17 -1

CHAPTER
Tactical
Decision
Making
 17 -2

Objectives
Objectives
1. Describe the After
tactical decision-making
studying this model.
After studying this
2. Explain howchapter,
the activity
you resource
should usage model
chapter, you should
is used in assessing
be relevancy.
be able
able to:
to:
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.
 17 -3

Objectives
Objectives
6. Use linear programming to find the optimal
solution to a problem of multiple constrained
resources. (Appendix)
 17 -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.
1. Build new facility
2. Lease larger facility; sublease current facility
3. Lease additional facility
4. Lease warehouse space
5. Buy shafts and brushings; free up needed space

Continued
Continued
 17 -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
Continued
 17 -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 135,000
Total $480,000
Buy shafts and bushings externally:
Purchase price $460,000
Differential cost $ 20,000

Continued
Continued
 17 -7

Model for Making Tactical Decisions

Step 5. Assess qualitative factors. Quality of shafts
1. Quality of external suppliers and brushing is
2. Reliability of external suppliers significantly
Not reliablelower
3. Price stability
4. Labor relations and community image
Step 6. Make the decision.
Continue to produce shafts and bushings internally;
lease warehouse
 17 -8

Relevant
Relevant Costs
Costs Defined
Defined
Relevant
Relevant costs
costs are
are future
future costs
costs that
that differ
differ
across
across alternatives.
alternatives. AAcost
cost must
must not
notonly
only
be
be aafuture
future cost
cost but
but most
most also
also differ
differ
between
between alternatives.
alternatives.
 17 -9

Flexible
Flexible resources
resources can can be
be
easily
easily purchased
purchased in in the
the amount
amount
needed
needed and
and at
at the
the time
time of
of use…
use…
like
like electricity.
electricity.
 17 -10

Committed
Committed resources
resources areare
purchased
purchased before
before they
they are
are used,
used,
such
such as
as salaried
salaried employees.
employees.
 17 -11

Activity
Activity Resource
Resource Usage
Usage Model
Model and
and
Assessing
Assessing Relevancy
Relevancy

Flexible
FlexibleResources
Resources

a. Demand Changes Relevant

b. Demand Constant Not Relevant

 17 -12

Activity
Activity Resource
Resource Usage
Usage Model
Model and
and
Assessing
Assessing Relevancy
Relevancy
Committed
CommittedResources
Resources
(Short-Term)
(Short-Term)

Supply – Demand = Unused Capacity

a.. Demand Increased < Unused Capacity Not relevant
b. Demand Increased > Unused Capacity Relevant
c. Demand Decease (Permanent)
1. Activity Capacity Reduced Relevant
2. Activity Capacity Unchanged Not Relevant
 17 -13

Activity
Activity Resource
Resource Usage
Usage Model
Model and
and
Assessing
Assessing Relevancy
Relevancy
Committed
CommittedResources
Resources
(Multiperiod
(MultiperiodCapacity)
Capacity)

Supply – Demand = Unused Capacity

a.. Demand Increased < Unused Capacity Not relevant
b. Demand Decreased (Permanent) Relevant
c. Demand Increase > Unused Capacity Capital Decision
 17 -14

Illustrative Examples of
Relevant Cost Applications
 Make or Buy

 Keep or Drop

 Special Order

 Sell or Process Further

 Product Mix

Important:
Important: Short-term
Short-term Perspective
Perspective
 17 -15

Make
Make or
or Buy
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.
 17 -16

Make
Make or
or Buy
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 2,000 0.20
Direct materials 10,000 1.00
Direct labor 20,000 2.00
Variable overhead 8,000 0.80
General fixed overhead 30,000 3.00
Total $82,000 $8.20
Enough material is on hand to make 5,000 parts.
 17 -17

Make
Make or
or Buy
Buy
The cost to make or buy 5,000 units follows:
Alternatives Differential
Make Buy Cost to Make
Rental of equipment $12,000 ------- $12,000
Direct materials 5,000 ------- 5,000
Direct labor 20,000 ------- 20,000
Variable overhead 8,000 ------- 8,000
Purchase cost ------- $47,500 -47,500
Receiving Dept. labor ------- 8,500 - 8,500
Total $45,000 $56,000 $-11,000
Make
Make
 17 -18

Keep-or-Drop
Keep-or-Drop Decisions
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 250 480 140 870
Contribution margin $250 $320 $ 30 $ 580
Less direct fixed expenses:
Advertising $ 10 $ 10 $ 10 $ 30
Salaries 37 40 35 112
Depreciation 53 40 10 103
Total $100 $ 90 $ 55 $ 245
Segment margin $150 $230 $- 45 $ 335
Less: Common fixed exp. 125
Operating income $ 210
 17 -19

Keep-or-Drop
Keep-or-Drop Decisions
Decisions
Differential

Sales Keep
$150 Drop
---- Amount
$150to Keep
Less: Variable expenses 140 ---- 140
Contribution margin $ 10 ---- $ 10
Less: Advertising -10 ---- -10
Cost of supervision -35 ---- -35
Total relevant benefit
(loss) $- 35 $ 0 $- 35

