Principles of Cost Analysis and Management Recommend a Course of Action in Outsourcing and Keep or Replace Decisions Principles of Cost Analysis and Management Show Slide #1: Recommend a Course of Action in Outsourcing and Keep or Replace Decisions References: FM 1-06 Financial Management Operations, Apr 14 Handouts and Excel Spreadsheets Facilitator Material: Each primary facilitator should possess a lesson plan, slide deck, course handouts, access to Excel spreadsheets, and practical exercises with the answer key, and a summary sheet containing FM 1-06 Financial Management Operations, Apr 14. All required printed reference material, and technical manuals will be provided by the Schoolhouse. Learner Material: Learners should possess all required printed reference material, course handouts, access to Excel spreadsheets, and a summary sheet containing FM 1-06 Financial Management Operations, Apr 14 and standard classroom supplies.

What will influence your decision? Two cars: same model, same price, same engine, same features and accessories, same financing. Show Slide #2: Concrete Experience (Motivational) Facilitator’s Note: (Concrete Experience 5 minutes) Present learners the scenario on the slide. Ask learners “What will influence their decision?” Facilitator’s Note: (Publish and Process 5 minutes) The critical portion of this part of the ELM process is to force the learners to reflect. Ask a series of thought influencing questions, for example: Do “the color really matter? What other information will they require before making a decision? Facilitator’s Note: Write the answers on the whiteboard and facilitate a discussion.

Terminal Learning Objective Action: Recommend a Course of Action in Outsourcing and Keep or Replace Decisions Condition: : FM Leaders in a classroom environment working as a member of a small group, using doctrinal and administrative publications, self-study exercises, personal experiences, practical exercises, handouts, and discussion. Standard: With at least 80% accuracy (70% for international Learners) you must: Describe relevant costs Identify relevant costs in an outsourcing decision Identify relevant costs in a keep-or-replace decision Describe other relevant cost decision Show Slide #3: Terminal Learning Objective (TLO) Action: Recommend a Course of Action in Outsourcing and Keep or Replace Decisions Conditions: FM Leaders in a classroom environment working individually and as a member of a small group, using doctrinal and administrative publications, self-study exercises, personal experiences, practical exercises, handouts, and discussion. Standard: With at least 80% accuracy (70% for international learners): Describe relevant costs Identify relevant costs in an outsourcing decision Identify relevant costs in a keep-or-replace decision Describe other relevant cost decision Facilitator’s Note: Throughout this lesson, solicit from learners the challenges they experienced in the current operational environment (OE) and what they did to resolve them. Encourage learners to apply at least 1 of the 8 critical variables: physical environment, political stability of the state, sociological demographics, infrastructure, military capabilities, information, time, and economics. Safety Requirements: In a training environment, leaders must perform a risk assessment in accordance with DA PAM 385-30, Risk Management. Leaders will complete a DD Form 2977 DELIBERATE RISK ASSESSMENT WORKSHEET during the planning and completion of each task and sub-task by assessing mission, enemy, terrain and weather, troops and support available-time available and civil considerations (METT-TC). Local policies and procedures must be followed during times of increased heat category in order to avoid heat related injury. Consider the work/rest cycles and water replacement guidelines IAW TRADOC Regulation 350-29. Risk Assessment Level: Low. Hazard Identification: Electrical Shock, Fire, Slippery Floors, Physical Injure/Strain, Tripping Tight Spaces in Classroom, and Influenza. Hazard controls: Primary Instructor (PI) will ensure: All electrical cords are properly stored under desks, liquid containers have lids on them and all spills are immediately cleaned and mopped and allowed to completely dry before allowing learners/personnel to walk on them. All chairs are ergonomically designed, adjust to individual preference and that all learners are awake and paying attention in class. All cables/cords are properly plugged in, sheathed, and secured along tables, walls, and ceilings. No damaged or frayed cords/cables will be used. PI will brief proper hand washing techniques, the use of hand sanitizer, and evacuation procedures. All trash will be removed daily. Environmental Statement: Environmental protection is not just the law but the right thing to do. It is a continual process and starts with deliberate planning. Always be alert to ways to protect our environment during training and missions. In doing so, you will contribute to the sustainment of our training resources while protecting people and the environment from harmful effects. Refer to FM 3-34.5 Environmental Considerations and GTA 05-08-002 ENVIRONMENTAL-RELATED RISK ASSESSMENT. Evaluation: Learners will take the Principles of Cost Analysis and Management 2 Exam at the end of Week Two. Learners must score 80% or higher and International officers must score 70% or higher. Instructional Lead In: Recommend a Course of Action in Outsourcing and Keep or Replace Decisions is a lesson designed for the learners to develop, compare, analyze, and select the “best course of action (COA) in the performance of duties as a Financial Manager. This type of analysis is especially useful in decisions whether to keep or replace equipment, or for outsourcing.

