CHAPTER 1 1 ACCOUNTING: INFORMATION FOR DECISION FOR DECISION MAKING
SOLUTIONS R EVIEW EVIEW QUESTIONS
1.1
Step 1: Specify the decision problem, problem, including the decision decision maker’s goals. Step 2: Identify options. Step 3: Measure benefits ad!antages" and costs disad!antages" to d etermine the !alue benefits reaped less costs incurred" of each option. Step #: Make the decision, choosing the option $ith the highest !alue.
1.2
%ecause people place different different emphasis emphasis on factors such as money, money, risk, risk, and leisure.
1.3
&he benefits benefits of of an option option less less its its costs. costs. %ecause %ecause !alue !alue is the the contributi contribution on of an option option to to the decision maker’s goals, $e measure !alue relati!e to the status 'uo, $hich is not doing anything at all.
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&he !alue of the ne(t best option.
1.)
*n organi+ation organi+ation is a group of indi!iduals indi!iduals engaged in a collecti!ely beneficial beneficial mission. mission. &he key difference bet$een indi!idual and organi+ational decision making relates to goals organi+ational goals rarely coincide $ith the goals of all indi!idual participants.
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1" olici olicies es and procedures/ procedures/ 2" Monitor Monitoring/ ing/ 3" 3" Incenti! Incenti!ee schemes schemes and performance performance e!aluation.
1.0
lanning lanning decisions decisions relat relatee to choices choices about ac'uiring ac'uiring and using using resourc resources es to deli!er deli!er product productss and ser!ices to customers. ontrol decisions relate to moti!ating, monitoring, and e!aluating performance.
1.
lan, lan, Imple Implemen ment, t, !alu !aluate ate,, 4e!ise 4e!ise I4 I4 ycle ycle". ".
1.5
&o help help measure measure the the costs costs and benefi benefits ts of decis decision ion opti options ons..
1.16 ersons outside the firm. &hese indi!iduals make decisions about buying and selling stock, lending money, di!idends, and ta(es. 1.11 ersons ersons inside the firm. firm. &hese indi!iduals indi!iduals make decisions decisions about $hich products products and ser!ices to offer, the prices of products and ser!ices, $hat e'uipment to purchase, $ho to hire and ho$ to pay them.
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1?2
1.12 &he primary users e(ternal e(ternal !s. internal", go!erning principles, the unit of analysis, emphasis, periodicity, and types of data considered. 1.13 thics thics relate to e!ery step step of the decision frame$or frame$ork. k. thics can shape our goals, goals, the options $e consider, ho$ $e measure costs and benefits, and the ultimate decision $e make. 1.1# &he 7oreign 7oreign orrupt orrupt ractic ractices es *ct *ct of 1500. 1500. 1.1) &he key financial financial players include the 8, 78, controller, treasurer, and chief internal auditor. &he &he roles of each player are described in detail in the appendi(. appen di(. 1.1- 1" ompetence, 2" onfidentiality, onfidentiality, 3" Integrity Integrity,, and #" 8b=ecti!ity. 8b=ecti!ity.
DISCUSSION QUESTIONS
1.10 ith >ith this goal in mind, mind, you ha!e to plan a career path and e!aluate the the three =ob offers to see $hich of these =obs $ill take you on that path. %esides pay, factors such as the reputation of the organi+ation, o rgani+ation, the 'uality of on?the?=ob training you $ill get, opportunities to climb the organi+ational ladder are !ery important from a career perspecti!e. If all three =ob offers are e'ually attracti!e attracti!e in terms of the career you ha!e chosen for yourself, then short?term goals and desires $ill dictate $hich =ob offer you should accept. *ll else e'ual, you $ill naturally $ant to accept the =ob offer that pays you the most, or you may be $illing to accept slightly lo$er pay to li!e in a city that you like, or $ork for an organi+ation $ith better reputation, and so on. 1.1
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1?2
1.12 &he primary users e(ternal e(ternal !s. internal", go!erning principles, the unit of analysis, emphasis, periodicity, and types of data considered. 1.13 thics thics relate to e!ery step step of the decision frame$or frame$ork. k. thics can shape our goals, goals, the options $e consider, ho$ $e measure costs and benefits, and the ultimate decision $e make. 1.1# &he 7oreign 7oreign orrupt orrupt ractic ractices es *ct *ct of 1500. 1500. 1.1) &he key financial financial players include the 8, 78, controller, treasurer, and chief internal auditor. &he &he roles of each player are described in detail in the appendi(. appen di(. 1.1- 1" ompetence, 2" onfidentiality, onfidentiality, 3" Integrity Integrity,, and #" 8b=ecti!ity. 8b=ecti!ity.
DISCUSSION QUESTIONS
1.10 ith >ith this goal in mind, mind, you ha!e to plan a career path and e!aluate the the three =ob offers to see $hich of these =obs $ill take you on that path. %esides pay, factors such as the reputation of the organi+ation, o rgani+ation, the 'uality of on?the?=ob training you $ill get, opportunities to climb the organi+ational ladder are !ery important from a career perspecti!e. If all three =ob offers are e'ually attracti!e attracti!e in terms of the career you ha!e chosen for yourself, then short?term goals and desires $ill dictate $hich =ob offer you should accept. *ll else e'ual, you $ill naturally $ant to accept the =ob offer that pays you the most, or you may be $illing to accept slightly lo$er pay to li!e in a city that you like, or $ork for an organi+ation $ith better reputation, and so on. 1.1
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1?3 1.21 Bifference Bifferencess in indi!idual indi!idual goals goals can arise arise from: from: •
• •
Bifferences in preferences: Some indi!iduals place a greater $eight on ma(imi+ing $ealth, others place a greater $eight on being the best in $hat they do the t$o are not al$ays perfectly correlated" *ttitudes to$ard risk: Some ha!e a greater tolerance for risk than others Bifferences in ethical thresholds: >hat is perfectly acceptable ethical beha!ior for some may not be acceptable to others.
* asino is a good e(ample of a business that e(ploits !ariations in indi!idual tastes for risk. asinos tailor their offerings to accommodate indi!iduals $ith different risk tolerance le!els some in!ol!e high stakes $here risks and returns are higher, and others in!ol!e lo$ stakes. 1.22 &his problem is an e(ercise e(ercise in conditional probability. probability.
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1.23 &he goal of a nonprofit nonprofit hospital hospital is to pro!ide ade'uate ade'uate healthcare healthcare to the community community it ser!es at lo$ cost, $ithout a profit moti!e. &he goal of a uni!ersity is to meet the educational needs of the communityCcountry and to promote kno$ledge and disco!ery. Many uni!ersities also attract students from other statesCcountries as part of an outreach effort to promote di!ersity and learning. State uni!ersities are mostly go!ernment funded and do not ha!e an e(plicit profit moti!e, but most pri!ate uni!ersities do. &he goal of an honor society in a uni!ersity is to promote academic aca demic e(cellence, cultural di!ersity, and leadership. 1.2# &he goal of a class is typically articulated articulated in the syllabus syllabus to effecti!ely communicate the the sub=ect matter and its importance to the students, and to ensure that students lea!e the class $ith a good understanding of the concepts, principles and methods relating to the sub=ect matter. orking >orking $ell in groups becomes a matter of life and death. So there is a natural alignment bet$een team and indi!idual goals. In a typical profit?making organi+ation, the Kfree?riderL problem is more difficult to to eliminate, because there is a natural incenti!e for each indi!idual to contribute minimally to team goals and yet try to reap the full benefit. hen $e say Kthat $asn’t $asn’t too bad,L $e are essentia essentially lly comparing comparing $hat happened happened $ith $hat $e e(pected $ould happen. &hat is, our e(pectations $ere not met. Most of us plan ahead, and sometimes things don’t 'uite go the $ay $e plan, for reasons beyond our control. In such instances, $e ad=ust our e(pectations and then e!aluate $hat actually happened. 7or e(ample, let us say you set out on a dri!e to hicago from Houston and you %alakrishnan, Managerial *ccounting 1e, A 2665
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1?) plan to co!er the distance in 12 hours. %ut along the $ay, you run into une(pected rough $eather, and it takes you 1 hours to reach hicago. Ji!en the dri!ing conditions that you had to endure, you say to yourself Kthat $asn’t too badL 1.2
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EXERCISES
1.33. a. Microsoft corporation lists “ [T]o enable people and businesses throughout the world to realize their full potential L as its o!erarching mission. &he firm also lists a !ariety of related goals and strategies, such as trust$orthy computing and broad customer connection, designed to accomplish this mission. Microsoft’s goals and ob=ecti!es are particularly note$orthy because they do not make e(plicit reference to the shareholders’ ultimate goal of ma(imi+ing the return on their in!estment. &here are at least t$o $ays to !ie$ this omission. Some argue that, as a modern organi+ation, Microsoft recogni+es the claims of multiple stakeholders in the corporation arising because of the firm’s si+e and impact on the economy. &hat is, the organi+ation recogni+es its obligations to parties such as its customers, employees, and society. * modern firm’s mission statement reflects this broader !ie$ of the organi+ation in $hich profit ma(imi+ation is not the firm’s only goal. 8thers argue that e!en the broader statements are a means to an end. 7or e(ample, the goal of Ktrust$orthy computingL or Ke(cellence in e!erything $e doL surely increases the market for Microsoft’s products. Similarly, a firm may stress en!ironment?friendly operations because doing so is good business. &he focus helps the firm reduce costs by reducing the risk of future litigation and payouts", increase re!enues by potentially enlarging the customer base", and comply $ith go!ernmental regulations thereby a!oiding fines". Similar arguments apply for firms’ attention to $orker health and safety. &hus, one might !ie$ all of Microsoft’s goals and strategies as being consistent $ith profit ma(imi+ation. %oth !ie$s are reasonable. &he strength of your belief in the for?profit orientation of corporations determines your choice bet$een the t$o e(tremes listed abo!e. b. &he mission statement for the Metropolitan Museum of *rt popularly kno$n as the Met" states: The mission of The Metropolitan Museum of Art is to collect, preserve, study, exhibit, and stimulate appreciation for and advance knowledge of works of art that collectively represent the broadest spectrum of human achievement at the highest level of uality, all in the service of the public and in accordance with the highest professional standards!
