Relevant Analysis - 1 RELEVANT ANALYSIS FOR 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 ORDERS Decision Rule  Special orders that do not involve a long-term contract should be priced in relationship to available capacity

Relevant Analysis - 11 AVAILABLE SURPLUS CAPACITY Decision 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 CAPACITY Decision 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 Input Joint 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 SunMonTueWedThuFriSat Short-term vs. Long-term Quantitative vs. Qualitative Data probability