What is Relevant? Synonyms for relevant: pertinent, applicable, related, appropriate, significant, and important. We have access to more information than ever. Not every piece of information is pertinent, applicable, or related to a decision. Example: fuel economy on new car models is not pertinent to a decision about whether to pursue your Master’s degree. Show Slide #4: What is Relevant? Learning Step/Activity #1: Describe relevant costs Method of Instruction: DSL (large or small group discussion) Facilitator to Learner Ratio: 2:25 Time of Instruction: 20 minutes Media: Slides, Printed Reference Materials Facilitator's Note: Before facilitating this lesson, ask the Learners which of the 21st Century Soldier Competency do they think pertain to this lesson? Facilitate a discussion on the answers given and at the end of the lesson revisit it and see if the Learners still believe their choice are the same. 6. Communication and Engagement (Oral, written, and negotiation) 7. Critical thinking, intergovernmental, and multinational competence 9. Tactical and Technical Competence Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) What is Relevant? Synonyms for relevant: pertinent, applicable, related, appropriate, significant, and important. We have access to more information than ever Not every piece of information is pertinent, applicable, or related to a decision Example: fuel economy on new car models is not pertinent to a decision about whether to pursue your Master’s degree

What is Relevant? (Cont.) Some pieces of information can be easily dismissed as unrelated or irrelevant. Other times it is more difficult to determine what is appropriate, significant, or important to the decision. Especially when the information is printed on an official report from the accounting system. Remember that the accounting system measures according to external requirements. Show Slide #5: What is Relevant? (con’t) Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) What is Relevant? (con’t) Some pieces of information can be easily dismissed as unrelated or irrelevant. Other times it is more difficult to determine what is appropriate, significant, or important to the decision. Especially when the information is printed on an official report from the accounting system. Remember that the accounting system measures according to external requirements.

What is Relevant? (Cont.) Relevant costs are those costs that change as a result of a decision. Identify the decision at hand Choice between two Courses of Action (COA) Frequently one of the options is status quo Identify related costs Which costs are the same for both courses of action? Which will change? Show Slide #6: What is Relevant? (con’t) Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) What is Relevant? (con’t) Relevant costs are those costs that change as a result of a decision. Identify the decision at hand Choice between two Courses of Action (COA) Frequently one of the options is status quo Identify related costs Which costs are the same for both courses of action? Which will change?

Cost Definitions Acquisition cost – all costs related to purchasing an asset and placing it into service. Operating cost – all costs related to operating an asset. Opportunity cost – the value of what is given up when choosing a particular course of action. Sunk cost – costs incurred in the past that cannot be recovered. Incremental cost – the additional cost incurred as the result of a decision. Show Slide #7: Cost Definitions Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Acquisition cost – all costs related to purchasing an asset and placing it into service. Operating cost – all costs related to operating an asset. Opportunity cost – the value of what is given up when choosing a particular course of action. Sunk cost – costs incurred in the past that cannot be recovered. Incremental cost – the additional cost incurred as the result of a decision.

Cost Definitions (con’t) Avoidable cost – cost we currently incur that would be eliminated or avoided by choosing another course of action. Unavoidable cost – cost we currently incur that would NOT be eliminated or avoided by choosing another course of action. Show Slide #8: Cost Definitions (con’t) Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Avoidable cost – cost we currently incur that would be eliminated or avoided by choosing another course of action. Unavoidable cost – cost we currently incur that would NOT be eliminated or avoided by choosing another course of action.

Classic Relevant Cost Problems Outsourcing – Should we provide this service in-house or purchase from a contractor? Keep or replace – Should we keep the equipment we have or replace with more efficient equipment? These are the two most applicable to government entities. Show Slide #9: Classic Relevant Cost Problems Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Outsourcing – Should we provide this service in-house or purchase from a contractor? Keep or replace – Should we keep the equipment we have or replace with more efficient equipment? These are the two most applicable to government entities.