&his statement underscores the museum’s not?for?profit moti!e and emphasi+es the museum’s mission on all aspects of the study of art. 9otice that, similar to the mission statement of the orporation for ublic %roadcasting, the Met’s mission statement is !ery inclusi!e regarding the definition of art and the museum’s beneficiaries.
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1?0 %oth Microsoft’s and the Metropolitan Museum of *rt’s mission statements take a broad !ie$ of the organi+ation’s mission. areful scrutiny re!eals that Microsoft’s mission statement is !ery customer focused, $hereas the Met’s mission statement focuses on the art itself. &he differing foci are indicati!e of Microsoft’s for?profit orientation 'uality, inno!ati!e products, and customer satisfaction are all stepping?stones to profit" and the Met’s orientation of increasing the appreciation for art regardless of profit". 1.3#.
&he credo for ohnson and ohnson states:
"e believe our first responsibility is to the doctors, nurses and patients, to mothers and fathers and all others who use our products and services! #n meeting their needs everything we do must be of high uality "e must constantly strive to reduce our costs in order to maintain reasonable prices! $ustomers% orders must be serviced promptly and accurately! &ur suppliers and distributors must have an opportunity to make a fair profit! "e are responsible to our employees, the men and women who work with us throughout the world! 'veryone must be considered as an individual! "e must respect their dignity and recognize their merit! They must have a sense of security in their (obs! $ompensation must be fair and adeuate, and working conditions clean, orderly and safe! "e must be mindful of ways to help our employees fulfill their family responsibilities! 'mployees must feel free to make suggestions and complaints! There must be eual opportunity for employment, development and advancement for those ualified! "e must provide competent management, and their actions must be (ust and ethical! "e are responsible to the communities in which we live and work and to the world community as well! "e must be good citizens ) support good works and charities and bear our fair share of taxes! "e must encourage civic improvements and better health and education! "e must maintain in good order the property we are privileged to use, protecting the environment and natural resources! &ur final responsibility is to our stockholders! *usiness must make a sound profit! "e must experiment with new ideas! +esearch must be carried on, innovative programs developed and mistakes paid for! ew euipment must be purchased, new facilities provided and new products launched! +eserves must be created to provide for adverse times! "hen we operate according to these principles, the stockholders should realize a fair return!
&he abo!e statement underscores N’s multi?faceted ob=ecti!es. It recogni+es obligations to customers, suppliers, employees, the community and shareholders. Interestingly, the statement puts shareholders last, almost asserting that if $e take care of the others, shareholders $ill automatically earn a fair return. &he importance of the credo to the firm also is e!ident by its placement on the firm’s home page.
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1.3). a. 7or this decision, your goal is to minimi+e the amount that you pay o!er the semester for fitness cost is your primary consideration. b. %ased on the information pro!ided, you ha!e t$o options: 1. oin the fitness center for the semester at a cost of O6. 2. ay for the fitness center on a per use basis at a cost of O# per !isit. >e also could include a third option not using the fitness center at all the status 'uo". Ho$e!er, it appears that you ha!e re=ected this option and are committed to using the fitness center in some fashion. c. &he cash outflo$ associated $ith option is: 1. O6, or the amount it costs to =oin the fitness center. 2. 1- P O# G O-#. Since you plan on using the fitness center 1- times and each !isit costs O#". d. Ji!en the a!ailable options, you are better off to the tune of O1-, or O6?O-#" by payin !"# $%& !i$n&'' (&n$ on a per?use basis rather than =oining the fitness center. 9otice ho$ the four step frame$ork is applicable to Ke!erydayL decisions, in addition to business decisions. Indeed, $e could use the four?steps to frame e!ery decision $e make *dditionally, the timing of cash flo$ may be important if a student has to pay the O6 all at once, then this reduces the attracti!eness of =oining as some students may not ha!e the O6 to spare, especially at the beginning of the semester 9ote: ncertainty and beliefs might affect students’ choices for e(ample, if students belie!e that there is a significant chance they $ill really get into e(ercise routine and use the fitness center more often than once a $eek, then =oining may be the best $ay to go. If students belie!e that they $ill use the center more than 26 times, then =oining is the lo$?cost alternati!e since 26 P O# G O6". 7urther, some may pay the fee to moti!ate themsel!es...KI ha!e paid O6 and I better get some return for it.L Ho$e!er, as $e $ill learn later, such thinking is a classic Ksunk cost fallacy.L 1.3-. a. &he !alue associated $ith scrapping the action figures is the cost associated $ith disposing of them. %ecause scrapping the action figures $ill cost O1,666, the !alue of this option is )*1+,,,- . b. 4e$orking the action figures $ill cost &oys *hoy O1,266, but selling them to the toy store $ill bring in O0)6 in re!enues. &hus, the !alue of re$orking the action figures and selling them to the toy store is O0)6 O1,266 G )*./,-0 %alakrishnan, Managerial *ccounting 1e, A 2665
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nfortunately, the !alue of both options is negati!e. Ho$e!er, relati!e to scrapping the toys, re$orking them increase’s &oys *hoy’s profit by O#)6" O1,666" G O))6. T%'+ #&2"#3in $%& a($i"n !i#&' i' $%& p#&!#&4 "p$i"n . c. Intuiti!ely, the fact that &oys *hoy spent O-.2) to produce each action figure is n"$ #&5&6an$ $" $%& 4&(i'i"n at hand because &oys *hoy has already incurred the e(penditure it is a sunk cost. That is, this cost does not change relative to the status quo. *s discussed in more detail in hapter 2, !alue is for$ard looking and in!ol!es measuring future sacrifices and future benefits. 1.30. a. &he opportunity cost of any option is the !alue of the ne(t?best option. *ssume on could use the same color paint for another =ob. >hat’s on’s ne(t?best optionQ &he problem makes it clear that the paint is Kuni'ueL and has fe$, if any, alternati!e uses. Ji!en this, on’s opportunity cost of using the paint for another =ob is *,. &his estimate assumes that there is no cost to storing the paint. b. on’s ne(t?best option is to dispose of the paint at a cost of O#6. on can a!oid this cost by using the paint for another =ob. &hus, the opportunity cost of using the paint for another =ob is )*.,-. on should therefore be $illing to pay someone up to O#6 to let him use the paint in their =ob c. &he fact that on recei!ed a non?refundable ad!ance of O3)6 does not change the opportunity cost in any $ay. &he re!enue and the cash costs are past e!ents and are sunk. %oth !alue and opportunity cost are for$ard looking 7&(a'& $%i' a8"n$ 4"&' n"$ (%an& #&5a$i6& $" $%& '$a$' 9"+ $%& */, i' n"$ #&5&6an$ $" $%& 4&(i'i"n a$ %an4 . 1.3. a. Rap’s decision problem centers on $hat to do $ith the 2),666 unsold KR*L kits. Rap’s goal is to ma(imi+e profits. 7or the unsold 2),666 units, this means ma(imi+ing the re!enue, or net cash inflo$, recei!ed number of units sold multiplied by the selling price per unit" from the sales of this product. It is important to note that the amount Rap paid to produce the 2),666 units, or 2),666 P O0.)6 G O10,)66 is sunk and is not at all rele!ant to their decision. 7rom a financial accounting standpoint, this amount $ill be e(pensed on the income statement regardless of the option chosen. b. %ased on the information pro!ided, Rap has t$o options: 1. Sell the 2),666 units to the national home?impro!ement store for O0 per unit. 2. Sell the product !ia the company’s $ebsite. nder this option, the company e(pects to sell -6D of the remaining 2),666 units at a selling price of O5.5) per unit.
