21-1 Activity Resource Usage Model and Tactical Decision Making Prepared by Douglas Cloud Pepperdine University Prepared by Douglas Cloud Pepperdine University

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Activity Activity Resource Usage Resource Usage

Model and Model and Tactical Decision Tactical Decision

MakingMakingPrepared by

Douglas Cloud Pepperdine University

Prepared by Douglas Cloud

Pepperdine University

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1. Describe the tactical decision-making model.2. Define the concept of relevant costs and

revenues.3. Explain how the activity resource usage

model is used in assessing relevancy.4. Apply the tactical decision-making concepts

in a variety of business situations.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

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The Tactical Decision-The Tactical Decision-Making ProcessMaking Process


Tactical decision making consists of choosing among alternatives with an immediate or limited end in view.

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1. Recognize and define the problem.

2. Identify alternatives as possible solutions to the problem, and eliminate alternatives that are not feasible.

3. Identify the predicted costs and benefits associated with each feasible alternative. Eliminate the costs and benefits that are not relevant to the decision.



ContinuedContinuedContinuedContinued

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4. Compare the relevant costs and benefits for each alternative, and then relate each alternative to the overall strategic goals of the firm and other important qualitative factors.

5. Select the alternative with the greatest benefit which also supports the organization’s strategic objectives.



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The Tactical Decision-The Tactical Decision-Making ProcessMaking Process——ExampleExample


Each year 25 percent of the harvest by an apple processor is small and odd-shaped. These apples cannot be sold in the normal distribution channels and have simply been

dumped in the orchards for fertilizer. What should the firm do

with these apples?

Step 1: Define the Problem

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Step 2: Identify Feasible Alternatives

1. Sell the applies to pig farmers.

2. Bag the applies in five-pound bags and sell them to local supermarkets as seconds.

3. Rent a local canning facility and convert the apples to applesauce.

4. Rent a local canning facility and convert the applies to pie filling.

5. Continue with the current dumping practice.

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Step 3: Predicting Costs and Benefits and Eliminating Irrelevant Costs

Labor and materials (bags and ties) for the bagging option would cost $0.05 per pound. A five-pound bag of apple could be sold for $1.30 to local supermarkets.

Making applesauce would cost $0.40 per pound for rent, labor, apples, cans, and other materials. It takes six pounds of apples to produce five, 16-ounce cans of applesauce. Each can sells for $0.78.

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Step 4: Comparing Relevant Costs and Relating to Strategic Goals.

The bagging alternative costs $0.25 to produce a five-pound bag ($0.05 x 5 pounds). The revenue is $1.30 per bag, or $0.26 per pound. The net benefit is $0.21 per pound ($0.26 – $0.05).

The net benefit of converting the apples into applesauce is $0.25 per pound ($0.65 – $0.40).

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Step 5: Select Best Alternative.

Since the apple producer is reluctant to follow a forward integration strategy, the bagging alternative should be chosen.

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The Tactical Decision-The Tactical Decision-Making ProcessMaking Process——ReviewReview

The Tactical Decision-The Tactical Decision-Making ProcessMaking Process——ReviewReview

Step 1Define Define

ProblemProblem

What to do with small, ill-shaped apples.

Step 2Identify Identify

AlternativesAlternatives

1. Sell to pig farmers.2. Sell bagged apples

(feasible).3. Make applesauce

(feasible).4. Make pie filling.5. Continue dumping.


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Step 3Predict Predict CostsCosts

Bagged alternative:a. Revenue $1.30 per

bag ($0.26 per pound)b. Cost $0.05 per pound

Applesauce alternative:a. Revenue: $0.78 per

can ($0.65 per pound)b. Cost: $0.40 per pound


Step 4Compare Compare

CostsCosts

Bagged Applesauce

Revenue $0.26 $0.65Cost 0.05 0.40Net benefit $0.21 $0.25

Bagged: DifferentiationApplesauce: Forward integration

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Step 5Select Select

AlternativesAlternatives

Select bagging alternative because it is profitable and is more consistent with strategic positioning desired by producer.

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Relevant Costs DefinedRelevant Costs DefinedRelevant Costs DefinedRelevant Costs Defined

Relevant costs are future costs that differ across alternatives. A cost must not only be a future cost but must also

differ between alternatives.

Relevant costs are future costs that differ across alternatives. A cost must not only be a future cost but must also

differ between alternatives.

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Sunk costs are past costs.

Example: The original cost of a building is a sunk cost when you are trying to decide whether or not to sell the business five years later.

Irrelevant Cost IllustratedIrrelevant Cost IllustratedIrrelevant Cost IllustratedIrrelevant Cost Illustrated

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

like electricity.

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

like electricity.

Flexible ResourcesFlexible ResourcesFlexible ResourcesFlexible Resources

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a. Demand Changes Relevant

Flexible ResourcesFlexible Resources

b. Demand Constant Not Relevant

Flexible ResourcesFlexible ResourcesFlexible ResourcesFlexible Resources

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Committed ResourcesCommitted ResourcesCommitted ResourcesCommitted Resources

Committed resources are purchased before they are used,

such as salaried employees.

Committed resources are purchased before they are used,

such as salaried employees.

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Committed ResourcesCommitted Resources

Supply – Demand = Unused Capacity

a. Demand Increase < Unused Capacity Not relevant

b. Demand Increase > Unused Capacity Relevant

c. Demand Decease (Permanent)1. Activity Capacity Reduced Relevant

2. Activity Capacity Unchanged Not Relevant

Committed ResourcesCommitted ResourcesCommitted ResourcesCommitted Resources

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A company has five manufacturing engineers who supply a capacity of

10,000 engineering hours (2,000 hours each). The cost of this

activity capacity is $250,000, or $25 per hour. The firm expects to

use 9,000 hours. If the firm decides to reject a special order requiring 500 hours, the cost of engineering

would be irrelevant.