Classic Relevant Cost Problems (Cont.) Additional business at reduced price – Should we accept or reject additional business at a reduced price? Scrap or re-work – Should we invest additional resources to bring the item up to standards or cut our losses? While less common, these also have government applications. Show Slide #10: Classic Relevant Cost Problems (con’t) Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Additional business at reduced price – Should we accept or reject additional business at a reduced price? Scrap or re-work – Should we invest additional resources to bring the item up to standards or cut our losses? While less common, these also have government applications.

A Template for Organizing the Data Based on the Statement of Activities: Item COA #1 COA #2 Δ Revenue or Benefit Revenue COA #1 Revenue COA #2 #2 - #1 Related Cost A Cost A from Related Cost B Cost B from Net Change (Rev – Cost) Rev – Costs COA #1 may be the status quo Show Slide #11: A Template for Organizing the Data Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Based on the Statement of Activities: Revenues minus Cost equals Net Change. Facilitator’s Note: (Advance slide) The headings are: Item (may be a revenue or a cost) COA #1, which may represent the status quo (keep current equipment, continue to provide a service in-house, etc.) COA #2, the other alternative (replace equipment or outsource a service) Δ (Delta) represents the difference between the two or the change from choosing COA #2 over COA #1. This column will reflect the RELEVANT costs.

Define revenues or quantifiable benefits from each COA A Template for Organizing the Data (Cont.) Based on the Statement of Activities Item COA #1 COA #2 Δ Revenue or Benefit Revenue COA #1 Revenue COA #2 #2 - #1 Related Cost A Cost A from Related Cost B Cost B from Net Change (Rev – Cost) Rev – Costs Define revenues or quantifiable benefits from each COA Show Slide #12: A Template for Organizing the Data (con’t) Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Not all Courses of Action will have revenues or quantifiable benefits. Ignore non-quantifiable benefits. They will be discussed later.

A Template for Organizing the Data (Cont.) Based on the Statement of Activities Item COA #1 COA #2 Δ Revenue or Benefit Revenue COA #1 Revenue COA #2 #2 - #1 Related Cost A Cost A from Related Cost B Cost B from Net Change (Rev – Cost) Rev – Costs Express Δ as Favorable or (Unfavorable) If the item is the same for COA #1 and COA #2 the Δ will be -0- indicating the item is irrelevant to the decision Show Slide #13: A Template for Organizing the Data (con’t) Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Express Δ as Favorable or (Unfavorable): Favorable differences are those that would INCREASE the net change. Unfavorable differences would DECREASE the net change. More revenue is GOOD or favorable. Less revenue is unfavorable. More cost is BAD or unfavorable. Less cost is favorable. Facilitator’s Note: (Advance slide) If the item is the same for COA #1 and COA #2 the Δ will be -0- indicating the item is irrelevant to the decision.

LSA #1 Check on Learning Q1. How are relevant costs defined? Q2. How does the table format help to identify irrelevant costs? A1. Costs that change as the result of a decision. Show Slide #14 LSA #1 Check on Learning Facilitator’s Note: Ask the following Questions; (Facilitate discussion on answers given) Q1. How are relevant costs defined? A1. Costs that change as the result of a decision Q2. How does the table format help to identify irrelevant costs? A2. By listing all related costs in the three-column format, it’s very easy to identify costs that do not change and are therefore irrelevant. ** Facilitator’s Note: LSA Summary will be given at the end of this lesson. A2. By listing all related costs in the three-column format, it’s very easy to identify costs that do not change and are therefore irrelevant.

LSA #1 Summary During this block, we defined several types of Cost and how they are applied to different governmental applications. Show Slide #15 LSA #1 Summary Facilitator’s Note: During this block, we defined several types of Cost and how they are applied to different governmental applications.

Outsourcing Decision: Outsource HR function for $200,000 per year or keep in-house? Direct labor cost = four employees @ $50,000 per employee annually Two would be laid off, two would be transferred to another command Unemployment taxes would increase $10,000 per year due to the layoffs Facilities and equipment cost = $35,000 per year Would remain idle Other operating costs = $15,000 per year Would be eliminated Show Slide #16: Identify relevant costs in an outsourcing decision 2. Learning Step/Activity #2: Identify relevant costs in an outsourcing decision Method of Instruction: DSL (large or small group discussion) Facilitator to Learner Ratio: 2:25 Time of Instruction: 20 minutes Media: Slides, Printed Reference Materials Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Outsourcing Facilities and equipment cost = $35,000 per year. Other operating costs = $15,000 per year. Decision: Outsource HR function for $200,000 per year or keep in-house? Unemployment taxes would increase $10,000 per year due to the layoffs. Direct labor cost = four employees @ $50,000 per employee annually. Two would be laid off, two would be transferred to another command. Would be eliminated. Would remain idle.