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1?16 >e could, of course, concei!e of other options, such as discarding all of the KR*L kits or donating them to a municipality for parks, etc.". Ho$e!er, it appears that Rap does not $ish to e(plore these options. c. &he increase in Rap’s cash flo$ under each option is:
(pected sales in units Selling price per unit 9et increase in cash flo$
Op$i"n 1. Sell to store 2. Sell via website 2),666 1),666 G 2),666 P .-6" O0.66 O5.5) *1;/+,,, *1.<+=/,
*gain, $e note that the cost of producing the 2),666 units, or 2),666 P O0.)6 G O10,)66 is a sunk cost and is not rele!ant to measuring the net cash flo$ associated $ith each option. Moreo!er, $e are interested in measuring the future sacrifices and future benefits associated $ith each option. &he fact that Rap spent O10,)66 to produce the 2),666 units is not rele!ant because the e(penditure and associated cash outflo$" occurred in the past it is a sunk cost. d. Ji!en the a!ailable options, Rap’s preferred option is to sell the remaining 2),666 units to the home?impro!ement store for O0 a unit. !en though it appears that Rap $ill lose O0.66 O0.)6 G O6.)6" per unit, the company ma(imi+es its cash flo$ and profit by selling the unsold units Kat a loss.L 9ote: &his e(ercise illustrates the classic price?'uantity tradeoff in this instance, the company is better off selling more units at a lo$er price than selling fe$er units at a higher price. In other instances, the relation flips. 1.35. a. &he o$ners likely ha!e multiple goals. Making a profit is important, as is $inning games and championships. Some o$ners also probably en=oy the prestige and glamour associated $ith o$ning a professional sports team.
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1?11 layers are also kno$n to engage in acts that increase their !isibility and stature at the team’s e(pense. >ho among us does not kno$ a Khot?doggingL athleteQ b. &eams can and do use a number of systems to align players’ incenti!es $ith team incenti!es. lauses gi!ing incenti!e pay for reaching different le!els of the playoffs and reaching milestones in performance e.g., batting a!erages, rushing yards" are common. ontracts also usually specify parameters for physical fitness, as $ell as norms for e(pected beha!ior. ontracts often allo$ teams to fire’ players if they engage in beha!ior that damages a team’s reputation. Besigning and implementing contract?based and formal control measures is difficult in this setting as team performance depends on many factors. It is often difficult to specify $hat players should do or to measure their contribution to the team’s success. &eams therefore rely a great deal on intangibles such as KleadershipL and KcultureL $hen moti!ating players to do the right thing. oaches sometimes discipline players by benching them for games or denying players time on the fieldCcourt. &hey also rely on the players’ ego and the !alue players attach to their reputation to keep players in check. 1.#6. 8rgani+ations in!est in monitoring programs because the organi+ation’s goals may not al$ays coincide $ith the goals of indi!idual employees. >hen o$ners and other stakeholders delegate decision making, they run the risk that employees $ill make decisions that may not be in the organi+ation’s best interests. 7or e(ample, employees may pad e(pense accounts, take e(cessi!e breaks or time off, or e!en steal from the company. Monitoring can help by either penali+ing undesired beha!ior or re$arding desired beha!ior. 7or e(ample, mystery shopper programs help assess the 'uality of store operations and make sure that employees are follo$ing company policies. 7or e(ample, a %urger Ting franchisee may substitute lo$er 'uality ketchup or other condiments, or not keep the facilities up to the standards consistent $ith the franchisor’s corporate image. *udit !isits and other mechanisms ser!e to deter such beha!ior in e(treme instances, the franchisee could lose its license. ust telling someone to follo$ the rules is not enough. nforcement or follo$?up is necessary. >ithout enforcement, employees might simply agree to the rules but then ignore them and do $hate!er they $ant. Incenti!e schemes such as bonus pay and stock options also help align indi!idual goals $ith organi+ational goals. 1.#1. &he follo$ing table pro!ides the re'uired classifications, including comments pertaining to the rationale underlying each classification. A($i"n>D&(i'i"n >hether to hire t$o or three dental hygienistsQ Br. Shapiro has narro$ed his choices to t$o or thee hygienists based on e(pected patient !olume. %alakrishnan, Managerial *ccounting 1e, A 2665
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Ra$i"na5& &his decision relates to the choice of a resource le!el. Hiring more staff pro!ides greater capacity, allo$ing Br.
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1?12 Shapiro to ser!e more patients, but also commits Br. Shapiro to greater costs.
repare a staffing schedule so that at least one hygienist is a!ailable during all times the office is open.
I8p5&8&n$
&his action relates to implementing the choice. &he associated decision $e could !ie$ each possible schedule as a decision option" relates to ho$ resources, in this case hygienists, $ill be used to deli!er ser!ices.
&rack the number of patients seen by each hygienist per $eek.
E6a5a$&
&his on?going control process helps Br. Shapiro figure out the efficiency and effecti!eness $ith $hich he is using costly resources. Moreo!er, because Br. Shapiro sees each patient during each !isit, he also can personally track the 'uality of $ork done by each of his hygienists.
4e?e!aluate the ade'uacy of current staffing le!els.
R&6i'&
8!er se!eral $eeks or months, Br. Shapiro $ill get a sense of $hether his hygienists are fully utili+ed. He $ill also determine $hether additional hygienists need to be hired or $hich, if any, of his hygienists need to be let go.
&his problem illustrates the classical loop bet$een planning and control. >e typically begin $ith a plan that is based on a set of assumptions in this case, e(pected patient !olume". &hese assumptions are our beliefs about the unkno$n future. >e then implement our choices. *s time passes, $e obtain ne$ information about the actual outcomes in this case, actual patient !olume and the 'uality of $ork done by each hygienist". 8n an on?going basis, this ne$ information $ill cause us to ad=ust ho$ $e implement our plans e.g., change the schedule for the ne(t $eek". 8!er a period, $e $ill accumulate enough information to re!ise our original set of assumptions, $hich might cause us to re!isit the decision. &he o!erall point is that there is a natural cycle of doing something based on a set of assumptions, comparing actual outcomes $ith e(pectations, and then re!ising our assumptions. In many instances, the broad loop relating to a decision contains smaller loops
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1?13 $ithin it. 7or instance, $e can think of creating each $eek’s schedule as forming a separate planning and control cycle. 1.#2. &he follo$ing table lists the four stages of the planning and control cycle and the associated decisionsCactions. &here are many possible decisions for each category. S$a&
A($i"n>D&(i'i"n
lan
8ne possible decision is $hether to price at the same le!els as last year or to raise prices by, for e(ample, 16D to account for the higher cost of flo$ers this year. 8ther decisions include $hether to hire additional help or ho$ much money to spend on ad!ertising.
Implement
%ased on the chosen price le!el, order and stock enough bou'uets to meet the e(pected demand. 9otice that $e could !ie$ this as a decision in itself, !ie$ing each !olume of order as an option."
!aluate
ompare actual sales to budgeted sales. Identify reasons for any de!iations. *gain, $e could !ie$ this as a decision by framing each possible reason for a de!iation as a possible option. >e then choose among possible e(planations."
4e!ise
Jina $ould use data on actual sales, her prices !ersus the prices of other florists, and national trends to re!ise her e(pectations about future sales. &his re!ised belief $ill be a key input into her pricing decision for ne(t Mother’s day.
*s $e see, Jina begins $ith a plan that is based on a set of assumptions in this case, ho$ much demand she might e(pect for any gi!en price". &hese assumptions are her beliefs about the unkno$n future. She then implements her choices e.g., post prices, order flo$ers". *s Mother’s day nears, pre?orders and information about other florists’ prices might gi!e Jina an impetus to re!ise her prices. &hat is, she obtains ne$ information on an ongoing basis, $hich in turn causes her to ad=ust her implementation e.g., re!ise prices, run more ads". 8!er a period, she $ill accumulate enough information to re!ise her original set of assumptions, $hich might cause her to impro!e the ne(t pricing decision. &he o!erall point is that there is a natural cycle of doing something based on a set of assumptions, comparing actual outcomes $ith e(pectations, and then re!ising our assumptions. In many instances, the broad loop relating to a decision contains smaller loops $ithin it. 7or instance, $e can think of offering a discount at day’s end as forming a separate planning and control cycle $ithin the o!erall cycle that $e discussed abo!e. 1.#3. a. >e classify the data from the financial statements into three broad groups. >e interpret financial statements broadly to mean any documentation filed $ith the Securities and (change ommission S" or other regulatory bodies.
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1?1# -inancial data such as the firm’s income and cash flo$ from operations are in!aluable in assessing future prospects. &he in!estor might also perform ratio analysis, such as computing the debt?to?e'uity and current ratio, to understand and e(plore a company’s risk factors. .overnance data such as the composition of the board of directors and compensation arrangements help the in!estor assess the effecti!eness of the company’s management and control systems.
