Decision making techniques Flashcards
What are relevant costs?
Costs which will always be those which can be affected by a certain decision
Future incremental cash flows
What are sunk costs?
Costs which have already been incurred and cannot change no matter what decision is to be made
What is an opportunity cost?
Income which is avoided by the course of action taken.
What are some factors to consider when outsourcing a product?
Price - Agreed price must be guaranteed for an acceptable period of time.
Quality - Is the quality up to standard for the business?
Supply - Can the outsourcing company guarantee continuity of supply and timely deliveries?
Commercial Sensitivity - Will consumers mind if the product isn’t made by the company itself?
How to answer a multiple limiting factor question?
Calculate contribution per unit (selling - variable)
Contribution divide by limiting factor per unit
When is linear programming used?
When there are two products and two or more limiting resources, work out how to maximise contribution
What is discounted cash flow?
Used to help long-term decision making by taking account of time-value of money when comparing cash flows.
What is net-present value?
The net result of comparing the present values of all relevant future cash flows - deducting negative flows from positive ones.
This will usually determine whether the project is worthwhile based on the figures.
What is payback period?
Name some disadvantages of using this method?
Appraisal method which simply asks how long will it take to get the initial investment back.
Dis - Ignores time-value money, ignores any cashflows outside of the payback period, doesn’t distinguish between projects needing large and small investment
What is IRR?
Internal rate of return - the discount rate that makes the net present value of all future cash flows from the investment equal to 0. If the % is above the cost of capital the investment is worth it.
Assumes linearity
IRR formula?
Low % rate + (NPV using low % rate/NPV difference) x % rate difference.
What is ARR?
Accounting rate of retrun - Based on profits, also known as the return on investment.
ARR formula?
(Average annual accounting profits / Investment) x 100
PROFIT IS BASED ON PROFITS AFTER DEPRECIATION
In a net present value question, if the question states payable at the end of every year, what is the significance?
No expenditure in year 0
If an initial investment has no scrap value, what will the value be when using the ARR formula?
Half the initial investment
Some facts about Linear programming
Assumes contirbution per unit remains constant
Usually caried out using simultaneous equations or a graph
Can be used two or more products/constraints
Assumes resources per unit remains the same
Ignores fixed costs
Only one oobjective
Name topics to talk about when analysing performance of different margins etc.
More units means fixed costs are spread over more units
More units could mean overtime working
If a cost is variable it will not affect profit margins
Talk about fixed costs between the two
How to calculate the discount in a target cost question?
Budgeted cost per kg using target costing / price per kg from supplier
Take away from 100
Which methods are simple to calculate and to understand?
Payback period and ARR
Which methods use cash flows and favours quick returns?
IRR
NPV
Discounted payback period
Payback period
Which methods includes all years results?
NPV
IRR
ARR
Which methods use time -value money?
NPV
IRR
Discounted payback period
Which method uses accounting profits and the result is comparable with ROCE?
ARR
Which method is the result comparable with cost of capital?
IRR
Advantages and disadvantages of payback period?
Advantages:
Easy to understand
Favour quick returns
Disadvantages:
Ignores time-value money
Ignores any cashflows outsdie of the payback period
No disitnction between large and small projects
Advantages and disadvantages of discounted payback period?
Advantages:
Easy to understand
Favour quick returns
Includes time-value money
Disadvantages:
Ignores any cashflows outsdie of the payback period
No disitnction between large and small projects