Outsourcing (Cont.) Item In-house Outsource Δ Revenue or Benefit -0- Direct labor $200,000 Cost of HR contract (200,000) Unemployment tax 10,000 (10,000) Facilities/Equipment 35,000 Other operating cost 15,000 Net Change -250,000 -245,000 5,000 Item In-house Outsource Δ Revenue or Benefit -0- Direct labor $200,000 Cost of HR contract (200,000) Unemployment tax 10,000 (10,000) Facilities/Equipment 35,000 Other operating cost 15,000 Net Change -250,000 -245,000 5,000 Item In-house Outsource Δ Revenue or Benefit -0- Direct labor $200,000 Cost of HR contract (200,000) Unemployment tax 10,000 (10,000) Facilities/Equipment 35,000 Other operating cost 15,000 Net Change -250,000 -245,000 5,000 Item In-house Outsource Δ Revenue or Benefit -0- Direct labor $200,000 Cost of HR contract (200,000) Unemployment tax 10,000 (10,000) Facilities/Equipment 35,000 Other operating cost 15,000 Net Change -250,000 -245,000 5,000 Item In-house Outsource Δ Revenue or Benefit -0- Direct labor $200,000 Cost of HR contract (200,000) Unemployment tax 10,000 (10,000) Facilities/Equipment 35,000 Other operating cost 15,000 Net Change -250,000 -245,000 5,000 Item In-house Outsource Δ Revenue or Benefit -0- Direct labor $200,000 Cost of HR contract (200,000) Unemployment tax 10,000 (10,000) Facilities/Equipment 35,000 Other operating cost 15,000 Net Change -250,000 -245,000 5,000 Show Slide #17: Outsourcing (con’t) Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Learners will have the blank slide. We will go over each line item and they can fill out their table as you. Facilitator’s Note: (Advance slide) Direct labor will be eliminated by outsourcing. Two employees will be laid off (and hopefully hired by the contractor!) and two will be transferred to another command, eliminating the cost from our books. This is shown in the delta column as $200,000 favorable. The cost of the HR contract is $200,000. If we choose to keep the function in-house, we will avoid this cost. This is shown as an unfavorable delta ($200,000) . Remember to use parentheses to identify unfavorable deltas. The increase in unemployment tax from laying off employees is $10,000. If we choose to keep the function in-house, we will avoid this cost. This is shown as an unfavorable delta. ($10,000) The facilities and equipment will remain idle. This is a cost of $35,000 per year that is unavoidable. We may have a long-term lease that can’t be cancelled. Since this cost will be incurred regardless of which course of action we choose, this cost is considered irrelevant. Unavoidable costs, by definition, are irrelevant. If we could find another use for the facilities and equipment and charge the cost to that program, we could then consider this an avoidable, and therefore relevant, cost. The other operating costs will be eliminated, therefore are shown as a 15,000 favorable delta. Finally, the net change. The net change from in-house operations is -250,000. (revenue of zero minus all costs). The net change from outsourcing is -245,000 (revenue of zero minus all costs). The delta is 5,000 favorable. Notice that, if you treat the unfavorable deltas as negative numbers and favorable deltas as positives, the sum of all deltas is equal to the delta for the net change. +200,000 – 200,000 -10,000 + 15,000 = 5000 We say that this “foots” (accounting term for summing a column of numbers) and “cross-foots” (accounting term for summing a row of numbers). This is also a way of checking your work.

Outsourcing Conclusions Going strictly by the numbers, we would save $5,000 by outsourcing. What else should we consider? Are there non-quantifiable benefits from keeping the function in-house? From outsourcing? What if the cost of facilities and equipment increases? Would that change our decision? Show Slide #18: Outsourcing Conclusions Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Going strictly by the numbers, we would save $5,000 by outsourcing. A favorable overall delta means that outsourcing is the favorable course of action. What else should we consider? Frequently there are non-quantifiable (or qualitative) issues to consider. Are there non-quantifiable benefits from keeping the function in-house? From outsourcing? Perhaps we want to hold on to valued employees. Can you think of any others qualitative issues? What if the cost of facilities and equipment increases? Would that change our decision? Since facilities and equipment are irrelevant, meaning they will not change as a result of the decision, it doesn’t matter if the cost of the facilities and equipment increases (or decreases, for that matter.) If the cost will not be avoided through outsourcing, it is not relevant to the decision.

