CHAPTER 11
DECISION MAKING AND RELEVANT INFORMATION
11-1 The five steps in the decision process outlined in Exhibit 11-1 of the text are
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
11-2 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.
11-3 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.
11-4 Quantitative factors are outcomes that are measured in numerical terms. Some
quantitative factors are financial––that is, they can be easily expressed in monetary terms. Direct
materials is an example of a quantitative financial factor. Other quantitative nonfinancial factors,
such as on-time flight arrivals, cannot be easily expressed in monetary terms. Qualitative factors
are outcomes that are difficult to measure accurately in numerical terms. An example is
employee morale.
11-5 Two potential problems that should be avoided in relevant cost analysis are
(i) Do not assume all variable costs are relevant and all fixed costs are irrelevant.
(ii) Do not use unit-cost data directly. It can mislead decision makers because
a. it may include irrelevant costs, and
b. comparisons of unit costs computed at different output levels lead to erroneous
conclusions
11-6 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.
11-7 No. Some of the total manufacturing cost per unit of a product may be fixed, 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). Furthermore,
managers should consider nonfinancial factors such as quality and timely delivery when making
outsourcing decisions.
11-8 Opportunity cost is the contribution to income that is forgone (rejected) by not using a
limited resource in its next-best alternative use.
11-1
, 11-9 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.
11-10 No. Managers should aim to get the highest contribution margin per unit of the
constraining (that is, scarce, limiting, or critical) factor. The constraining factor is what restricts
or limits the production or sale of a given product (for example, availability of machine-hours).
11-11 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.
Allocated costs and fixed costs that will not be saved are irrelevant to the shut-down decision.
11-12 Cost written off as depreciation is irrelevant when it pertains to a past cost such as
equipment already purchased. But the purchase cost of new equipment to be acquired in the
future that will then be written off as depreciation is often relevant.
11-13 No. Managers often 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.
11-14 The three steps in solving a linear programming problem are
(i) Determine the objective function.
(ii) Specify the constraints.
(iii) Compute the optimal solution.
11-15 The text outlines two methods of determining the optimal solution to an LP problem:
(i) Trial-and-error approach
(ii) Graphic approach
Most LP applications in practice use standard software packages that rely on the simplex method
to compute the optimal solution.
11-2
DECISION MAKING AND RELEVANT INFORMATION
11-1 The five steps in the decision process outlined in Exhibit 11-1 of the text are
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
11-2 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.
11-3 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.
11-4 Quantitative factors are outcomes that are measured in numerical terms. Some
quantitative factors are financial––that is, they can be easily expressed in monetary terms. Direct
materials is an example of a quantitative financial factor. Other quantitative nonfinancial factors,
such as on-time flight arrivals, cannot be easily expressed in monetary terms. Qualitative factors
are outcomes that are difficult to measure accurately in numerical terms. An example is
employee morale.
11-5 Two potential problems that should be avoided in relevant cost analysis are
(i) Do not assume all variable costs are relevant and all fixed costs are irrelevant.
(ii) Do not use unit-cost data directly. It can mislead decision makers because
a. it may include irrelevant costs, and
b. comparisons of unit costs computed at different output levels lead to erroneous
conclusions
11-6 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.
11-7 No. Some of the total manufacturing cost per unit of a product may be fixed, 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). Furthermore,
managers should consider nonfinancial factors such as quality and timely delivery when making
outsourcing decisions.
11-8 Opportunity cost is the contribution to income that is forgone (rejected) by not using a
limited resource in its next-best alternative use.
11-1
, 11-9 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.
11-10 No. Managers should aim to get the highest contribution margin per unit of the
constraining (that is, scarce, limiting, or critical) factor. The constraining factor is what restricts
or limits the production or sale of a given product (for example, availability of machine-hours).
11-11 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.
Allocated costs and fixed costs that will not be saved are irrelevant to the shut-down decision.
11-12 Cost written off as depreciation is irrelevant when it pertains to a past cost such as
equipment already purchased. But the purchase cost of new equipment to be acquired in the
future that will then be written off as depreciation is often relevant.
11-13 No. Managers often 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.
11-14 The three steps in solving a linear programming problem are
(i) Determine the objective function.
(ii) Specify the constraints.
(iii) Compute the optimal solution.
11-15 The text outlines two methods of determining the optimal solution to an LP problem:
(i) Trial-and-error approach
(ii) Graphic approach
Most LP applications in practice use standard software packages that rely on the simplex method
to compute the optimal solution.
11-2
