Relevant Analysis - 1

RELEVANT ANALYSISFOR

TACTICAL DECISIONS

X

Y

Z

Which one do we choose???

Relevant Analysis - 2

RELEVANT ANALYSIS

Relevant items– Items (either revenues or costs) that

DIFFER across alternatives– Items relating to FUTURE courses of

action

Irrelevant– Past items (“sunk costs”)– Future items that DO NOT differ across

alternatives

Relevant Analysis - 3

SUNK COSTS

Costs of resources that have already been committed, and regardless of what decision is made by managers, cannot be changed. These costs are irrelevant in decision making.

Significance of historical costs– Basis for determining cost behavior– Tax implications

Relevant Analysis - 4

EXAMPLES OF RELEVANT COSTS AND REVENUES

Cost increases & cash outflows

Down payment on a new machine

Monthly lease payments on a new machine

Cash savings and cash inflows

Disposal of old machine

Monthly cost savings– Materials– Labor– Overhead

Relevant Analysis - 5

OPPORTUNITY COST

The potential benefit sacrificed when, in selecting one alternative, another

alternative is given up

Relevant Analysis - 6

RELEVANT ANALYSIS MODEL

Recognize and define problem Identify feasible alternatives Identify relevant items Total relevant costs and

benefits for each alternative Assess qualitative factors Select alternative with

greatest overall benefit

Relevant Analysis - 7

RELEVANT ANALYSIS &CONTRIBUTION ANALYSIS

Contribution analysis is normal first step in relevant analysis

Cost behavior and relevance are NOT identical

Relevant Analysis - 8

ADDITIONAL CONSIDERATIONS

When determining “costs,” what costs are relevant? – All? – Only short-term variable?

How flexible are the capacities of the firm’s resources?

Relevant Analysis - 9

TACTICAL DECISIONS

Make or Buy (Outsourcing)

Retain or Drop Product Lines

Special Orders

Sell or Process Further

Changes in Product Mix

Relevant Analysis - 10

SPECIAL ORDERSDecision Rule

Special orders that do not involve a long-term contract should be priced in relationship to available capacity

Relevant Analysis - 11

AVAILABLE SURPLUS CAPACITYDecision Rule

When capacity is available, incremental revenues have to be greater than incremental costs

Relevant Analysis - 12

DECISION RULE - OPPORTUNITY COSTS

The alternative that has the greatest contribution margin per unit of constrained resource should be selected, thereby minimizing the opportunity cost

Relevant Analysis - 13

NO AVAILABLE CAPACITYDecision Considerations

Additional capacity may be acquired through:

– Overtime operations– Subcontracting

Which result in additional costs

When capacity is not available, incremental revenues have to be greater than incremental costs

Relevant Analysis - 14

Joint InputJoint

Costs

Product A

Product B

Separate

Processing

Separate

Processing

Split-off

point Joint products

Should the company

process further?

A Decision to Sell or Process Further

Relevant Analysis - 15

Implications of Relevant Analysis

January 1996

January 1996

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January 1996

January 1996

SunMonTueWedThuFriSat

1

8

15

22

29

7

14

21

28

6

13

20

27

5

12

19

26

4

11

18

25

3

10

17

24

31

2

9

16

23

30

• Short-term vs. Long-term

• Quantitative vs. Qualitative

• Data probability