LSA #2 Check on Learning Q1. Which costs are irrelevant in outsourcing decisions? Q2. How are unfavorable deltas identified? A1. Unavoidable costs are irrelevant, because they will not change as the result of the decision. Fixed costs are usually irrelevant. Show Slide #19: LSA#2 Check on Learning Facilitator’s Note: Identify relevant costs in an outsourcing decision Facilitator’s Note: Ask the following Questions; (Facilitate discussion on answers given) Q1. Which costs are irrelevant in outsourcing decisions? A1. Unavoidable costs are irrelevant, because they will not change as the result of the decision. Fixed costs are usually irrelevant. Q2. How are unfavorable deltas identified? A2. They should be identified in brackets. ** Facilitator’s Note: LSA Summary will be given at the end of this lesson. A2. They should be identified in brackets.

LSA #2 Summary During this block, we discussed how to solve an ‘Outsourcing’ scenario by identifying relevant and irrelevant information. Show Slide #20: LSA #2 Summary Facilitator’s Note:

Keep or Replace Your command recently purchased a machine for $50,000. The annual operating cost of the machine is $100,000. An alternative machine to perform the same function has just become available. The new machine costs $70,000 and costs $75,000 per year to operate. We could sell the “old” machine today for $10,000 salvage. Either machine would have a useful life of three years from today, and would produce no revenues. Show Slide #21: Keep or Replace Facilitator’s Note: Identify relevant costs in a keep-or-replace decision 3. Learning Step/Activity #3: Identify relevant costs in a keep-or-replace decision Method of Instruction: DSL (large or small group discussion) Facilitator to Learner Ratio: 2:25 Time of Instruction: 15 minutes Media: Slides, Printed Reference Materials Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Keep or Replace Your command recently purchased a machine for $50,000. The annual operating cost of the machine is $100,000. An alternative machine to perform the same function has just become available. The new machine costs $70,000 and costs $75,000 per year to operate. We could sell the “old” machine today for $10,000 salvage. Either machine would have a useful life of three years from today, and would produce no revenues.

Keep or Replace (Cont.) Decision: Replace Old Machine with More Efficient New Machine? Item Keep Replace Δ Salvage of old (benefit) -0- $10,000 Cost of Old (Sunk) $50,000 50,000 Cost of New 70,000 (70,000) Operating Costs 3 yrs 300,000 225,000 75,000 Net Change -350,000 -335,000 15,000 Item Keep Replace Δ Salvage of old (benefit) -0- $10,000 Cost of Old (Sunk) $50,000 50,000 Cost of New 70,000 (70,000) Operating Costs 3 yrs 300,000 225,000 75,000 Net Change -350,000 -335,000 15,000 Item Keep Replace Δ Salvage of old (benefit) -0- $10,000 Cost of Old (Sunk) $50,000 50,000 Cost of New 70,000 (70,000) Operating Costs 3 yrs 300,000 225,000 75,000 Net Change -350,000 -335,000 15,000 Item Keep Replace Δ Salvage of old (benefit) -0- $10,000 Cost of Old (Sunk) $50,000 50,000 Cost of New 70,000 (70,000) Operating Costs 3 yrs 300,000 225,000 75,000 Net Change -350,000 -335,000 15,000 Item Keep Replace Δ Salvage of old (benefit) -0- $10,000 Cost of Old (Sunk) $50,000 50,000 Cost of New 70,000 (70,000) Operating Costs 3 yrs 300,000 225,000 75,000 Net Change -350,000 -335,000 15,000 Show Slide #22: Keep or Replace (con’t) Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Learners will have the blank slide. Give them time to fill in the blanks as you step through the table line by line. Here is the completed table. We will discuss each line item. Even though neither machine produces revenue, the salvage value of the old machine is a benefit and is relevant. We would not receive this cash inflow if we kept the old machine. It is 10,000 favorable. The cost of the old machine is a sunk cost. That is, we will not recover it. Sunk costs, by definition, are irrelevant. Facilitator’s Note: (Advance slide) The cost of the new machine is, of course relevant. We would not incur this cost if we kept the old machine. It is 70,000 unfavorable. The operating costs are relevant, as they will change if we purchase the new machine. Over three years, this is 75,000 favorable. (ignoring time value of money, which we will address on day 7). The net change from keeping the old machine is -350,000 and the net change from purchasing the new machine is -335,000, for a delta of 15,000 favorable. Notice that the delta column foots and cross-foots.