7inally, operating data such as the capacity of the plant, and the number of plants and employees help in!estors understand the business. In!estors may also e(amine the firm’s client base e.g., does one client account for 16D or more of salesQ". In addition, the management discussion of results section probably $ill discuss the company’s pipeline of drugs and their potential. b. In!estors $ould consider the costs and benefits of other in!estment options. * firm’s financial statements pro!ide information only about its o$n affairs. &hus, the in!estor has to look else$here to assess the firm’s relati!e standing i.e., to assess the opportunity cost of in!esting in the firm". 7or instance, some competitor analysis is necessary to =udge $hether the firm is earning similar or higher rates of return than its competitors. In!estors also $ould likely collect data from pharmaceutical publications abou t the market potential for the firm’s current and proposed drugs. 7or instance, financial statements might not re!eal a lot about obtaining 7B* appro!al for the drugs in?process. Medical publications and conference presentations might help refine these beliefs. 8ther data pertinent to market share and gro$th from trade associations" also seem important. 7inally, considerations such as the e(tent of di!ersification pro!ided and fit $ith the in!estor’s risk?profile also play an important part in the in!estment decision. 1.##. *s sho$n in the table belo$, ;inda may be surprised to find managerial accounting information in!aluable in her ne$ position. *s a manager, ;inda decides ho$ best to use the organi+ational resources entrusted to her, and she $ill find both financial and non?financial information from her company’s managerial accounting system to be helpful for making these decisions.
D&(i'i"n >hether actual costs are in line $ith e(pectationsQ
In!"#8a$i"n I$&8' %udgeted costs
A#& $%& in!"#8a$i"n i$&8' !inan(ia5>n"n?!inan(ia5 in na$#&@ %udgeted and actual cost data are financial in nature.
*ctual costs
;inda may use non?financial data such as the !olume of production to ad=ust her estimates of e(pected costs. *fter all, the more units produced, the greater the e(pected cost as the company $ill be using more materials and labor. ;inda also may rely on non?financial data such as absenteeism rates and $hether her company $as starting a ne$ product to figure out the source of the cost differences.
*ctual !olume of production
%alakrishnan, Managerial *ccounting 1e, A 2665
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1?1)
>hether to make a tool in? house or buy it from a supplierQ
rice charged by the supplier ost to make the tool internally
&he supplier’s price and internal cost data are financial. 9on?financial data include supplier 'uality and reliability, as $ell as the reliability and 'uality of the tools if they $ere manufactured by ;inda’s firm.
Supplier 'uality and reliability Ho$ many tools to purchase for making 166,666 units of a productQ
4ate of $ear
>hat is the right in!entory le!el for a gi!en toolQ
(pected rate of use, !ariance in use rates across time periods e.g., ;inda’s firm may ha!e seasonal production cycles"
(pected cost of tool
se data, such as rate of $ear, are non?financial. ost data, $hich $ould be used to determine the amount of safety stock, are in financial terms.
(pected loss if tool not a!ailable Bata concerning use patterns, including rate of $ear and !ariance in use rates, are non?financial. Bata about cost estimates, including storage costs and capital costs, are e(pressed in financial terms.
ost of tool, cost of capital, other storage costs
>hether to make a ne$ tool or to refurbish an e(isting toolQ
ost to make the ne$ tool
*gain, the cost data are in financial terms $hereas data pertaining to 'uality and e(pected li!es are non?financial in nature.
ost to refurbish e(isting tool (pected li!es of the t$o tools Uuality of the tools
%alakrishnan, Managerial *ccounting 1e, A 2665
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1?1-
1.#). ;et us begin by computing the expected cost if you had stayed at a hotel: ost of hotel for one night er?diem meal allo$ance &otal
O1#6.66 O166.66 *=., 0,,
9e(t, let us compute your actual expenses: ost of car rental ost of dinner >ednesday ost of other meals &otal cost
O6.66 O56.66 O#).66 *=1/ 0,,
At least five views exist regarding the appropriate expense report/ •
•
•
*t another e(treme, some $ould argue for a report of O#) only, being the actual meal cost. nder this !ie$, the car rental and the dinner are personal e(pen ses and non? reimbursable. 7urther, you should only claim the lo$er of actual e(penses or the per? diem allo$ance.
•
•
* final !ie$, $hich is perhaps $hat many of us $ould do, is to claim the car rental and the per?diem for t$o days O16 G O6 F 2 days P O)6 per day", reasoning that the car rental is a reasonable off?set to the cost of the hotel.
*s you can tell, there is no clear ans$er, and different people $ould reasonably claim different amounts. Beciding the reasonableness of tra!el e(penses can be difficult. 7or instance, some might argue that the cost sa!ings are fictitious.
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1?10 you tra!el and spend time a$ay from your family. *llo$ing you to spend time $ith friends and sightsee is one $ay to compensate for these non?pecuniary costs. Many firms a!oid these problems by formulating e(plicit policies. 7or instance, they might reimburse you O166 per day as a flat fee if you do not stay at a hotel. &his e(ercise nicely illustrates that, =ust like beauty Klies in the e yes of the beholder,L there often is no bright line test for $hat is ethical or unethical. >e can see this confusion in ad!ice columns such as K*sk the thicistL that appear in the New York Ties Maga+ine. 1.#-. &here are se!eral a!ailable options. 7irst, ay can bill the client for O),666, reasoning that this is the Kmarket rateL for the $ork. &his option ma(imi+es ay’s current income and reduces the chance that the client $ould be disgruntled after comparing notes. Ho$e!er, this option is unethical in the !ie$ of the *merican %ar *ssociation *%*". Specifically, *%* 7ormal thics 8pinion 53?305 says that attorneys can only charge for hours actually spent, and for fees actually earned. It e(plicitly disappro!es billing the second client for $ork already done, on the grounds that you ha!e not VearnedV the second set of fees. *%* 7ormal thics 8pinions are not binding on anyone, but they are often influential in =udicial proceedings. *nother option is to bill the second client for O1,2)6, the hours actually $orked. learly, this strategy is ethical. Ho$e!er, it increases the chance of the first client being discontent. 7urther, the strategy is not fully consistent $ith ay’s goal of ma(imi+ing income W He is deli!ering a 'uality product for substantially belo$ market $ages. >hat can be doneQ 9ote that the *%* 7ormal 8pinion’s conclusion appears to be limited to hourly billing. &hus, a third strategy might be to arrange an alternati!e basis for billing the client. 9otice that the client benefits from ay ha!ing already done the research and kno$ing ho$ to do the $ork. &hus, if ay charges a flat fee, kno$ing that the $ork to accomplish the matter $as already done and rendering his effecti!e hourly rate higher than it $ould ha!e been other$ise, that $ould probably be acceptable to the client and to the *%*. 8f course, $e are assuming that the ultimate fee is not Vunreasonable.V" In case he follo$s this strategy, ay $ill need to disclose to the client fully and honestly $hat the fee $as and the basis on $hich it $ould be calculated. He might also be $ell ad!ised to disclose to the first client staying $ithin bounds of client confidentiality" that he did find subse'uent use for $ork that he belie!ed to be uni'ue. He might also consider gi!ing some kind of a price break to the first client for future $ork. More generally, $hen doing $ork that de!elops transferable skills or kno$ledge, good managers do not seek to e(tract all of the cost from the first client. 4ather, they charge for less than the actual $ork done, KbankingL some costs to be billed to future clients e(pected to benefit from the $ork. 8f course, the client is billed to the full e(tent if the $ork is =udged to be Kuni'ueL or Kone?off.L In either case, the key point is to stay in full, open and honest communication $ith the clients, and to be fair in appearance and in fact.
%alakrishnan, Managerial *ccounting 1e, A 2665
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1?1 9ote: >e thank rofessor Margaret 4aymond of the ni!ersity of Io$a ;a$ School for helpful discussions on this topic.
PROLEMS
1.#0. a. Ji!en the hourly $age rate of O.2), #6 hours per $eek, and 12 $eeks, the money earned for $orking as a checkout clerk this summer is: Ea#nin' B W"#3in a' a (%&(3"$ (5 G 12 P #6 P O.2) G *+<, .
b. 7irst, $e need to calculate the e(pected hourly compensation from $aiting tables, $hich e'uals the base $age rate of O# per hour F tips.