Preliminary
Preliminary figures
figures indicate
indicate that
that the
the tile
tile
segment
segment should
should be
be dropped!
dropped!
 17 -20

Keep-or-Drop
Keep-or-Drop Decisions
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

Sales Keep
$1,450 Drop Amount
$1,186.0 to Keep
$264.0
Less: Variable expenses 870 666.6 203.4
Contribution margin $ 580 $ 519.4 $ 60.6
Less: Advertising -30 -20.0 -10.0
Cost of supervision -112 -77.0 -35.0
Total $ 438 $ 422.4 $ 15.6

Keep
Keeproofing
roofingtile
tilesegment!
segment!
 17 -21

Keep-or-Drop
Keep-or-Drop Decisions
Decisions
Alternate
AlternateUse
Useof
ofFacilities
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 40,000
Contribution margin $ 60,000
Less: Direct fixed expenses 55,000
Segment margin $ 5,000
 17 -22

Keep-or-Drop
Keep-or-Drop Decisions
Decisions
Alternate
AlternateUse
Useof
ofFacilities
Facilities

Drop and Differential

Sales Keep $1,286.00

$1,450 Replace Amount $164.00to Keep
Less: Variable expenses 870 706.60 163.40
Contribution margin $ 580 $ 579.40
$1,450 – $150 $ 0.60
–$50 –– $140
$870 $64 +–
$25 –$100
$38.40 +
Decision:
Decision: Continue
Continue making
making
$40 roof
roof tile!
tile!
 17 -23

Special-Order
Special-Order Decisions
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.
 17 -24

Special-Order
Special-Order Decisions
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
Wholesale Total variable costs $ 1.50
price = Total fixed costs 0.097
$2.00 Total costs $1.597
 17 -25

Special-Order
Special-Order Decisions
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.
 17 -26

Special-Order
Special-Order Decisions
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
Which costs Total variable costs $1.50
$1.45
are irrelevant? Total fixed costs 0.097
Total costs $1.597
$1.45
 17 -27

Special-Order
Special-Order Decisions
Decisions
Accept the
the offer
Acceptcosts:
Variable offer ($0.10
($0.10
xxDairy
2,000,000
2,000,000 ==$200,000
$200,000
ingredients $ 0.70
more
Sugarmore profit).
profit). 0.10
Flavoring 0.15
Direct labor 0.25
Packaging 0.20
Commissions 0.02
Distribution 0.03
Other 0.05
Which costs Total variable costs $$1.45
1.50
are irrelevant? Total fixed costs 0.097
Total cost $1.597
$1.45
 17 -28

Sell or Further Process

Yield at Split-Off Further Processing
Grade A
800 lb
Sell for $0.40 lb

Bagged
Joint Cost
Grade B 120 Bags
$300
600 lb Cost $0.05/Bag
Sell for $1.30/Bag

Applesauce
Grade C 500 16-oz Cans
600 lb Cost $0.10/lb
Sell for $0.75 can
 17 -29

Sell or Further Process

Process Differential Amount

Further Sell to Process Further
Revenues $450 $150 $300
Processing cost 120 ---- 120
Total $330 $150 $180

Further
Further process!
process!
 17 -30
Two Approaches to Pricing

1. Cost-Based Pricing
2. Target Costing and
Pricing
 17 -31
Cost-Based Pricing

Revenues $856,500
Cost of goods sold:
Direct materials $489,750
Direct labor 140,000
Overhead 84,000 713,750
Gross profit $142,750
Selling and administrative expenses 25,000
Operating income $117,750
 17 -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
 17 -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) 5,400
Estimated cost of goods sold $114,400
Plus 20 percent markup of COGS 22,880
Bid price $137,280
 17 -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.

 17 -35

Legal
Legal Aspects
Aspects of
of Pricing
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
The Robinson-Patman
Robinson-Patman Act Act isis the
the most
most potent
potent
weapon
weapon against
against price
price discrimination,
discrimination, but but itit doesn’t
doesn’t
cover
cover services
services and
and intangibles.
intangibles.
 17 -36

Linear
Linear Programming
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
 17 -37

Linear
Linear Programming
Programming
Max. Z = $25X x $10Y
Subject to:
2X + 0.5Y  40,000
X  15,000
Y  40,000
X0
Y0
 17 -38

80 –
75 – Machine Hours Constraint
70 – 2X + 0.5Y  40,000
65 –
60 – Demand Constraint
55 – X  15,000
50 –
45 –
E D
40 –
35 – Demand Constraint
30 – Y  40,000
25 –
C
20 – Feasibility
15 – Region
10 –
5–
0–
A | | |B | |
5 10 15 20 25
 17 -39

Linear
Linear Programming
Programming
Corner Point X-Value Y-Value Z = $25X + $10Y

A 0 0 $ 0
B 15 0 375
C 15 20 575
D 10 40 650
E 0 40 400

Manufacture 10,000 units of Gear X and 40,000 of

Gear Y.
 17 -40

Chapter Seventeen

The
The End
End
17 -41