Keep or Replace Conclusions Replacing the “old” machine will save $15,000 over the three-year period What else should be considered? Any qualitative factors? What if the projected operating costs of the new machine are overly optimistic? What if the actual operating costs are $80,000 per year? $85,000? How would that change our decision? Show Slide #23: Keep or Replace Conclusions Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Replacing the “old” machine will save $15,000 over the three-year period (again, ignoring time value of money, which we will cover on Day 7). Remember that our “old” machine was only recently purchased. Even so, the savings in operating costs justify purchasing the new machine. What else should be considered? Any qualitative factors? These can vary. Some managers may consider replacing such a recently purchased machine to indicate a poor decision in the first place. They may see this as a loss of face. Can you think of any others? (such as, it may not be environmentally desirable to dispose of the machine.) What if the projected operating costs of the new machine are overly optimistic? What if the actual operating costs are $80,000 per year? $85,000? How would that change our decision? An increase in costs of just $5000 per year makes the new machine a wash. If the actual costs turn out to be $85,000 per year, we would be better off keeping the old machine. Our decision hinges on this estimate.

LSA #3 Check on Learning Q1. Which costs are always irrelevant in keep or replace decisions? A1. Sunk costs – the original acquisition cost of the machine. Show Slide #24: LSA #3 Check on Learning Facilitator’s Note: Ask the following Questions; (Facilitate discussion on answers given) Q1. Which costs are irrelevant in outsourcing decisions? A1. Sunk costs – the original acquisition cost of the machine. ** Facilitator’s Note: LSA Summary will be given at the end of this lesson.

LSA #3 Summary During this block, we discussed how to solve a ‘Keep or Replace’ scenario by identifying relevant and irrelevant information. Show Slide #25: LSA #3 Summary Facilitator’s Note:

Additional Business, Reduced Price The dining hall can serve 200 for breakfast, but averages only 40 on weekends.   Daily fixed costs for the morning shift (three employees for four hours, plus cost of facilities) are $500, and variable costs are $2 per breakfast. The regular price for breakfast is $5. A local community service group would like to use the dining hall on Sunday mornings for their meetings. They would pay $3 per person for breakfast. Average attendance at meetings is 75. Show Slide #26: Additional Business, Reduced Price 4. Learning Step/Activity #4: Describe other relevant cost decision Method of Instruction: DSL (large or small group discussion) Facilitator to Learner Ratio: 2:25 Time of Instruction: 20 minutes Media: Slides, Printed Reference Materials Additional Business, Reduced Price Here is an example of additional business at a reduced price that applies to military organizations: The dining hall can serve 200 for breakfast, but averages only 40 on weekends.   Daily fixed costs for the morning shift (three employees for four hours, plus cost of facilities) are $500, and variable costs are $2 per breakfast. The regular price for breakfast is $5. A local community service group would like to use the dining hall on Sunday mornings for their meetings. They would pay $3 per person for breakfast. Average attendance at meetings is 75.

Additional Business, Reduced Price (Cont.) Item Status Quo With Additional Δ Breakfast sales 40 @ $5 $200 40 @ $5 + 75 @ $3 $425 $225 Variable Costs 40 @ $2 80 115 @ $2 230 (150) Fixed Costs 500 -0- Net Change -380 -305 75 Show Slide #27: Additional Business, Reduced Price (con’t) Facilitator’s Note: Here is the table. [Learners will have COMPLETE slide this time, since they should be familiar with the format] We will go over item by item on the next slides. Facilitator’s Note: (Advance slide) The additional revenue from accepting the additional business at the reduced price is $225. That is equal to 75 breakfasts at $3. This is known as incremental revenue, the increase in revenue due to the additional business.

Additional Business, Reduced Price (Cont.) Item Status Quo With Additional Δ Breakfast sales 40 @ $5 $200 40 @ $5 + 75 @ $3 $425 $225 Variable Costs 40 @ $2 80 115 @ $2 230 (150) Fixed Costs 500 -0- Net Change -380 -305 75 Show Slide #28: Additional Business, Reduced Price (con’t) Facilitator’s Note: Here is the table. [Learners will have COMPLETE slide this time, since they should be familiar with the format] We will go over item by item on the next slides. Facilitator’s Note: (Advance slide) Variable costs will also increase, which is unfavorable. The delta is $150, which is equal to 75 breakfasts at $2 variable cost per breakfast. This is the incremental cost, the increase in cost due to the additional business.