c. %ased solely on our computations in XaY and XbY, $aiting tables is the preferred option because it has the highest amount you e(pect to earn O#,66 from $aiting tables this summer !ersus O3,5-6 from $orking as a checkout clerk. &he additional money from $aiting tables is O126 G O#,66 O3,5-6. &he difference bet$een the t$o options, ho$e!er, is rather small. &hus, $e could readily see $here indi!iduals, based on $hat they !alue, might make differing =ob choices. 7or e(ample, there is the risk associated $ith the tip component of being a $aiter. * risk?a!erse person might take the sure thing of O.2) per hour o!er the possibility that sChe may earn only O0 per hour $aiting tables. *lternati!ely, someone $ho is sure of hisCher interpersonal skills may assess a much higher than )6D chance that they $ill earn O# F O- G O16 per hour from $aiting tables. &hus, the K$ait tablesL option may be more attracti!e than the checkout clerk option. &he nature of the t$o =obs also differs as a $ait person, you are constantly on your feet and mo!ing some indi!iduals may or may not" prefer this to the more sedentary role of being a checkout clerk, $ho typically is at hisCher station for the better part of the day. 1.#. a. >ynter has t$o options: 1" accept the O266,666 offer, or 2" re=ect the O266,666 offer and $ait for a future offer. If she accepts the offer, then >ynter’s opportunity cost includes the e(pected !alue of a bid from another buyer. In estimating this number, she has to factor in both the probability of recei!ing a higher bid and the !alue of the bid. She also has to factor in the time until the ne(t bid arri!es because, until the house is sold, she $ill incur costs to %alakrishnan, Managerial *ccounting 1e, A 2665
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1?15 maintain the house, pay the mortgage, and accrue for insurance and property ta(es by accepting the offer, these costs $ill not be incurred". 7inally, >ynter has to factor in the cost of the an(iety associated $ith selling a house the house has to be clean all the time/ plans to buy a ne$ house may ha!e to be put on hold. Many of these factors are 'ualitati!e and are based on beliefs about the future. 9either >ynter’s initial purchase price of O22),666 nor the amount of time and money $hich she !alues at O#6,666" associated $ith de!eloping a fabulous yard ha!e any rele!ance in estimating her opportunity cost both of these costs are sunk. >ynter currently has to assess future bids and future costs, taking as gi!en the status of the market and her house’s relati!e attracti!eness. &he fact that the house has not attracted a bid for a month indicates that the property may be o!er?priced at O20),666. *ll in all, >ynter may be $ell ad!ised to gi!e the offer serious consideration. b. >ynter no$ has a third option make a counter offer. &his option may be preferred o!er an outright re=ection because it preser!es the option of going back to the original offer price but holds the promise of obtaining a higher price. In making the counter offer, >ynter has to estimate the final selling price, $hich $ould likely result after se!eral offers and counter? offers. &his estimation depends on >ynter’s assessment of the bu!er"s opportunity cost. >ynter also has to factor in the probability that the sale might fall through because the buyer may come across a better !alue from the buyer’s perspecti!e". 8!erall, >ynter faces a difficult, and highly sub=ecti!e, decision. * realtor can often help in such situations by bringing >ynter the latest market information and the e(perience of pricing many such transactions. 1.#5. a. *s stated in its $ebsite, the mission of the nited >ay is to impro!e people’s li!es by mobili+ing the caring po$er of communities. nited >ay helps raise funds for o!er 1,#66 community?based organi+ations, each $ith its o$n board and !olunteers. 8ther ma=or charities ha!e e'ually laudable goals. b. &here is little doubt that the officers and staff subscribe to the charity’s goals. sually, these are talented indi!iduals $ith multiple employment and lifestyle options. &hey often make significant financial and professional sacrifices to $ork for the charity, perhaps because of the satisfaction they deri!e from ad!ancing a goal they belie!e in. Ho$e!er, the officers are also indi!iduals $ith their o$n $ants and needs. >hile they may be $illing to $ork for a smaller salary or under harder operating conditions, they cannot typically $ork for a nominal sum. &he 'uestion therefore turns on $hat is KappropriateL compensation and not $hether they need to be compensated or not. &o ans$er this 'uestion, notice that charities such as the nited >ay are large organi+ations that control significant assets the nited >ay has re!enues in e(cess of O#6 million a year" and operate in a highly comple( political and economic en!ironment. 7or instance, the nited >ay organi+ation itself not the member organi+ations" uses the ser!ices of se!eral hundred professional staff and consultants. Bischarging these responsibilities is not a tri!ial %alakrishnan, Managerial *ccounting 1e, A 2665
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1?26 task and re'uires the ser!ices of competent managers. ompetiti!e market conditions determine the Kgoing rateL for such professional managers. 8ften, charities $ill engage outside consultants and re!ie$ers to help them assess $hat is and is not appropriate gi!en the charity’s operations and the indi!idual’s skill set. Seen in this light, $e can =ustify an annual compensation package in the hundreds of thousands of dollars for the 8 of a large charity. 1.)6. a. ompare selling 22) confirmed seats to selling only 216 seats. If the airline only sells 216 seats, then there is high likelihood that not all 216 passengers $ill sho$ up. In this case, the plane $ill ha!e one or more empty seats. If these seats could be filled $ith paying passengers, then the airline’s profit increases there are fe$ additional costs associated $ith the e(tra passengers. &he chance of lost profit due to empty seats decreases as the airline sells more than 216 seats. &he airline must balance this cost $ith the cost of bumping passengers. If the airline sells 22) tickets, then there is a chance that more than 216 passengers $ill sho$ up. &he airline has to pro!ide compensation to the bumped passengers. &he additional re$ards e.g., a tra!el certificate, hotel accommodations, meal !ouchers, etc." and negati!e good$ill reduces the airline’s profit. *irlines use sophisticated models to estimate these t$o costs and to determine the KoptimalL number of seats to sell. 7or instance, they $ould not sell 366 tickets on a 216 seat flight." Historical records help agents tailor the amount of o!erbooking to the time and the day of the flight, as $ell as to the profile businessC!acationCfamily" of the a!erage passenger. b. If bumped, the passenger gi!es up the confirmed seat. &he ma=or cost of being bumped is the con!enience associated $ith tra!eling on the scheduled flight and arri!ing earlier at the destination hopefully". &his cost !aries $idely across passengers, resulting in some rushing to the podium to claim their re$ard $hile others $ait. 7or instance, a college student going home for the holidays probably is more $illing to gi!e up the seat than a businessperson attending an important meeting. &hat is, cost and !alue are specific to each indi!idual’s goals. c. ;ike the airline, the passengers are trading off benefits $ith sacrifices. Suppose the current re$ard e(ceeds the costs associated $ith taking a later flight. e consider expected costs and benefits, $hen unkno$n future e!ents $ill someone else !olunteer firstQ" affect our reali+ed costs and benefits. &he problem also illustrates the role of uncertainty $hen making decisions.
%alakrishnan, Managerial *ccounting 1e, A 2665
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1?21 d. If a passenger is involuntaril! bumped, the cost of missing the scheduled flight e(ceeds the offered re$ard. &hat is, the airline is imposing a cost on the passenger by in!oluntarily remo!ing them from the flight. &his cost $ill translate into ill $ill, damage to public image, and future lost business for the airline. &his cost !aries across passengers. &he potential cost is much higher if the airline bumps a full fare?paying businessperson $ho tra!els e!ery $eek than if the airline bumps a discount? fare passenger $ho is tra!eling alone and $ho is not a fre'uent flier. %umping part of a group is more e(pensi!e image $ise" than bumping single passengers. Indi!idual circumstances again shape the airline’s costs. 9aturally, airlines consider these !ariations $hen picking passengers to bump in!oluntarily. *irlines de!elop detailed passenger profiles to help the ticket agent select passengers the airline’s options include the set of all passengers $ith confirmed seats and the decision is $hich one to pick. 1.)1. a. 7or this decision, &erry has t$o options: 1" keep the old &@, and 2" sell the old &@ and buy the ne$ HB&@. &erry’s spouse has informed us that $e can rule out the possibility that &erry $ill keep both &@ sets". &he option of keeping the old &@ really =ust postpones the problem to a later date. &erry can al$ays sell the old &@ a year from no$ and purchase the ne$ HB&@ of course, the resale !alue of old &@ and the price for the ne$ HB&@ $ould change in a year". &erry should consider the follo$ing costs and benefits in his decision: #ash outflow associated with purchasing the $%T& : &erry can ob=ecti!ely estimate this cost it is O1,-55 F 6.6- P O1,-55" G O1,66.5#. &his cost $ill only be incurred if &erry purchases the HB&@. #ash inflow associated with selling the old T& : &erry can ob=ecti!ely estimate this benefit it is O-66, or the amount the neighbor is $illing to pay &erry for his old &@. &erry $ill only recei!e this money if he purchases the HB&@. 'etter qualit! picture and sound : &his is the primary benefit associated $ith the ne$ HB&@. &erry must sub=ecti!ely estimate this benefit. (tilit! fro being current : Many persons deri!e utility from their KtoysL such as fast cars, stereos, boats, tele!isions, etc. &erry might be such a person and recei!e a psychological benefit from o$ning a Kcutting?edgeL HB&@. Similar to better 'uality picture and sound, &erry must sub=ecti!ely estimate this benefit.
