Question

For each of the situations below (in your words - do not copy from textbook), describe the analysis to be done and what would be the deciding factors in making each choice?

*Make or Buy

*Scrap or rework

*Sell as is or process further

*Sales Mix Selection

*Segment Elimination

*Keep assets or Replace assets

Answer 1

1. Make or Buy: In make or buy decision, we should select the lowest cost alternative.The cost of making the product internally is the cost that will be avoided if the product is not made. This will be the maximum outside purchase price. Other deciding factors are: the quality of the product purchased compared wih the quality of the product manufactured,the reliablility of the purchased product,the value of service contracts orother warranties, risks associated with buying outside etc.

2. Scrap or rework : As long as rework costs are recovered through sale of the product, and rework does not interfere with normal production,we should rework rather than scrap products in process.

3 Sell or process further: This decision is made based on profitability. The decision on whether to sell at the split off point is made by comparing the incremental cost and the incremental revenue generated after the split-off point. If the incemental revenue exceeds the incremental cost, the organization should process further. If the incremental cost exceeds the incremental revenue,the organization should sell at the split-off point.

4. Sales mix selection : In deciding the best sales mix, the management must consider, the contribution margin of each product,the facilities required to produce each product and anyconstraints on the facilities, the demand for each product.

5. Segment elimination : We should compare the fixed costs that can be avoided if the segment is dropped to the contribution margin that will be lost if the segment is dropped. Kep the segment if the lost contribution margin exceeds avoided fixed costs. Drop the segment if the lost contribution margin is less than avoided fixed costs.

6.Keep assstes or replace assets : This decision is based on the net present value and incremental rate of return of the incremental cash flows i.e the difference between periodic net cash flows if the existing asset is kept and the periodic net cash flows if the asset is replaced.