Additional Business, Reduced Price (Cont.) Item Status Quo With Additional Δ Breakfast sales 40 @ $5 $200 40 @ $5 + 75 @ $3 $425 $225 Variable Costs 40 @ $2 80 115 @ $2 230 (150) Fixed Costs 500 -0- Net Change -380 -305 75 Show Slide #29: Additional Business, Reduced Price (Con’t) Facilitator’s Note: Here is the table. [Learners will have COMPLETE slide this time, since they should be familiar with the format] We will go over item by item on the next slides. Facilitator’s Note: (Advance slide) Fixed costs will not change. Fixed costs, by definition, do not change as number of units increases or decreases. We will still have to have the three employees (cook, server, dishwasher) and the use of the facilities. Therefore the delta is zero. The fixed costs are not relevant to our decision.

Additional Business, Reduced Price (Cont.) Item Status Quo With Additional Δ Breakfast sales 40 @ $5 $200 40 @ $5 + 75 @ $3 $425 $225 Variable Costs 40 @ $2 80 115 @ $2 230 (150) Fixed Costs 500 -0- Net Change -380 -305 75 Show Slide #30: Additional Business, Reduced Price (con’t) Facilitator’s Note: Here is the table. [Learners will have COMPLETE slide this time, since they should be familiar with the format] We will go over item by item on the next slides. Facilitator’s Note: (Advance slide) Where we were in a net loss of $380 before, we improve to a net loss of $305.

Additional Business, Reduced Price (Cont.) Assumptions: Excess capacity exists Proposed business will not detract from regular business Rules of thumb: As long as incremental revenue exceeds incremental cost, additional business is desirable Fixed costs are irrelevant Show Slide #31: Additional Business, Reduced Price (con’t) Assumptions: Excess Capacity Exists – in this case we have plenty of room to bring in the additional customers from the community group. Proposed Business will not Detract from Regular Business. There is no overlap between the community group and our regular customer base. Rules of thumb: As long as incremental revenue exceeds incremental cost, additional business is desirable Fixed costs are irrelevant

Additional Business, Reduced Price (Cont.) Q1. What else should the dining hall management consider? Potential questions might be: Will the community group’s meeting disturb regular full-price customers? Is there any way to reduce fixed cost in the long run? Should regular breakfast prices be increased? Should the dining hall close altogether on weekends? Are there intangible benefits of building a relationship with the community service group? Others? Note that, assuming that the dining hall does not have the option of closing on the weekends, the loss of $305 is preferable to the loss of $380. Show Slide #32: Additional Business, Reduced Price (con’t) Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Q1. What else should the dining hall management consider? Potential questions might be: Facilitator's Note: (Advance Slide) Will the community group’s meeting disturb regular full-price customers? Is there any way to reduce fixed cost in the long run? Should regular breakfast prices be increased? Should the dining hall close altogether on weekends? Are there intangible benefits of building a relationship with the community service group? Others? Note that, assuming that the dining hall does not have the option of closing on the weekends, the loss of $305 is preferable to the loss of $380.

Scrap or Rework Should we sell an inferior product as scrap or invest the necessary resources to make the product salable? This has application to military in the area of training. Should we discharge individuals who fail basic training or re-train? Show Slide #33: Scrap or Rework Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) Should we sell an inferior product as scrap or invest the necessary resources to make the product salable? This has application to military in the area of training. Should we discharge individuals who fail basic training or re-train?

Cost of Basic training is a Sunk Cost and therefore irrelevant Discharge or Re-train Item Discharge Re-train Δ Benefit of trained soldier -0- X Cost of Basic Training Y Cost of Re-training Z (Z) Net Change -Y X – Y – Z X – Z Cost of Basic training is a Sunk Cost and therefore irrelevant Show Slide #34: Discharge or Re-train Facilitator’s Note: (Facilitator read and facilitate discussion using the slide) We have not attempted to quantify the benefit of a trained soldier, but we can say for sure that there is no benefit to be received from a discharged soldier. Therefore the benefit of the trained soldier is a favorable delta “X”. Facilitator’s Note: (Advance slide) We have also not attempted to quantify the cost of basic training, although that doesn’t really matter because it is a sunk cost, which is irrelevant. We have already invested this cost, and will not get it back if we discharge the soldier or if we re-train. We also did not attempt to quantify the cost of re-training. This may differ with each individual. What is important to note is that the decision comes down to this: Is the benefit of the trained soldier greater than the cost to re-train the soldier? If the answer is yes, then it is desirable to re-train. If the answer is no, then it is not desirable to re-train. The one thing that should NOT be considered in the decision is the investment in the soldier’s training to-date. That is a sunk cost, and is irrelevant. If X (benefit of trained soldier) is greater than Z (cost to re-train) then re-training is desirable.