&erry’s decision hinges on $hether the 'ualitati!e benefits associated $ith being current and ha!ing a better 'uality picture and sound e(ceed the net monetary cost associated $ith purchasing the ne$ HB&@. In other $ords, if &erry estimates that the benefits e(ceed O1,66.5# O-66, or O1,266.5#, then he should purchase the HB&@/ other$ise, &erry should %alakrishnan, Managerial *ccounting 1e, A 2665
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1?22 keep his old &@. %ifferent people will attach different weight to the qualitative factors and, thus, ake different purchasing decisions. 9otice that the O1,)66 purchase price of &erry’s current &@ does not factor into &erry’s decision. It is a sunk cost and, conse'uently, is not a rele!ant cost or benefit. b. &erry may o$e money on his old &@ if he purchased it on an installment plan e.g., he financed it $ith a store credit card". 9otice that &erry $ould o$e the store O366 regardless of $hether he keeps his current &@ or buys the ne$ HB&@. Hence, the O366 is not rele!ant to &erry’s analysis and should ha!e no impact on his decision to purchase the ne$ HB&@. 9ote: Installment contracts fre'uently contain clauses that, in this instance, $ould gi!e the store a lien on the &@ set. &his clause may re'uire &erry to pay off the balance if he sells the &@. Such a re'uirement affects &erry’s cash flo$ and, in turn, could affect his decision. &he effect in this instance arises because of &erry’s constrained budget. *bsent such a budget constraint i.e., if &erry had enough cash to pay off the loan and to purchase the ne$ HB&@", the amount is not rele!ant. c. In this case, &erry has three options: 1" keep the O-66 and not replace the &@, 2" use the O-66 to replace his old &@, and 3" use the O-66 to$ard the purchase of the ne$ HB&@. ompared to part XaY, $e see that &erry has more options. Ho$e!er, &erry’s option of keeping the old &@ is no longer a!ailable. &he !alue associated $ith purchasing the HB&@, ho$e!er, has not changed. %efore the flood, &erry had to pay O1,66.5# O-66 G O1,266.5#. *fter the flood, &erry still needs to pay O1,266.5# to purchase the ne$ set. In both cases, &erry has O-66 to assist $ith the purchase of the HB&@ it doesn’t matter $here the O-66 comes from. 9ote: >e belie!e that many people $ho $ould ha!e stayed $ith the old &@ in part XaY $ould purchase the HB&@ in part XcY, e!en though the !alue has not changed. >hile !alue has not changed, the problem is fraed differently. art XaY frames the problem as selling the old &@ to get a ne$ &@. In part XcY, the decision is $hether to spend O-66 to get a dated &@ or O1,66.5# to purchase a state?of?the?art HB&@. *lthough there is no economic rationale for the phenomenon, psychologists ha!e demonstrated that differences in framing often lead to differences in decision making. 1.)2. &his problem captures some of the comple(ities in administering a comple( organi+ation such as a uni!ersity in a resource?constrained en!ironment. &he follo$ing costs and benefits seem rele!ant. 9otice that there is !ery little in the form of incremental re!enue to the school as tuition re!enue is independent of Bean Ma(ton’s decision. 8ne could possibly argue that the decision could affect future donations to the school e.g., a student becomes rich and attributes hisCher success to the school and the Bean’s decision to open up the course to
%alakrishnan, Managerial *ccounting 1e, A 2665
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1?23 additional students". &his seems unlikely, ho$e!er, leading us to consider the direct out of pocket costs !is?Z?!is a 'ualitati!e assessment of the educational benefits. &he direct costs in this problem are relati!ely easy to measure. &hese costs only include the cost of the instructor in option 2. If, for some reason, the school’s budget is tight and the school is not in a position to bear this cost, then the Bean $ould ha!e to choose either option 1 or option 3. More than likely, though, this cost $ould not limit the Bean’s options. &hus, the decision seems to hinge on the educational tradeoffs and ma(imi+ing student $elfare. Belineating the educational tradeoffs, or e!en defining student $elfare, is a rather difficult and sub=ecti!e task. &he Bean $ill ha!e to measure and $eigh the follo$ing factors in each option to arri!e at the !alue of each option: 8ption 1: >hat are the costs of not appearing to be responsi!e to student needsQ >hat are the lost educational benefits, if any, of capping the enrollment in the Strategic ost ManagementQ *re there other high 'uality courses offered by the school that lead to the same, or similar, le!el of educational benefitsQ Ho$ costly is it for students to delay taking the course by a semester or a yearQ 8ption 2: >hat are the costs of canceling a class that is Kon the booksQL Here, the Bean needs to consider the costs to the si( enrolled students in the canceled class as $ell as any costs associated $ith the school reneging on $hat many might !ie$ as a commitment. 7urther, in addition to the direct costs of hiring the instructor, the Bean needs to consider $hether the 'uality of instruction in the course $ould decline that is, $ill the ne$ instructor deli!er the goodsQ &he Bean must $eight all of these factors against the incremental educational !alue of offering the Strategic ost Management course to the 1) students $ho $ish to take the class. 8ption 3: &here are unlikely to be any costs or benefits for the 15 students enrolled in the other course. &hus, Bean Ma(ton needs to assess the incremental benefits associated $ith allo$ing the 1) students to take Strategic ost Management !ersus the cost to the 26 students currently enrolled in the course e.g., due to the instructor changing to a lecture?oriented teaching style and change in e(am format". ltimately, the Bean’s decision hinges on the 'ualitati!e factors, e!en though these factors are difficult to measure $ith any reasonable degree of accuracy. 8!erall, it is likely that the Bean $ould choose option 3 since the incremental benefits are likely to out$eigh the incremental costs, $hereas the costs in options 1 and 2 likely o!er$helm any benefits. &his is simply our con=ecture, though. 8ne can make plausible arguments to support choosing any of the options. 1.)3. a.
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1?2# may place a premium on mobility or, alternati!ely, $orry about the potential for theft and loss. 7inally, some students may emphasi+e computing po$er or monitor si+e. &he key point to remember is that K!alueL is like beauty it lies in the eyes of the beholder W as it is measured $ith respect to an indi!idual’s preferences. b. * narro$ definition yields t$o options: 1" * desktop machine, and 2" a laptop machine. * broader definition might include a laptop $ith a docking station, $hich gi!es us a hybrid of a desktop and a laptop. It also is important to recogni+e that e(ternal factors KconstraintsL" may limit you from considering other options. 7or e(ample, a budget of O-66 is likely to rule out most laptop machines. If taking notes in class is the primary role for your ne$ purchase, then desktops $ould be eliminated. *t an e(treme, some schools specify that you choose among limited configurations from a K!endor of choice,L a constraint that also limits your options. c. &here are numerous costs and benefits to be considered the follo$ing are perhaps the most salient: )rice* 7or e'ui!alent computing and storage po$er, laptops are more e(pensi!e than desktop machines. #oputing power. %y !irtue of their si+e, desktop machines offer features microprocessor speeds, 4*M amounts, ability to handle add?on e'uipment !ia their multiple ports" una!ailable in laptop machines. +onitor sie, &ideo #ards, - Speakers. >e can configure desktop machines $ith larger monitors and better !ideo cards and speakers. &hese features may be particularly important to students $ho plan to use the machine for gaming andCor $atching mo!ies. +obilit!* >e can more easily mo!e laptop machines/ they can be used in the classroom, library, cafeteria, and so on. Safet!* nfortunately, laptop machines can Kgro$ feet.L &hat is, they are far more susceptible to theft and loss.
d. %ecause many of the costs and benefits are 'ualitati!e, they $ill !ary across indi!iduals. 7or e(ample, students $ho are al$ays Kon the goL may assign more $eight to mobility, and therefore be more likely to purchase a laptop. Similarly, students $ho lo!e !ideo games may assign more $eight to monitor si+e and the 'uality of the !ideo card and speakers, and therefore lean to$ards purchasing a desktop. In the end, each person $ill add up all of the benefits and subtract all the costs of each machine type, selecting the option $ith the highest personal !alue.
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1?2)
1.)#. a. &he ob=ecti!e is to obtain the ma(imum !alue from your !acation. Indi!idual preferences dictate the definition of !alue. 7or e(ample, some indi!iduals may place a premium on outdoor acti!ities, desiring a !acation that in!ol!es golf, scuba di!ing, fishing, hiking, or camping. 8ther indi!iduals may place a premium on rest and rela(ation, desiring to !acation at a spa or resort $here guests are pampered. 8ther indi!iduals may place a premium on !isiting a foreign country or city, !isiting historical sites and monuments, or cultural e!e nts. 7inally, some indi!iduals may place a premium on cost, desiring simply to take 1# days off for the lo$est possible amount. 4emember that !alue is like beauty it lies in the eyes of the beholder. !en though you might share many interests, you and your friend’s ob=ecti!es are unlikely to be perfectly aligned. %y definition, groups comprise multiple indi!iduals, each $ith uni'ue preferences. &he group’s preferences are some aggregation of indi!idual preferences. *s discussed in the te(t, goal congruence is the o!erlap bet$een the group’s and the indi!idual’s goals and is rarely perfect. ach indi!idual in the group therefore $ill try to push the group to make the decision that ma(imi+es his or her o$n $ell being. %ecause of differences in indi!idual preferences, this can lead to different indi!iduals pushing for different choices. In this instance, e!en though you are best friends, it is likely that each of you attaches differing !alues to different options. &here is both a group and a personal decision here. ach !acation possibility must be e!aluated in terms of the relati!e benefits it yields to both parties in!ol!ed. 7or e(ample, consider trips to
784 I9S&4&84 S 89;<
1?2la+a hotel in 9e$ hat you $ill be KdoingL on !acation, be it fishing, camping, or !isiting historical sites, is clearly important as discussed abo!e". /ocation, (niqueness*
d. %ecause many of the costs and benefits are 'ualitati!e, they $ill !ary across indi!iduals. Indeed, there are a plethora of places to !acation, and $e see people making different !acation choices all the time. In the end, you and your friend $ill add up all of the benefits and subtract all the costs of !acation destinations in your option set, selecting the one $ith the highest !alue. *gain, it is important to remember that as discussed under part XaY" you and your friend $ill likely attach differing !alues to the different !acation options. &hus, your final !acation destination is likely to reflect a compromise bet$een $hat you truly desire and $hat your friend truly desires. Many students $ill likely recall that this happens all the time $ith family !acations $here the preferences of the children and adults do not coincide in!ariably, some compromise is struck.
