nonmanufacturing costs
$4.00
$25.00
Opportunity Cost:
No. units of lost sales
1,000
CM per unit--regular sales
($45.00 − $9 − $8 − $4 − $8)
$16.00
Total opportunity cost
$16,000
No. units in special order
5,000
$3.20
Minimum acceptable price
$28.20
Chapter 11 - Decision Making with a Strategic Emphasis
11-10
11-22 (Continued-2)
3. Goal Seek Solution:
Step One: Set up the Equation
Cell D99 contains the appropriate equation: =D89-D94-D97
Step #2: Run Goal Seek (i.e., change the selling price per unit, cell
C89) until the value in Cell D99 equals zero)
Chapter 11 - Decision Making with a Strategic Emphasis
11-11
11-22 (Continued-3)
Step #3: Results
Chapter 11 - Decision Making with a Strategic Emphasis
11-12
11-23 Special Order; Use of Opportunity Cost Information (15 min)
1. The special order should have been accepted since the relevant cost is
$3.50 − $1.50 = $2.00 per cap, or $2.00 × 15,000 = $30,000 total cost.
mistaken reliance on full cost, instead of relevant costs.
2. Research studies have consistently found that decision makers often
ignore opportunity costs. For this reason, it is particularly important that the
development of decision-making skills place particular emphasis on
identifying and incorporating opportunity costs. Interestingly, a recent study
found that decision makers with greater expertise in developing
comparative income statements appeared to ignore fixed costs more than
costs.
Other studies have shown that the decision maker’s cognitive style, the
presence of unused capacity, or the relative amount of the opportunity cost
can affect the use of opportunity cost information by the decision makers in
experimental studies. Overall, these results show that in practice, decision
makers have a difficult time using opportunity cost information properly and
consistently.
References: Sandra C. Vera-Munoz, “The Effects of Accounting
Knowledge and Context on the Omission of Opportunity Costs in Resource
Allocation Decisions,” The Accounting Review, January 1998, pp. 47–72.
Steve Buchheit, “Reporting the Cost of Capacity,” Accounting,
Organizations and Society, August 2003, p. 549; Robert E. Hoskin,
“Opportunity Cost and Behavior,” Journal of Accounting Research, Spring
1983, p. 78; Robert Chenhall and Deigan Morris,” The Effect of Cognitive
Style and Sponsorship Bias on the Treatment of Opportunity Costs in
Resource Allocation Decisions,” Accounting, Organizations and Society 16,
Issue 1, pp. 27–46.
Chapter 11 - Decision Making with a Strategic Emphasis
11-13
11-24 Special Order (10-15 minutes)
To begin the analysis, Fred Stanley, the Earth Baby CFO, should recognize
that the $3.00 full cost for its product includes $1.00 of irrelevant fixed
overhead. Only the variable costs of $2.00 per unit are relevant. From this
However, the agreement with GDI could be a potentially serious strategic
liability for Earth Baby. Earth Baby’s reputation is built upon differentiation
and product superiority, features which make it attractive to a small, but
important segment of the baby products market. To sell its products
through a discount retailer, even under another brand name, could harm
the differentiated image of Earth Baby’s product line, and cause it to lose
market share in its usual distribution channels (the high-end grocery stores
and specialty baby retail stores). This is especially true given that GDI has
the limited right to market the product as “manufactured by Earth Baby.”
Chapter 11 - Decision Making with a Strategic Emphasis
11-14
11-25 Make or Buy; Continuation of Problem 9-25 (15 min)
1. The answer is zero. In contrast to 9-25, for which Machine X was a
relevant cost (it had not been purchased yet), the proper analysis was to
compare the cost of purchasing Machine X versus the cost of
purchasing from the outside vendor. The analysis was as follows,
showing that Calista should purchase Machine X if volume is expected
to exceed 100,000 units:
Machine X
$2.00 Q = $0.65Q + $135,000
2. Here we use an approach similar to that used in 9-25, except that the
$135,000 purchase cost of Machine X is irrelevant. The answer for 9-25
was 197,143 units, but now it is much higher, 582,857 units. The
3. Using Goal Seek to Calculate the Above Volume-Indifference Level
Step #1: Define the Cost-Differential Equation
Chapter 11 - Decision Making with a Strategic Emphasis
11-15
11-25 (Continued)
Note: cell C69 contains the formula =(C64+C65)−(C67+C68)
cell C65 =C62*C13 (where C13 contains the variable cost per
unit for Machine X)
cell C67 =E12 (where E12 contains the fixed cost per year for
Step #3: Results (the indifference volume is 582,857, the same as
calculated above in Part 2)