LSA #4 Check on Learning Q1. Which costs are irrelevant in deciding whether to accept additional business at a reduced price? Q2. What is the rule of thumb? A1. Fixed costs. They will not change with the additional business. Show Slide #35: LSA #4 Check on Learning Facilitator’s Note: (Advance slide for Answers) Q1. Which costs are irrelevant in deciding whether to accept additional business at a reduced price? A1. Fixed costs. They will not change with the additional business. Q2. What is the rule of thumb? A2. If incremental revenue is greater than incremental cost, we should accept the business A2. If incremental revenue is greater than incremental cost, we should accept the business

LSA #4 Summary During this block, we discussed how to solve an ‘Additional Business, Reduced Price’ & ‘Scrap or Rework’ scenario by identifying both relevant and irrelevant information. Show Slide #36: LSA #1-4 Summary Facilitator’s Note: As FM Leaders in a classroom environment, using doctrinal and administrative publications, personal experiences, handouts, and discussion, we covered: Describe relevant costs Identify relevant costs in an outsourcing decision Identify relevant costs in a keep-or-replace decision Describe other relevant cost decision Facilitator's Note: At this time, have one learner from each group to explain the most important take away to them from this lesson. Facilitate a discussion on each answer.

Practical Exercises Show Slide #37: Deploy the Practical Exercise (PE) Facilitator’s Note: Run Phase Method of Instructions. This is your opportunity to apply what you have learned about recommending a Course of Action in Outsourcing and Keep or Replace Decisions. You will have 15 minutes to complete the practical exercise (PE). Do your best to complete the PE in the allotted time. We will conduct an review of the PE as a group.

TLO Summary Action: Recommend a Course of Action in Outsourcing and Keep or Replace Decisions Condition: : FM Leaders in a classroom environment working as a member of a small group, using doctrinal and administrative publications, self-study exercises, personal experiences, practical exercises, handouts, and discussion. Standard: With at least 80% accuracy (70% for international Learners) you must: Describe relevant costs Identify relevant costs in an outsourcing decision Identify relevant costs in a keep-or-replace decision Describe other relevant cost decision Show Slide #38: TLO Summary Facilitator’s Note: Restate the TLO Action: Recommend a Course of Action in Outsourcing and Keep or Replace Decisions Conditions: FM Leaders in a classroom environment working individually and as a member of a small group, using doctrinal and administrative publications, self-study exercises, personal experiences, practical exercises, handouts, and discussion. Standard: With at least 80% accuracy (70% for international learners): Describe relevant costs Identify relevant costs in an outsourcing decision Identify relevant costs in a keep-or-replace decision Describe other relevant cost decision “Or” Facilitator's at this time, have one learner from each group to explain the most important take away to them from this lesson. Facilitate a discussion on each answer. Facilitator’s Note: Read TLO Summary: Real world scenarios rarely present themselves as neatly as textbook or classroom examples. Frequently there are multiple elements of information available that can cloud the real issue. It is important to sort out the pieces of information that are relevant to the decision at hand. Relevant costs are those that will change as a result of the decision. In situations where the relevant pieces of information are not easily identifiable it helps to arrange the information in a comparison format. Identify the two courses of action (COA) to be compared (one COA may be status quo, or make no change) and then arrange them side-by-side with a delta column to the right. Anything with a zero delta is not relevant to the decision and can be eliminated from the analysis. This type of analysis is especially useful in decisions whether to keep or replace equipment, or for outsourcing. Some rules of thumb to keep in mind are that sunk costs are always irrelevant. Unavoidable costs such as fixed costs are also irrelevant. By definition, avoidable costs are relevant to a decision. Avoidable costs are costs that will be eliminated or avoided by choosing a particular COA. Facilitator’s Note: At this time, select a Learner to explain the most important take away from this lesson. Facilitate a discussion on the answer given.