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PGP Section D
Instructor: Akanksha Jalan
Session 7: February 2, 2017
Session Objectives:
Understand:
If something has been done in the past and cannot be changed by any future action, it is
considered SUNK and hence, irrelevant for decision making
Similarly, if an item will remain the same under all the alternatives being considered, its
incremental impact on a decision is zero. It is therefore, considered irrelevant
The airline currently flies routes between Europe and the United States,
between several European cities and several Asian and African cities.
Case 1: Replacement decision
At Heathrow airport in London, Worldwide Airways
John Orville decides not to dispose the parts since doing so will
entail a loss of $ 3,000, which is the difference between book value
and sale value for these.
Wright knows that WAs two jumbo jets that are not currently in use. WA is not
currently planning to launch any new routes, hence the two jets are lying idle.
Also, $ 5,000 will be saved in variable operating costs of running these special
flights, related to ticketing etc.
Given the cost data for a typical round-trip flight between Hong Kong and
London in the next slide, do you suggest accepting the Chinese companys offer?
Cost data HK to London, round-trip
Revenue:
Passenger $ 2,50,000
Expenses:
Variable costs:
Variable costs:
85,000
Variable costs:
Now suppose that you are informed that discontinuation of the WA club
Scarcity necessitates that these resources be used in the best possible manner, to maximize profitability
Scarcity can be dealt with relatively easily in case of a firm selling a single product, but they can be
difficult to deal with in a multi-product firm, given the need to calculate the production priority or the
optimum mix
The reason is that different products use different quantities of the scarce resource, have different
contribution margins etc.
Simple thumb-rule: Always calculate for each product, its contribution per unit of the scarce
resource and then calculate ranks in terms of production preference
Example: International
Chocolate Company
Source: Managerial Accounting, Hilton and Platt, 9th edition
The International Chocolate Company
(ICC)
The ICCs Bruges plant makes two specialty products bars and truffles
The contribution-margin data for both these products is provided to you:
Bars Truffles
Machine hours required per case 0.02 0.05
Sales price $ 10 $ 14
Less: Variable costs
Direct material $3 $ 3.75
Direct labor 2 2.50
Variable overhead 3 3.75
Variable selling and administrative costs 1 2
Total variable costs $ 9.00 $ 12.00
Contribution margin per case $ 1.00 $ 2.00
A. Dealing with scarcity
You are further informed that the Bruges plant capacity is limited by
its available machine time. Only 700 machine hours are available in
the plant each month
Sales price $ 10 $ 14
Rank 1 2
1. Now suppose that the maximum quantity of bar cases that can be
sold in the market are 25,000. How much of each product would you
produce now?