STRATEGIC COST MANAGEMENT - Solutions Manual

CHAPTER 12

QUANTITATIVE TECHNIQUES FOR DECISION MAKING

Questions
1. a. Decision tree analysis provides a systematic framework for analyzing a sequence of
interrelated decisions which may be made over time. Decision making is formulated in terms
of the consequence of acts, events and consequences because it is believed that present
decisions affect future profitability. The study and understanding of alternative scenarios is
encouraged with the use of decision tree analysis.
b. Advantages of Decision Tree Analysis
1. Clarifies the choices, risks, and monetary gains involved in an investment problem.
2. Presents the relevant information more clearly.
3. Combines action choices with different possible events or results of action which are
partially affected by chance or other uncontrollable circumstances.
4. Encourages the focus on the relationship between current and future decisions.
5. Utilizes such analytical techniques as present value and discounted cash flow.
6. Considers various alternatives with greater ease.
Weaknesses of Decision Tree Analysis
1. Not all events that can happen can be/are identified.
2. Not all the decisions that must be made on a subject under analysis are listed because
choices are usually not restricted to two or three.
3. If a large number of choices is involved, decision tree analysis by hand becomes
complicated.
4. Uncertain alternatives are generally treated as if they were discrete, well-defined
possibilities.
2. Refer to page 347 of the textbook.
3. PERT is superior to Gantt Charts in complex projects because:
a. PERT charts are flexible and can reflect slippage or changes in plans, but Gantt charts simply
plot a bar chart against a calendar scale.
b. PERT charts reflect interdependencies among activities; Gantt charts do not.
c. PERT charts reflect uncertainties or tolerances in the time estimates for various activities;
Gantt charts do not.
4. The use of PERT provides a structured foundation for planning complex projects in sufficient
detail to facilitate effective control.
A workable sequence of events that comprise the project are first identified. Each key event
should represent a task; then the interdependent relationships between the events are structured.
After the network of events is constructed, cost and time parameters are established for each
package. Staffing plans are reviewed and analyzed.
The “critical path” computation identifies sequence of key events with total time equal to the time
allotted for the project’s completion. Jobs which are not on the critical path can be slowed down
and the slack resources available on these activities reallocated to activities on the critical path.
Use of PERT permits sufficient scheduling of effort by functional areas and by geographic
location. It also allows for restructuring scheduling efforts and redeployment of workers as
necessary to compensate for delays or bottlenecks. The probability of completing this complex
project on time and within the allotted budget is increased.

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5. Time slippage in noncritical activities may not warrant extensive managerial analysis because of
available slack, but activity cost usually increases with time and should be monitored.
6. The critical path is the network path with the longest cumulative expected activity time. It is
critical because a slowdown along this path delays the entire project.
7. Crashing the network means finding the minimum cost for completing the project in minimum
time in order to achieve an optimum tradeoff between cost and time. The differential crash cost
of an activity is the additional cost of that activity for each period of time saved.
8. Slack is the amount of time an event can be delayed without affecting the project’s completion
date. Slack can be utilized by management as a buffer against bottlenecks that may occur on the
critical path.
9. Unit gross margin are typically computed with an allocation of fixed costs. Total fixed costs
generally will not change with a change in volume within the relevant range. Unitizing the fixed
costs results in treating them as though they are variable costs when, in fact, they are not.
Moreover, when multiple products are manufactured, the relative contribution becomes the
criterion for selecting the optimal product mix. Fixed costs allocations can distort the relative
contributions and result in a suboptimal decision.
10. This approach will maximize profits only if there are no constraints on production or sales, or if
both products use all scarce resources at an equal rate. Otherwise management would want to
maximize the contribution per unit of scarce resource.
11. The opportunity cost of a constraint is the cost of not having additional availability of the
constrained resources. This is also called a shadow price.
12. The feasible production region is the area which contains all possible combinations of production
outputs. It is bounded by the constraints imposed on production possibilities. The production
schedule which management chooses must come from the feasible production region.
13. The accountant usually supplies the contribution margin data that is used in formulating a profit-
maximizing objective function. In addition, the accountant participates in the analysis of linear
programming outputs by assessing the costs of additional capacity or of changes in product mix.
14. a. Hourly fee for inventory audit (C)
b. Salary of purchasing supervisor (N)
c. Costs to audit purchase orders and invoices (P)
d. Taxes on inventory (C)
e. Stockout costs (P)
f. Storage costs charged per unit in inventory (C)
g. Fire insurance on inventory (C)
h. Fire insurance on warehouse (N)
i. Obsolescence costs on inventory (C)
j. Shipping costs per shipment (P)
15. Although the inventory models are developed by operations researchers, statisticians and
computer specialists, their areas of expertise do not extend to the evaluation of the differential
costs for the inventory models. Generally, discussions of inventory models take the costs as
given. It is the role of the accountant to determine which costs are appropriate for inclusion in an
inventory model.
16. Cost of capital represents the interest expense on funds if they were borrowed or opportunity cost
if funds were provided internally or by owners. It is included as carrying cost of inventory
because funds are tied up in inventory.

