Chapter 11: Decision Making Flashcards
Make or buy
Outsourcing
Adv and disadv
In financial terms - business looks at cost of making the unit against cost of buying it, should consider non-financial issues as well in final decision
Adv
-Cost savings if the other business can make it more efficiently
-Releases capital from machinery spent
-may lack expert skills which the other business has
-frees up time for managers to focus on other areas
Disadv
-Demotivate staff who do not have any work to do or face redundancy
-Lack control over production process which can impact quality
-A loss of in-house skills and expertise and increasing reliance on other business
-Supplier might not be reliable with delivery dates
-Product may not be tailored for our needs
Relevant and non-relevant costs
three criteria
Relevant costing is concerned with determining the objective cost for a business decision.
-FUTURE cost and
-INCREMENTAL costs and
-CASH COST
Future cost - take place in the future as a result of a decision. Sunk or historic costs are not relevant
Incremental costs - avoidable if the decision is not implemented.
Cash Cost - A cost that incurs an outflow of cash, non-cash costs are depreciation, allocation or apportionment of head office costs for example
Closure Decisions
Should you close down a location. department or product line?
Focus on purely financial aspects and only on relevant costs.
Net Present Value NPV
Identify all cash-flows that are relevant to the investment being considered and group them by year.
Add up total cash flows for each year and multiply by relevant discount factor
Add up present values to give ‘NPV’
Accept if positive
Net Present Cost
Looking at the costs of a project only.
The cash outflows will be positive
Multiply costs by appropriate discount factors
Chose the lower Net present Cost
Lease or buy
How to acquire the asset?
-Buy outright - incur an up-front capital cost
-Lease the asset by paying a leasing company an annual amount (or installment)
Analyse the NPV of each option
Net Terminal Cost
Instead of looking at a project in present terms, the terminal cost looks at the values at the end point of the project i.e when it terminates.
Cash flows are compounded (rather than discounted) using cost of capital to establish their value at the end of the project.
IRR
Internal Rate of Return - what is it, what is the approx formula
IRR is the discount factor which gives a zero NPV.
Actual % return that the projects returns.
IRR = L+ (NPVL/NPVL-NPVH)*(H-L)
L= lower discount factor
H=higher discount factor
Adv and disadv of IRR
Adv
-allows time value or money
-Does not require an exact cost of capital to be known
-As a % measure it is familiar to non accountants
-It looks at the entire project (includes all available financial data)
Disadv
-Does not tell you to accept or reject the project
-There could be more than one IRR
Accounting rate of return (ARR)
also known as return on capital employed
adv and disadv
Average Annual profit / Total investment * 100
Average annual profit = (total cash inflow - total depreciation) / length of project
Adv
-Simple to calculate
-As a % measure familiar to non accountants
-Looks at the entire project
Disadv
-Ignores time value
-Based on profits rather than cash flows, meaning different accounting policies can affect the figures
Does not consider the length of the project
Payback period and discounted payback period
Adv and DISADV
How long it takes for the net cash flow from an invesment to repay the initial investment.
Adv
-Simple to calculate
-Easy to understand, esp for non accountants
-Uses cash flows
-initial screening tool on projects before undertaking a more detailed review
-Crudely allows for risk in the timing of cash flows
Disadv
-Ignores time value of money if not discounted payback
-considers cash flows up to payback date only
-May lead to short term decision making
-no clear decision rule
Target Costing
Calculate the maximum cost we can afford to incur to produce a unit of producing a unit in order to give a certain profit.
Start with selling price that has been determined
Calculate profit per unit we want
Deduct the profit from the sales price to give a total target cost
Cost Gap
what is it and how to close the cost cap
Difference between target cost and budgeted cost
Closing the cost cap
-Redesign the product
-Redesign the production process
-Renegotiate with suppliers
-Improve staff efficiency through training
-use cheaper staff, be careful that quality does not suffer
Ethical considerations
Costs can be saved by:
Ethical considerations should be included in order to promote good citizenship.
Consumers may be willing to pay extra for products and services from businesses that are committed to positive social and environmental impacts
Costs can be saved by:
-limiting the use of resources and improving efficiencies
-Reducing packaging materials
-Installing energy efficient lighting
-minimising transportation costs
Valuing engineering - cost prevention
what is it?
Redesigning of a product before production occurs to design out costs.
The value added by the design is and component parts is considered to prevent costs.