%alakrishnan, Managerial *ccounting 1e, A 2665
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1?20
1.)). a. 9atalie’s decision problem centers on $hat to do $ith the unsold merchandise. 9atalie’s goal is to ma(imi+e her profit. 7or the unsold merchandise, this means ma(imi+ing the re!enues recei!ed from selling the merchandise less any additional costs associated $ith selling the merchandise. &he amount that 9atalie paid for the unsold merchandise, or O166,666 O-),666" P .)6 G O10,)66 is sunk and is not rele!ant to 9atalie’s decision. b. %ased on the information pro!ided, 9atalie has ) options: 1. Store the unsold merchandise for 16 months and attempt to sell it ne(t season. 2. Hold an 6D off sale. 3. Hold a 06D off sale. #. Hold a -6D off sale. ). Hold a )6D off sale. >e could, of course, concei!e of other alternati!es such as donating all of the unsold merchandise, but 9atalie does not seem to be interested in e!aluating these options. c. &he increase in 9atalie’s cash flo$ under each option is: 1. Store and Sell Next Year* 4e!enue ne(t year acking and storage costs Increase in cash flo$
O166,666 O-),666" × .36
O16,)66 #,666" *+/,,
H"54 ana#y a!$?C%#i'$8a' Sa5& 2. 0 off sale 3. 4 off sale 5. 6 off sale 7. 7 off sale
4emaining re!enues at original price Biscount G D off × O3),666 4e!enues at discounted price D of items e(pected to be sold Increase in ash flo$
O3),666
O3),666
O3),666
O3),666
2,666
2#,)66
21,666
10,)66
O0,666
O16,)66
O1#,666
O10,)66
166D *;+,,,
6D *+.,,
))D *;+;,,
#6D *;+,,,
N"$&: >e focus on cash flo$s in this problem, rather than profit, because the cost of the merchandise is sunk and not rele!ant to the decision at hand. Moreo!er, if 9atalie $ere to focus on profit, $e $ould XerroneouslyY calculate the !alue of each option as being negati!e as the amount 9atalie paid for the unsold merchandise e(ceeds the proceeds recei!ed from sale. >hat $e need to remember is that the cost of the unsold merchandise $ill be e(pensed e!en if 9atalie $ere to do nothing and hold onto the merchandise the status 'uo" that is, she $ould ha!e to $rite it off due to obsolescence. %alakrishnan, Managerial *ccounting 1e, A 2665
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1?2
d. &he opportunity cost of each option is the !alue of the ne(t best option. &hus, $e ha!e: 1. 2. 3. #. ). e.
O,#66 O,#66 O0,066 O,#66 O,#66
Ji!en the a!ailable options, $e find that 9atalie’s best strategy is to hold a K06D offL sale. &his strategy nets 9atalie O066 more than the ne(t?best option, $hich is the -6D off sale. Moreo!er, this option is the only one $hose !alue e(ceeds its opportunity cost.
%etail O3),666 × .)6 × .#6 O3),666 × .#6 × .1) O3),666 × .36 × .2) O3),666 × .26 × .26
8evenues O0,666 2,166 2,-2) 1,#66 *1+1=/
1.)-. a. &he opportunity cost of labor is the amount that $e can obtain from the ne(t best use of labor. &he unskilled labor has +ero opportunity cost as there is no other use for the time already paid for and is a!ailable. Ho$e!er, $e need to pay an additional amount for skilled labor. >e sa!e this amount if the city’s =ob $ere not there. >e calculate this amount as: Skilled labor* Hours needed for =ob: Hours a!ailable (tra hours needed ost per hour Opp"#$ni$y ("'$ %alakrishnan, Managerial *ccounting 1e, A 2665
166 0) 2) [1) ;/
[1) G [)2)C3) W& i6& p $%i' a8"n$ in (a'%0 784 I9S&4&84 S 89;<
1?25 (nskilled labor* Hours needed for =ob: Hours a!ailable (tra hours needed Opp"#$ni$y ("'$
)6 166 6 ,
&hat is, $e gi!e nothing up
&hus, the "pp"#$ni$y ("'$ "! 5a7"# for completing the city’s special =ob is ;/.
b. &he opportunity cost associated $ith using the chromic acid is not the original purchase price because it is a sunk cost. 7urther, if the chromic acid is used for the city’s special =ob, >ood Juardians $ill not be able to use these materials on the other =ob, as originally planned. &hus, >ood Juardians $ill need to ac'uire additional chromic acid for [66. onse'uently, $%& "pp"#$ni$y ("'$ "! 8a$ia5' i' ,, . c. &his information changes the opportunity cost associated $ith using the chromic acid. %ecause >ood Juardians has no alternati!e use for the chromic acid, they must dispose of it at a cost of [)66. &hus, >ood Juardians actually saves [)66 by using the materials for the city’s special =ob. onse'uently, the "pp"#$ni$y ("'$ "! 8a$ia5' ("'$ i' ?/,, i.e., the opportunity cost of this resource is negati!e". d. >ood Juardian’s $"$a5 "pp"#$ni$y ("'$ G [30) for skilled labor F [6 for unskilled labor ? [)66 for materials G ?1=/ . &he minimum price is the price at $hich >ood Juardians =ust reco!ers its opportunity cost. %ecause the opportunity cost is negati!e, W""4 Ga#4ian' a($a55y i' 2i55in $" pay $%& (i$y 1=/ for the =ob &his, of course, is the minimum price that >ood Juardians is $illing to accept. %asing the price on >ood Juardian’s opportunity cost alone, ho$e!er, is not a good strategy. &he recommended price must account for the cit!"s or more generally, customer’s" opportunity cost as $ell. If the city $ent else$here, the ne$ supplier likely $ill ha!e to buy the materials and pay for the labor i.e., it is unlikely that the ne$ supplier $ill ha!e both the materials in stock and e(cess labor capacity". &hus, the ne$ supplier’s opportunity cost is likely to be positi!e, resulting in a positi!e price to the city. &his price is the city’s opportunity cost, and >ood Juardians management must estimate this opportunity cost &his estimate $ill be important to >ood Juardians pricing strategy. 9ote: &his problem emphasi+es that $e compute opportunity cost on a resource?by?resource basis. &hus, it is possible that $e ha!e some resources in short supply but ha!e plentiful supply of others.
1.)0. a. &here are many possible factors the follo$ing four seem important:
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1?36 llowed inutes. %oth the total number of minutes and their distribution matters. 7or instance, a plan $ith unlimited nights and $eekends may be preferred e!en if it has fe$er KanytimeL minutes. #ontract length. Jenerally, a shorter contract is preferred because it allo$s for more fle(ibility. 8n the other hand, a long contract also protects you from a price increase a remote possibility in the face of intense competition". Service qualit!. &his is a !ery important dimension. Ha!ing all the minutes in the $orld doesn’t matter much if one cannot use them 9nitial cost of phone and activation. arriers attract customers by subsidi+ing this cost hiding it in the form of higher monthly fees andCor longer contract lengths". &he feature’s attracti!eness depends on one’s current cash flo$. 9ot many students can afford to spend O166 or more on a phone and acti!ation.