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 17. Costs that vary with the average number of units in inventory:
Inventory insurance P 2.80
Inventory tax 2.05 (P102.25 x 2%)
Total P 4.85
Costs that vary with the number of units purchased:
Purchase price P102.25
Insurance on shipment 1.50
Total P103.75
Total carrying cost = (25% x P103.75) cost of capital + P4.85 = P25.94 + P4.85 = P30.79
Order costs:
Shipping permit P201.65
Costs to arrange for the shipment 21.45
Unloading 80.20
Stockout costs 122.00
Total P425.30

Answer to Problems

Problem 1 (Solution is found on the next page.)

Problem 2

Requirement (a)
The critical path through each of the three alternative paths calculated as the longest is 0 - 1 - 6- 7- 8.
0-1-2-5-8 2 + 8 + 10 + 14 = 34
0-1-3-4-7-8 2 + 8 + 7 + 5 + 3 = 25
0-1-6-7-8 2 + 26 + 9 + 3 = 40*
________
* critical

Requirement (b)
40 - 3 - 5 = 32

Requirement (c)
If path 4 - 7 has an unfavorable time variance of 10, this means it takes a total time of 15 to finish this
activity rather than 5. This gives the path 0 - 1 - 3 - 4 - 7 - 8 a total time of 35, but since this is less
than the critical path of 40, it has no effect.

Requirement (d)
The earliest time for reaching event 5 via 0 - 1 - 2 - 5 is 20, the sum of the expected times.

Problem 3

No, they didn’t make a right decision, since they included fixed costs which do not differ in the short
run. If they had used contribution margin instead of gross margin, they would have had P5 for G1
and P6.50 for G2, therefore they would have decided to produce G2 exclusively.

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Problem 1

Requirement (a)

TASKS 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28

Hobbing Order 1 Order 3 Order 4 Order 2

Machining X X X X Order 1 X X Order 3 X X X Order 4 Order 2

___________
X Dead Time

Requirement (b)

28 days are required for the four orders.

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Problem 4

Order costs = Insurance + Other order costs

P = P860 + P18 = P878

Carrying costs = Out-of-pocket Cost of capital

costs + on inventory
S = P65 + 20% x P222 = P119.40

a. Carrying costs:
QS 250 x P109.40
2 = 2 =P13,675.00

Order costs:
AP 1,500 x P878
Q = 250 = P 5,268.00

Total P18,943.00

b. Economic order quantity:


2 x 1,500 x P878
Q* = =  24,077 = 155 units
P109.40

Carrying costs:
QS 155 x P109.40
2 = 2 =P 8,478.50

Order costs:
AP 1,500 x P878
Q = 155 = P 8,496.77

Total P16,975.27

Problem 5

It is necessary to evaluate the annual carrying costs and expected stockout costs at each safety-stock
level. The carrying cost will be P24.40 for each unit in safety stock. With the given order size, there
are 15 orders placed a year (i.e., 39,000/2,600 = 15). Based on these computations, we prepare the
following schedule:

Safety Carrying Costs Expected Stockout Total

Stock of Safety Stock Costs Costs
0 0 0.50 x 15a x P1,650 = P12,375 P12,375
150 150 x P24.40 = P3,660 0.20 x 15a x P1,650 = P 4,950 8,610
175 175 x P24.40 = P4,270 0.05 x 15a x P1,650 = P 1,273.5 5,507.5 (optional)
250 250 x P24.40 = P6,100b 0.01 x 15a x P1,650 = P 247.5 6,347.5

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 Additional computations:
a
15 is the number of orders per year.
b
It should be evident that at this level the carrying costs alone exceed the total costs at a safety stock of 175
units. Therefore, it is not possible for this or any safety-stock level larger than 250 to be less costly than 175
units. Indeed, given a total cost at 175 units of P5,507.5, stockout costs would have to occur with probability
zero for any safety stock greater than 225.72 units (i.e., P5,507.5 / P24.40 = P225.72).

Answer to Multiple Choice Questions

1. A 11. B 21. B 31. C 41. C

2. A 12. D 22. D 32. A 42. C
3. B 13. C 23. B 33. A 43. D
4. B 14. B 24. B 34. A 44. C
5. B 15. A 25. D 35. C 45. D
6. C 16. B 26. C 36. D 46. D
7. B 17. C 27. B 37. C 47. C
8. D 18. D 28. D 38. A 48. C
9. A 19. D 29. B 39. A 49. D
10. D 20. A 30. D 40. A 50. D

51. B 61. C
52. D 62. D
53. C 63. D
54. B
55. A
56. C
57. D
58. A
59. C
60. D

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