Decision Making in break
even analysis
Decisions
A decision model is a formal method
of making a choice, often involving
both quantitative and qualitative
analyses.
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Relevant Cost Decisions
A relevant cost is a cost that
differs between alternatives.
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Types of Decisions
Make or Buy decisions
Multi product decisions.
Product add or drop decisions.
Capacity expansion decisions.
Equipment selection decisions.
Production process selection
decisions.
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The Make or Buy Decision
A decision concerning whether an item
should be produced internally or
purchased from an outside supplier is
called a “make or buy” decision.
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Factors affecting make or buy
decisions
Available capacity:
Expertise
Quality considerations
Nature of demand
cost
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Secondary factors
Availability of suppliers
Control of design secrets
Desire to expertise in the relevant
field
Delivery schedule to be met
Employee preference for particular
nature of work.
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When to make?
Higher purchase price
Assurance of timely availability
Availability of the required facility in
house
Better control of quality
Need to preserve trade secrets and
designs
Savings on transportation cost
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End
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Product-Mix Decisions
The decisions made by a company
about which products to sell and in
what quantities
Decision Rule (with a constraint):
choose the product that produces the
highest contribution margin per unit
of the constraining resource
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Adding or Dropping Customers
Decision Rule: Does adding or
dropping a customer add operating
income to the firm?
Yes – add or don’t drop
No – drop or don’t add
Decision is based on profitability of
the customer, not how much revenue
a customer generates
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Joint Products
Joint
Oil
Costs
Common
Joint
Production Gasoline
Input
Process
Chemicals
Split-Off
Point
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Joint Products
Joint
Separate Final
Costs Oil
Sale
Processing
Common
Joint Final
Production Gasoline
Input Sale
Process
Separate Final
Chemicals
Processing Sale
Split-Off Separate
Point Product
Costs
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The Pitfalls of Allocation of Joint
Costs
Joint costs are really common costs
incurred to simultaneously produce a
variety of end products.
Joint costs are often allocated to end
products on the basis of the relative
sales value of each product or on
some other basis.
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Sell or Process Further
Decision Rule:
It will always profitable to continue
processing a joint product after the
split-off point so long as the
incremental revenue exceeds the
incremental processing costs incurred
after the split-off point.
Let’s look at the Kere example.
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Sell or Process Further
Kere Company cuts logs from which
unfinished lumber and sawdust are the
immediate joint products.
Unfinished lumber is sold “as is” or
processed further into finished lumber.
Sawdust can also be sold “as is” to
gardening wholesalers or processed
further into “ready-logs.”
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Adding/Dropping Segments
One
One of
of the
the most
most important
important decisions
decisions
managers
managers make
make is
is whether
whether to to add
add or
or
drop
drop aa business
business segment
segment such
such as
as aa
product
product or
or aa store.
store.
Let’s
Let’s see
see how
how relevant
relevant costs
costs
should
should be
be used
used in
in this
this
decision.
decision.
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