Committed ResourcesCommitted Resources——ExampleExampleCommitted ResourcesCommitted Resources——ExampleExample

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Committed ResourcesCommitted Resources——ExampleExampleCommitted ResourcesCommitted Resources——ExampleExample

The firm can purchase a component that will drop the

demand from engineering hours from 9,000 to 7,000. Since engineering activity

capacity is acquired in chunks of 2,000, the company can lay

off one engineer or reassign the engineer to another plant.

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Important: Short-term PerspectiveImportant: Short-term Perspective

Some Types of Decisions Some Types of Decisions IllustratedIllustrated

Some Types of Decisions Some Types of Decisions IllustratedIllustrated

Make or Buy

Keep or Drop

Special Order

Sell or Process Further

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Make or BuyMake or Buy

Talmage Company produces a mechanical part used in one of its

engines. (Talmage produces engines for snowblowers.) An outside supplier has

offered to sell a part (Part 34B) for $4.75. The company normally produces

100,000 units of the part each year.

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Differential Make Buy CostUsing materials $ 50,000 $ 0 $ 50,000

Using direct labor 200,000 0 200,000Providing supervision 300,000 240,000 60,000Moving materials 394,000 345,000 49,000Providing power 90,000 0 90,000Inspecting products 301,000 263,000 38,000Setting up equipment 600,000 540,000 60,000Acquiring Part 34B 0 475,000 -475,000 Total $1,935,000 $1,863,000 $ 72,000

Buy the part!

ABC Make-or-Buy AnalysisABC Make-or-Buy Analysis

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Functional Based Make-or-Buy AnalysisFunctional Based Make-or-Buy Analysis

Using materials $ 50,000 $ 0 $ 50,000Using direct labor 200,000 0 200,000Providing supervision 300,000 240,000 60,000Providing power 90,000 0 90,000Acquiring Part 34B 0 475,000 -475,000 Total $640,000 $715,000 $ -75,000

Make the part!

Differential Make Buy Cost

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Keep-or-Drop DecisionsKeep-or-Drop DecisionsKeep-or-Drop DecisionsKeep-or-Drop Decisions Seat Covers Floor Mats TotalSeat Covers Floor Mats Total

Sales $950,000 $1,680,000 $2,630,000Less unit-level variable

expenses:Direct materials -300,000 -400,000 -700,000Direct labor -210,000 -210,000 -420,000Maintenance -90,000 -90,000 -180,000Power -35,000 -25,000 -60,000Commission -30,000 -40,000 -70,000

Contribution margin $ 285,000 $ 915,000 $1,200,000Less traceable expenses -405,000 -325,000 -730,000Product margin $-120,000 $ 590,000 $ 470,000

DROP?DROP?

Less common expenses -430,000Income before taxes $ 40,000

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Keep-or-Drop DecisionsKeep-or-Drop DecisionsKeep-or-Drop DecisionsKeep-or-Drop Decisions

Keep Alternative Drop AlternativeKeep Alternative Drop Alternative

Contribution margin $285,000 $ 0Advertising, direct fixed -50,000 0Supervision, direct fixed -30,000 0Inspecting products, nonunit variable -20,000 0Inspecting products, traceable fixed -80,000 0Inspecting products, unused capacity -40,000 0Material handling, nonunit variables -10,000 0Material handling, traceable fixed -70,000 0Customer service, traceable fixed -45,000 -15,000 Total $ -60,000 $-15,000

Dropping the product saves $45,000!

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Special-Order CostSpecial-Order CostSpecial-Order CostSpecial-Order Cost

Polarcreme, Inc., an ice-cream company, is operating at 80

percent of its 20 million half-gallon capacity. A distributor from another geographically area offered to buy 2 million units of premium ice cream at

$1.75 per unit. They have agreed to provide their own label and pay transportation

costs. This sale would avoid a sales commission.

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Variable costs:Dairy ingredients

$0.70Sugar

0.10Flavoring

0.15Direct labor

0.25Packaging

0.20Commissions

0.02Distribution

0.03Other

0.05 Total unit-level costs

$1.50

Which costs are irrelevant?

$1.45$1.45


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The nonunit-level variable costs will also be incurred, producing a total increment cost of $304,000 or $0.152 per unit (for

an order of 2 million units). Revenue per unit of $1.75, less the unit-level variable

cost ($1.45) plus the nonunit-level variable cost ($0.152) provides a net

benefit of $0.148 per unit. Thus Polarcreme’s profit would increase by

$296,000 ($0.148 x 2,000,000).


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Joint products have common processes and costs of production up to a split-off point.

The point of separation is called the split-off point.

Sell or Process FurtherSell or Process FurtherSell or Process FurtherSell or Process Further

Assume that the hot sauce sells for $1.50 per bottle. Also, assume that the additional processing costs amount

to $1,000. The total revenue at split-off for Grade A tomatoes are $400 ($0.40 x 1,000 pounds). If the Grade

A tomatoes are processed into hot sauce, the total revenues are $1,500 ($1.50 per bottle).

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Sell or Process FurtherSell or Process FurtherSell or Process FurtherSell or Process Further

Differential Amount Sell Process Further to Process Further

Revenues $400 $1,500 $1,100

Processing costs ---- 1,000 1,000

Total $400 $ 500 $ 100

Decision: Further Process

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End ofEnd of

ChapterChapter

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21-1 Activity Resource Usage Model and Tactical Decision Making Prepared by Douglas Cloud Pepperdine University Prepared by Douglas Cloud Pepperdine University