Chapter 11 Decision Making and Relevant Information

Describe two potential problems that should be avoided in​ relevant-cost analysis.

1. Assuming that all variable costs are relevant and all fixed costs are irrelevant. 2. Using​ unit-cost data directly.

Select the three steps​ (in the proper​ order) that are used to solve a linear programming problem.

1. Determine the objective function 2. Specify the constraints 3. Compute the optimal solution

How might the optimal solution of a linear programming problem be​ determined?

1. Trial-and-error solution approach 2. Graphical solution approach

Outline the​ five-step sequence in a decision​ process, in the correct order.

1 Identify the problem and uncertainties 2 Obtain information 3 Make predictions about the future 4 Make decisions by choosing among alternatives 5 Implement the decision, evaluate performance, and learn

​"A branch office or business segment that shows negative operating income should be shut​ down." Do you​ agree? Explain briefly.

No. For​ example, if the revenues that will be lost exceed the costs that will be​ saved, the branch or business segment should not be shut down. Shutting down will only increase the loss.

​"Management should always maximize sales of the product with the highest contribution margin per​ unit." Do you​ agree? Why?

No. Managers should aim to get the highest contribution margin per unit of the constraining factor. The constraining factor is what restricts or limits the production or sale of a given product.

​"Managers will always choose the alternative that maximizes operating income or minimizes costs in the decision​ model." Do you​ agree? Why?

No. Managers tend to favor the alternative that makes their performance look best so they focus on the measures used in the​ performance-evaluation model. If the​ performance-evaluation model does not emphasize maximizing operating income or minimizing​ costs, managers will most likely not choose the alternative that maximizes operating income or minimizes costs.

​"All future costs are​ relevant." Do you​ agree? Why?

No. Relevant costs are defined as those expected future costs that differ among alternative courses of action being considered.​ Thus, future costs that do not differ among the alternatives are irrelevant to deciding which alternative to choose.

​"A component part should be purchased whenever the purchase price is less than its total manufacturing cost per​ unit." Do you​ agree? Why?

No. Some of the total unit costs to manufacture a product may be fixed​ costs, and,​ hence, will not differ between the make and buy alternatives. These fixed costs are irrelevant to the​ make-or-buy decision. The key comparison is between purchase costs and the costs that will be saved if the company purchases the component parts from outside plus the additional benefits of using the resources freed up in the next best alternative use​ (opportunity cost).

​"Variable costs are always​ relevant, and fixed costs are always​ irrelevant." Do you​ agree? Why?

No. Some variable costs may not differ among the alternatives under consideration​ and, hence, will be irrelevant. Some fixed costs may differ among the alternatives​ and, hence, will be relevant.

​"Managers should always buy inventory in quantities that result in the lowest purchase cost per​ unit." Do you​ agree? Why?

No. When deciding on the quantity of inventory to​ buy, managers must consider both the purchase cost per unit and the opportunity cost of funds invested in the inventory. For​ example, the purchase cost per unit may be low when the quantity of inventory purchased is​ large, but the benefit of the lower cost may be more than offset by the high opportunity cost of the funds invested in acquiring and holding inventory.

Distinguish between quantitative and qualitative factors in decision making.

Qualitative factors are outcomes that are difficult to measure accurately in numerical terms. An example is employee morale. Quantitative factors are outcomes that are measured in numerical terms. Some factors are financiallong dashthat ​is, they can be easily expressed in monetary terms. An example is direct materials.

Define relevant costs. Why are historical costs​ irrelevant?

Relevant costs are expected future costs that differ among the alternative courses of action being considered. Historical costs are irrelevant because they are past costs​ and, therefore, cannot differ among alternative future courses of action.

Define opportunity cost.

The contribution to income that is forgone​ (rejected) by not using a limited resource in its​ next-best alternative use.

​"Cost written off as depreciation on equipment already purchased is always​ irrelevant." Do you​ agree? Why?

Yes. Cost written off as depreciation is irrelevant when it pertains to a past cost such as equipment already purchased. The purchase cost of new equipment to be acquired in the future that will then be written off as depreciation is often relevant.