Decision Points

Decision	Guidelines
1. What is the five-step process that managers can use to make decisions?	The five-step decision-making process is (a) identify the problem and uncertainties; (b) obtain information; (c) make predictions about the future; (d) make decisions by choosing among alternatives; and (e) implement the decision, evaluate performance, and learn.
2. When is a revenue or cost item relevant for a particular decision, and what potential problems should managers avoid in relevantcost analysis?	To be relevant for a particular decision, a revenue or cost item must (a) be an expected future revenue or expected future cost and (b) differ among alternative courses of action. Relevant-revenue and relevant-cost analysis only consider quantitative outcomes that can be expressed in financial terms. But managers must also consider nonfinancial quantitative factors and qualitative factors, such as employee morale, when making decisions.
	Two potential problems to avoid in relevant-cost analysis are (a) making incorrect general assumptions—such as all variable costs are relevant and all fixed costs are irrelevant—and (b) losing sight of total fixed costs and focusing instead on unit fixed costs.
3. What is an opportunity cost, and why should managers consider it when making insourcing-versus-outsourcing decisions?	Opportunity cost is the contribution to income that is forgone by not using a limited resource in its next-best alternative use. Opportunity cost is included in decision making because the relevant cost of any decision is (a) the incremental cost of the decision plus (b) the opportunity cost of the profit forgone from making that decision. When capacity is constrained, managers must consider the opportunity cost of using the capacity when deciding whether to produce a product in-house versus outsourcing it.
4. When a resource is constrained, how should managers choose which of multiple products to produce and sell?	When a resource is constrained, managers should select the product that yields the highest contribution margin per unit of the constraining or limiting resource (factor). This will maximize total contribution margin.
5. What steps can managers take to manage bottlenecks?	Managers can take four steps to manage bottlenecks: (a) recognize that the bottleneck operation determines throughput (contribution) margin, (b) identify the bottleneck, (c) keep the bottleneck busy and subordinate all nonbottleneck operations to the bottleneck operation, and (d) increase bottleneck efficiency and capacity.
6. In deciding to add or drop customers or to add or discontinue branch offices or business divisions, what should managers focus on, and how should they take into account allocated overhead costs?	When making decisions about adding or dropping customers or adding or discontinuing branch offices and business divisions, managers should focus on only those costs that will change and any opportunity costs. Managers should ignore allocated overhead costs.
7. Is book value of existing equipment relevant in equipment-replacement decisions?	Book value of existing equipment is a past (historical or sunk) cost and, therefore, is irrelevant in equipment-replacement decisions.
8. How can conflicts arise between the decision model a manager uses and the performanceevaluation model top management uses to evaluate that manager?	Top management faces a persistent challenge: making sure that the performance-evaluation model of lower-level managers is consistent with the decision model. A common inconsistency is to tell these managers to take a multiple-year view in their decision making but then to judge their performance only on the basis of the current year’s operating income.