lecture 17

Question 1

what is decision making concerned with

Answer 1

it concerned with the future and involves a choice between alternatives

many factors, both quantitative and qualitative needs to be considered and for many decisions, financial information is a critical factor

Question 2

what are relevant costs

Answer 2

1. theyre future cash flows arising as a direct consequence of a decision
2. theyre cash flows - depreciation expense is non-cash expense and hence is not relevant
3. only cash flows which differs between 2 alternatives should be considered

Question 3

what costs are relevant in making a decision

Answer 3

1. avoidable cost
   - associated with shutdown or disinvestment decisions = costs that a company can eliminate if it stops a certain activity, shuts down a division or disinvests from a particular sector
   - can be identified with an activity or sector of a decision, and which can be avoided if that activity or sector did not exist
2. opportunity cost : the decision forgone from the next best alternative use of the resources as a result of using the resources in the current facility
   - the level of profit/ benefit forgone by the pursuit of a particular course of action
   - they are the real economic costs of taking one course of action as opposed to another

Question 4

what are some irrelevant costs

Answer 4

1. sunk cost :
   - costs that have already been incurred
   - they dont affect any future costs and cannot be changed by any current or future action
   - e.g. book values of assets
2. committed costs
   - future cash outflow that will be incurred anyway
   - may exist because of contracts already entered into by the organisation
   - most fixed costs are committed unless increased cuz of the new project

Question 5

how to evaluate if something is relevant or not

Answer 5

1. evaluate the options on a monetary basis using cost vs benefit analysis
2. take account of the qualitative factors associated with each option in the decision

Question 6

what are the shut down decision criteria

Answer 6

if a company has a range of products of products, one of which is deemed to be unprofitable, it may consider dropping the item from its range

decision criteria
1. determine the contribution from the product
a. if the contribution margin is -ve = discontinue the product
b. if the contribution margin is +ve = continue

Question 7

how do we choose a product with 1 limited resources

Answer 7

situation arises when theres not enough of a resource to produce sufficient output to meet all potential sales demand
- decision must be made about what resources there are

• when got scarce resources, contribution is maximised by earning the biggest possible contribution per unit of scarce resources
• we assume fixed cost is unchanged and the only relevant cost is the variable cost

Question 8

what is the decision criteria to decide which products to produce once determining u have limited resources

Answer 8

1. confirm one resource is in short supply
2. determine the contribution margin per unit
3. determine the scarce resources per unit
4. determine the CM per unit of the scarce resources
5. rank the products in accordance to the ‘contribution margin per unit” of the limiting factor , highest to lowest
6. prepare the optimal production schedule