| What are the 5 steps in the decision making process? | Step 1: Gathering information
- What is the problem, what is the objective of solving it, and what are our alternatives?
Step 2: Making predictions
- Calculate the costs of each alternative solution to the problem.
Step 3: Choosing an alternative
Both quantitative (Costs) and qualitative (employee morale etc.) considerations
Step 4: Implementing the decision
Step 5: Evaluating performance |
| What are relevant and irrelevant information in decision making? And why does short-term and long term decision making change this? | Relevant:
Expected future costs, expected revenue
Irrelevant:
Historical costs from the past (May be useful as a predictor)
Sunk costs (Ie. historical costs) are costs we have incurred/must incurre in the future (such as a lease). As we can do nothing about them, they are irrelevant.
Fixed costs cannot be changed in the short term. Hence, they are irrelevant for short term decision making but relevant long term. |
| How do we most often answer decision making questions? | By calculating loss/gain of revenue and loss/gain of costs. These must also be incorporated into the full P/L statement with all products if there are multiple products.
Remember to state why you include the costs you do in your calculations! |
| What must you be carefull with regarding one-off special orders? | Comparing unit costs! Comparing the unit cost of the one-off special order to your regular production might give incorrect interpretations regards what is best for operating profit. |
| What can choosing to outsource mean for the capacity of the company? | If we choose to outsource, we might have unused capacity meaning we have fixed costs that goes toward nothing! However, maybe the unused capacity can be used to manufacture more of the main product? If that earns more profit than the cost of purchasing the part externally, then we should outsource! REMEMBER, to state an assumption of this if you assume the unused capacity could be used toward producing more products. |
| What are the two approaches to an outsourcing decision? | 1. Total-alternatives approach
Calculate all costs and profits in relation to each possible outcome.
2. Opportunity cost approach
Here, we note that us choosing to manufacture the part ourselves means that we give up the opportunity of producing more products for sale. |
| What is an opportunity cost? | Opportunity cost is the potential loss from a missed opportunity—the result of choosing one alternative and forgoing another. |
| How does costs of stock relate to opportunity costs? | When buying and storing direct materials, there might be opportunity costs associated with doing so. We have a limited resource that is cash, and we must decide what is the best use for it. Is it in buying direct materials? Investment in materials stock? Government bonds? We must use the money for what generates most profit! |
| What are som qualitative considerations to make in relation to cost of stock and opportunity costs? | Qualitative things to consider:
- We might not need all the stock we purchase in the beginning of the year! Recall from variance analysis: the budgeted budget rarely matches the actual budget!
- If we purchase monthly, issues with delivery might mean we do not produce at full capacity. Goods can also be damaged. It is much easier to negate for this if all goods are delivered in the beginning of the year.
Remember to assume that all deliveries will be on time etc. if you choose monthly delivery of goods! |
| What are som quantitative considerations to make in relation to cost of stock and opportunity costs? | For instance, we might consider buying all stock in the beginning of the year or buy stock monthly. Multiple quantitative things to consider regarding this:
- If we buy all stock in the beginning of the year, we lose interest on the money we would normally have in the bank.
- We might be able to get a cheaper purchase price due to us buying more stock. |
| How does capacity constraints affect product-mix decisions, and what is the decision rule under capacity constraints? | If there is a production constraint, we must find the optimal mix of products to produce under the constraint to maximize profits. For instance, if the firm cannot produce enough of the most profitable products, they must find what products to prioritize.
Decision rule under capacity constraints: Prioritize the product with the highest contribution margin per unit of the constraining factor. |
| Can it make sense to produce a product, even if it is at a loss? | Sometimes it makes sense to produce a product even if that product has a loss. This is because you can allocate the fixed costs to the losing product as well as the profitable product. If you were to allocate all fixed costs to the profitable product, it might not be profitable anymore! Of course, important to look at overall profit here, but you might find this to be the difference of overall loss or overall profit. |
