Decision making

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Decision making process
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First: Determine Organization’s First: Determine Organization’s Competitive Environment and Strategy; Second: Specify the Criteria and Identify the Alternative Actions; Third: Relevant Cost Analysis and Strategic Analysis; Fourth: Select and Implement a Course of Action; Fifth: Evaluate Performance
Relevant cost
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a future cost that differs between the decision alternatives
Features of relevant cost
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Both characteristics must be present for a cost to be relevant; Relevant costs can be variable or fixed, but variable costs are generally relevant while fixed costs are not; Relevant cost analysis and total cost analysis produce the same results
Sunk cost
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is a cost that has been incurred in the past or committed for the future
Opportunity cost
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the benefit lost when one chosen option precludes the benefits from an alternative option, should also be considered in the analysis of alternative options
When depreciation is included in the relevant cost?
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when considering tax implications
When time value of money is relevant?
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When deciding among alternatives with cash flows over two or more years
Importance of qualitative factors
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Differences in quality; Functionality; Timeliness of delivery; Reliability in shipping; After-sale service level
What are the features of Relevant Cost Analysis?
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short-term focus, not linked to a strategy, product cost focus, focused on individual decision
What are the features of strategic analysis?
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long-term focus, linked to the firm's strategy, customer focus, considers all customer factors
This decision framework can be used to address common management decisions such as:
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The special-order decision; The make-lease-or-buy decision; The decision to sell before or after additional processing; The short-term product-mix decision; Profitability analysis
What is special-order decision?
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when a firm has a one-time opportunity to sell a specified quantity of its product or service; these orders are generally non-recurring
What would happen if X were producing near full capacity?
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it would have to consider opportunity costs
What would happen if Special order decisions were on the regular basis?
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can erode profitability
Lease cost is the same as...?
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Purchase cost
Profitability analysis addresses issues such as:
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Which product lines are most profitable?; Are the products priced properly?; Which products should be promoted and advertised more aggressively?; Which product-line managers should be rewarded?; Which product-line managers should be rewarded?;
What should be the management's goal?
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To maximize contribution margin while minimizing fixed costs
What should be managers careful about?
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Managers must be careful not to include irrelevant, including sunk, costs in their decision making; When fixed costs are shown as cost per unit, many managers tend to improperly classify them as relevant

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