1. Tactical Decision Making
CHAPTER
Tactical Decision Making

2. After studying this chapter, you should be able to:
Objectives
1. Describe the tactical decision-making model.
2. Explain how the activity resource usage model is used in assessing relevancy.
3. Apply tactical decision-making concepts in a variety of business situations.
4. Choose the optimal product mix when faced with one constrained resource.
5. Explain the impact of cost of pricing decisions.
After studying this chapter, you should be able to:

3. Objectives
6. Use linear programming to find the optimal solution to a problem of multiple constrained resources. (Appendix)

4. Model for Making Tactical Decisions
Step 1. Recognize and define the problem.
Increase capacity for warehousing and production.
Step 2. Identify alternatives as possible solutions to the problem; eliminate alternatives that are clearly not feasible.
Build new facility
Lease larger facility; sublease current facility
Lease additional facility
Lease warehouse space
Buy shafts and brushings; free up needed space
Continued

5. Model for Making Tactical Decisions
Step 3. Identify the costs and benefits associated with each feasible alternative. Classify costs and benefits as relevant or irrelevant, and eliminate irrelevant ones from consideration.
Lease warehouse space:
Variable production costs $345,000
Warehouse lease 135,000
Buy shafts and bushings externally:
Purchase price $460,000
Continued

6. Model for Making Tactical Decisions
Step 4. Total the relevant costs and benefits for each alternative.
Lease warehouse space:
Variable production costs $345,000
Warehouse lease ,000
Total $480,000
Buy shafts and bushings externally:
Purchase price $460,000
Differential cost $ 20,000
Continued

7. Model for Making Tactical Decisions
Step 5. Assess qualitative factors.
Quality of shafts and brushing is significantly lower
Quality of external suppliers
Reliability of external suppliers
Price stability
Labor relations and community image
Not reliable
Step 6. Make the decision.
Continue to produce shafts and bushings internally; lease warehouse

8. Relevant Costs Defined
Relevant costs are future costs that differ across alternatives. A cost must not only be a future cost but most also differ between alternatives.

9. Flexible resources can be easily purchased in the amount needed and at the time of use… like electricity.

10. Committed resources are purchased before they are used, such as salaried employees.

11. Activity Resource Usage Model and Assessing Relevancy
Flexible Resources
a. Demand Changes
Relevant
b. Demand Constant Not Relevant

12. Supply – Demand = Unused Capacity
Activity Resource Usage Model and Assessing Relevancy
Committed Resources
(Short-Term)
Supply – Demand = Unused Capacity
a.. Demand Increased < Unused Capacity Not relevant
b. Demand Increased > Unused Capacity Relevant
c. Demand Decease (Permanent)
Activity Capacity Reduced Relevant
Activity Capacity Unchanged Not Relevant

13. Supply – Demand = Unused Capacity
Activity Resource Usage Model and Assessing Relevancy
Committed Resources
(Multiperiod Capacity)
Supply – Demand = Unused Capacity
a.. Demand Increased < Unused Capacity Not relevant
b. Demand Decreased (Permanent) Relevant
c. Demand Increase > Unused Capacity Capital Decision

14. Illustrative Examples of Relevant Cost Applications
Make or Buy
Keep or Drop
Special Order
Sell or Process Further
Product Mix
Important: Short-term Perspective

15. Make or Buy
Swasey Manufacturing currently produces an electronic component used in one of its printers. Swasey must produce 10,000 of these parts. The firm has been approached by a supplier who offers to build the component to Swasey’s specifications for $4.75 per unit.

16. Enough material is on hand to make 5,000 parts.
Make or Buy
The full absorption cost for the 10,000 parts is computed as follows:
Total Cost Unit Cost
Rental of equipment $12,000 $1.20
Equipment depreciation 2,
Direct materials 10,
Direct labor 20,
Variable overhead 8,
General fixed overhead 30,
Total $82,000 $8.20
Enough material is on hand to make 5,000 parts.

17. Make or Buy The cost to make or buy 5,000 units follows:
Alternatives Differential
Make Buy Cost to Make
Rental of equipment $12, $12,000
Direct materials 5, ,000
Direct labor 20, ,000
Variable overhead 8, ,000
Purchase cost $47, ,500
Receiving Dept. labor , ,500
Total $45,000 $56,000 $-11,000
Make

18. Keep-or-Drop Decisions
Norton Materials, Inc. produces concrete blocks, bricks, and roofing tile. The controller prepared the following income statements:
Blocks Bricks Tile Total
Sales revenue $500 $800 $150 $1,450
Less: Variable expenses
Contribution margin $250 $320 $ 30 $ 580
Less direct fixed expenses: Advertising $ 10 $ 10 $ 10 $
Salaries
Depreciation Total $100 $ 90 $ 55 $ 245
Segment margin $150 $230 $- 45 $ 335
Less: Common fixed exp
Operating income $ 210

19. Keep-or-Drop Decisions
Differential
Keep Drop Amount to Keep
Sales $ $150
Less: Variable expenses
Contribution margin $ $ 10
Less: Advertising
Cost of supervision
Total relevant benefit
(loss) $- 35 $ 0 $- 35
Preliminary figures indicate that the tile segment should be dropped!

20. Keep-or-Drop Decisions
Tom Blackburn determines that dropping the tile section will reduce sales in all sections as follows: $50,000 for blocks, $64,000 for bricks, and $150,000 for roofing tile. His summary in thousands is shown below:
Differential
Keep Drop Amount to Keep
Sales $1,450 $1,186.0 $264.0
Less: Variable expenses
Contribution margin $ $ $ 60.6
Less: Advertising
Cost of supervision
Total $ $ $ 15.6
Keep roofing tile segment!

21. Alternate Use of Facilities
Keep-or-Drop Decisions
Alternate Use of Facilities
The marketing manager sees the market for floor tile as stronger and less competitive than roof tile. He submits the following figures for floor tile sales:
Sales $100,000
Less: Variable expenses ,000
Contribution margin $ 60,000
Less: Direct fixed expenses ,000
Segment margin $ 5,000

22. Alternate Use of Facilities
Keep-or-Drop Decisions
Alternate Use of Facilities
Drop and Differential
Keep Replace Amount to Keep
Sales $1,450 $1, $164.00
Less: Variable expenses
Contribution margin $ $ $
$1,450 – $ –$50 – $64 + $100
$870 – $140 – $25 – $ $40
Decision: Continue making roof tile!

23. Special-Order Decisions
An ice cream company is operating at 80 percent of its productive capacity (20 million half gallon units). The unit costs associated with producing and selling 16 million units are shown on the next slide.

24. Special-Order Decisions
Variable costs:
Dairy ingredients $ 0.70
Sugar 0.10
Flavoring 0.15
Direct labor 0.25
Packaging 0.20
Commissions 0.02
Distribution 0.03
Other
Total variable costs $ 1.50
Wholesale price = $2.00
Total fixed costs
Total costs $1.597

25. Special-Order Decisions
An ice cream distributor from a geographic region not normally served by the company has offered to buy two million units at $1.55 per unit, provided its own label can be attached to the product. The distributor has agreed to pay the transportation cost.

26. Special-Order Decisions
Variable costs:
Dairy ingredients $0.70
Sugar 0.10
Flavoring 0.15
Direct labor 0.25
Packaging 0.20
Commissions 0.02
Distribution 0.03
Other 0.05
Total variable costs $1.50
Which costs are irrelevant?
$1.45
Total fixed costs
Total costs $1.597

27. Special-Order Decisions
Accept the offer ($0.10 x 2,000,000 = $200,000 more profit).
Variable costs:
Dairy ingredients $ 0.70
Sugar 0.10
Flavoring 0.15
Direct labor 0.25
Packaging 0.20
Commissions 0.02
Distribution 0.03
Other 0.05
Total variable costs $ 1.50
Which costs are irrelevant?
$1.45
Total fixed costs
Total cost $1.597

28. Sell or Further Process
Yield at Split-Off
Further Processing
Grade A
800 lb
Sell for $0.40 lb
Bagged
120 Bags
Cost $0.05/Bag
Sell for $1.30/Bag
Joint Cost $300
Grade B
600 lb
Applesauce
oz Cans
Cost $0.10/lb
Sell for $0.75 can
Grade C
600 lb

29. Sell or Further Process
Process Differential Amount
Further Sell to Process Further
Revenues $450 $150 $300
Processing cost
Total $330 $150 $180
Further process!

30. Two Approaches to Pricing
1. Cost-Based Pricing
2. Target Costing and Pricing

31. Cost-Based Pricing Revenues $856,500 Cost of goods sold:
Direct materials $489,750
Direct labor 140,000
Overhead , ,750
Gross profit $142,750
Selling and administrative expenses ,000
Operating income $117,750

32. Determining Markup Percentages
Markup on COGS =
(S & A expenses + Operating income) ÷ COGS
= ($25,000 + $117,750) ÷ $713,750
= 0.20
Markup on direct materials =
(DL + OH + S & A expenses + Oper. income) ÷ Direct mater. =
($140,000 + $84,000 + $25,000 + $117,750) ÷$489,750 = 0.749

33. Determining Markup Percentages
Direct materials (computer components, etc.) $100,000
Direct labor (100 x 6 hours x $15) 9,000
Overhead (60 percent of direct labor cost) ,400
Estimated cost of goods sold $114,400
Plus 20 percent markup of COGS ,880
Bid price $137,280

34. Target Costing and Pricing
Target costing is a method of determining the cost of a product or service based on the price (target price) that customers are willing to pay.
This is referred to as price-driven costing.

35. Legal Aspects of Pricing
Predatory pricing. The practice of setting prices below cost for the purpose of injuring or eliminating competitors.
Price discrimination. Charging different prices to different customers for essentially the same product.
The Robinson-Patman Act is the most potent weapon against price discrimination, but it doesn’t cover services and intangibles.

36. Linear Programming
The maximum demand for Gear X is 15,000 units and the maximum demand for Gear Y is 40,000 units. The contribution margin for X is $25 and for Y is $10.
Z = $25X x $10Y
Two machine hours are used for each unit of Gear X, and 0.5 machine hour is used for a unit of Gear Y.
2X + 0.5Y  40,000

37. Linear Programming Max. Z = $25X x $10Y Subject to: 2X + 0.5Y  40,000

38. Machine Hours Constraint
80 –
75 –
70 –
65 –
60 –
55 –
50 –
45 –
40 –
35 –
30 –
25 –
20 –
15 –
10 –
5 –
0 –
Machine Hours Constraint
2X + 0.5Y  40,000
Demand Constraint X  15,000 A B C D E
Demand Constraint Y  40,000
Feasibility Region
| | | | |

39. Linear Programming Corner Point X-Value Y-Value Z = $25X + $10YB C D E
Manufacture 10,000 units of Gear X and 40,000 of Gear Y.

40. Chapter Seventeen
The End