b. &his 'uestion highlights that people ha!e differing goals. * person $ho makes many long distance calls state to state" $ould likely prefer plan *. &he plan’s KfreeL long?distance feature lo$ers the total cost. * person $hose calls are almost surely $ithin the calling +one $ould likely prefer plan %. Many students are likely to be in this category. Ho$e!er, the relati!ely high cost for acti!ation might pose a problem for cash?strapped students. &his plan also might be chosen by someone $ho is looking to replace their landline $ith a cell phone. lan is likely attracti!e to someone $hose usage !aries $idely $ith other plans, unused minutes e(pire $hereas they carry o!er in plan . lan also likely appeals to persons $ho use the cell phone as a Ksecondary,L or emergency, phone rather than as a primary line. 7inally, plan is attracti!e because it has fle(ibility plans * and % lock the user into a t$o? year contract $hereas plan allo$s for easy s$itching. 1.). a. asinos monitor their employees because of the di!ergence bet$een its goals and its employee’s goals. &he casino’s goal, $hich is to ma(imi+e profit, is at odds $ith employees’ goals, $hich is to ma(imi+e their personal $ealth. >ithout monitoring, employees $ould be tempted to increase their o$n $ealth by stealing money and chips. Such concerns are particularly salient in casinos because employees handle large sums of money and, $ithout monitoring, could easily hide the theft by simply claiming that a patron $as lucky and $on the money. asinos therefore monitor their employees to reduce losses associated $ith employee theft. asinos can use both proacti!e and reacti!e controls to reduce this loss. roacti!e controls include !ideo sur!eillance, physical monitoring by floor super!isors and pit bosses, lock and key de!ices for slot machines, safe?keeping of high?!alue chips by sliding them into a locked cabinet, tracking gains and losses and comparing them to peer data, and using background security checks. 4eacti!e policies could include firing or prosecuting employees caught %alakrishnan, Managerial *ccounting 1e, A 2665
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1?31 cheating. *s $e see, there are many means casinos use to stop employees and patrons from cheating the number is limited only by management’s creati!ity. b. 4elati!e to physical monitoring, !ideo monitors are less intrusi!e. &he casino $ants to pro!ide a friendly en!ironment $here patrons feel at ease and are more $illing to gamble. atrons may not like ha!ing ob!ious KsecurityL types hang around. *nother ad!antage is that !ideo feed can be recorded. &his allo$s e!ents to be re!ie$ed and makes for compelling e!idence in a court of la$ $hile security staff can also testify, their memory is more fallible and less ob=ecti!e". 7inally, the casino must also monitor the security guards themsel!es to pre!ent them from colluding $ith other employees to cheat the casino. @ideo monitoring, ho$e!er, does ha!e some dra$backs. 7irst, ha!ing a !isible security presence may alter people’s beha!ior and make them more prone to obeying the rules. >e all ha!e slo$ed do$n $hen $e see a patrol car in the distance. &he patrol car therefore ser!es a useful role, e!en if aerial monitoring from a helicopter is more effecti!e at identifying speeders. Second, !ideo monitoring may be more e(pensi!e than hiring security guards. 7inally, it may be more difficult to pick up subtle beha!ioral and body language type clues from a !ideo monitor relati!e to direct obser!ation. In this regard, physical monitoring may be more effecti!e than !ideo monitoring. c. Multiple monitoring systems make sense because, as discussed in part XbY, any gi!en system is likely to ha!e some $eak spots. &he use of multiple systems increases the probability that an! improper beha!ior $ill be detected and corrected. &he best mi( of monitoring systems depends on the specific circumstances. 7or e(ample, casinos rely hea!ily on !ideo sur!eillance because indi!idual employees continuously recei!e and pay out large sums of money $ithout physical or electronic documentation such as a receipt". * fast?food chain, on the other hand, is less likely to use !ideo sur!eillance because employees monitor each other i.e., $ork closely together", handle less money, and transactions $ith customers are better documented e.g., all customers recei!e a receipt for their purchase" in this case, the best control may be to reconcile the money in the cash dra$er $ith the tape total at the end of each day or shift. &o understand this point better, consider $hy your instructor may use both multiple choice and essay 'uestions on e(ams. ach type of 'uestion is ad!antaged in testing one aspect of learning. Multiple choice 'uestions are easy to grade and can test Kfact learningL !ery $ell. ssay 'uestions test student understanding and integration of material, making them much harder to grade. %ecause both types of learning are important, an instructor may use both types of 'uestions. 9ote: *nother factor to consider is the concept of diminishing marginal returns. &hus, $e usually find a portfolio of controls rather than one control alone. 1.)5. a. 7eli( has four options: •
Bo not paint the bedrooms no$.
%alakrishnan, Managerial *ccounting 1e, A 2665
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1?32 • • •
aint the bedrooms by himself. aint the bedrooms $ith 8scar’s help. ontract out the painting =ob.
b. &here appears to be little conflict bet$een 7eli(’s and 8scar’s ob=ecti!es. %oth indi!iduals $ish to ha!e a good 'uality paint =ob. &his congruence in ob=ecti!es, ho$e!er, does not imply that monitoring is not needed. 7eli( $ould do $ell to monitor 8scar’s progress and $ork 'uality. &he purpose of this monitoring is to pro!ide feedback and to impro!e 'uality impro!e 8scar’s skill as a painter" rather than to e!aluate 8scar’s performance. &ranslating to organi+ational settings, $e must pay attention to the purpose of the monitoring mechanism $hen choosing the mechanisms. * system that is appropriate for monitoring performance may $ell be ill?suited to pro!ide diagnostic and feedback information. c. 7eli( and the contractor ha!e differing ob=ecti!es. &he contractor’s ob=ecti!e is to make a profit. &he contractor can do this by deli!ering =ust the 'uality the a!erage customer cannot discern the difference bet$een good and e(cellent 'uality" that the client demands, and by taking the least amount of time possible. 7eli(, on the other hand, cares deeply about 'uality. nless 7eli( is !ery careful to spell out his 'uality e(p ectations, it is likely that there $ill be a dispute about =ob 'uality. erformance e!aluation is the key role for control measures and monitoring in this setting. 9ote: It is $orth$hile to contrast the differing roles for monitoring in the t$o settings. sually, the purpose of monitoring is to ensure compliance $ith policies and procedures. Such monitoring is re'uired because organi+ational and employee goals differ. 7or e(ample, attendance records ensure that employees sho$ up on time. &his role for monitoring does not e(ist $ith 8scar but does $ith the contractor. *lthough 7eli( is likely to assess 'uality in both settings, the purpose differs. It also is possible that some types of e!aluations contain both performance assessment and feedback aspects. Some instructors gi!e tests both $ith the ob=ecti!e of testing student’s kno$ledge and $ith the ob=ecti!e of helping students figure out $hat they kno$ and $hat they do not kno$. &he former is the e!aluati!e aspect of the e(am $hile the latter is a feedback role. 1.-6. It is true that, as a result of the bonus contract, Sally has a direct interest in ma(imi+ing the Biamond ubilee’s profit. &hus, the bonus contract does help align Sally’s interests $ith those of the casino. Ho$e!er, the bonus contract may not fully align Sally’s interests $ith those of the partnership/ there are at least t$o areas of concern: 1. Sally and the partnership may ha!e different time hori+ons. Sally may be more interested in ma(imi+ing today’s, or short?run, profit because, for e(ample, she is close to retirement, she is planning to mo!e, or she is planning to s$itch =obs. 8n the other hand, the partnership
%alakrishnan, Managerial *ccounting 1e, A 2665
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1?33 probably is more interested in ma(imi+ing the long?run stream of profits, or the present !alue of future cash flo$s accruing to the casino. Such differences in time hori+on could lead Sally to take actions that increase current profits at the detriment of future profits. 7or e(ample, Sally may not in!est in ne$ e'uipment e.g., slot machines or other gaming de!ices" or may defer maintenance or upgrades to the ri!erboat because such actions $ould increase e(penses, thereby reducing current profit and Sally’s bonus. &he partnership, ho$e!er, may prefer such actions be taken to ensure the long? run !itality and success of the casino. Bifferences in time hori+on also may lead Sally to not in!est in increasing customer loyalty and good$ill. 7or e(ample, Sally may not offer casino patrons comps such as free drinks, free food, free chips, or discounted rooms. >hile such actions may increase short?term profits because they reduce the casino’s costs" they may =eopardi+e long?term profits because it has been sho$n that offering comps gets people and their friends" to come back to the casino. 2. * second source of discord may arise because Sally’s contract appears to encourage her to consume many per'uisites. Sally may be moti!ated to consume per'uisites because she recei!es all of the benefits $hile only bearing )D of the cost i.e., her lost share of profit". 7or e(ample, if Sally orders a ne$ chair for her office that costs O1,666, Sally gets e(clusi!e use of the ne$ chair and it only costs her O1,666 × .6) G O)6 in lost bonus income $hile casino profit goes do$n by O1,666". Sally may decide that, at O)6, the ne$ chair is a bargain casino partners, though, may !ie$ the matter differently. *nalogously, Sally may be moti!ated to gi!e herself a larger office andCor gi!e her friends and relati!es free meals and free chips. 7inally, Sally may e!en engage in unethical an d illegal beha!ior such as falsifying receipts and e(penses. 7or e(ample, if Sally submits a false receipt asking for a O)66 reimbursement, Sally recei!es the O)66 less the O2) reduction in her bonus O)66 × .6) G O2)" G O#0). >e see that Sally’s contract is indeed imperfect. &hese e(amples sho$ that Sally’s interests are not fully aligned $ith those of the partnership. *ccordingly, it probably $ould not be in your best interest to delegate all decisions to Sally and gi!e her complete control of the casino. Moreo!er, the lack of incenti!e alignment may trigger the need for additional performance measures abo!e and beyond linking Sally’s compensation to casino profitability" to ensure that Sally acts in the best interest of the partnership. 7irst, you probably $ould restrict the decisions Sally could make for e(ample, you may re'uire her to obtain appro!al before she purchases a chair or submits an e(pense report.
784 I9S&4&84 S 89;<
1?3# regarding ho$ your casino and employees" are performing !is?Z?!is other casinos and their employees. 1.-1. a. &here clearly is some !alue to teaching boys the !alue of $ork and the dignity of labor. Ho$e!er, the State’s ob=ecti!e of Kreforming delin'uent youthL probably encompasses turning troubled kids into producti!e members of society. It is unclear ho$ digging holes accomplishes this ob=ecti!e i.e., ho$ it $ill lead troubled kids to not commit crimes, find gainful employment, and ac'uire social skills. It is possible to assess the effecti!eness of the >arden’s performance measure. 7or e(ample, they $ould need to track the boys’ progress o!er a long?term hori+on and compare this to the progress of youths at other =u!enile camps $here they use different methods to reform the kids". In the short?run, it $ould seem that the State $ould $ant to measure the kids’ academic progress i.e., reading and math skills" so that they are ac'uiring the necessary tools to be producti!e upon release. b. &he measure seems to correspond !ery $ell $ith the >arden’s ob=ecti!e. &his is an e(treme case of the >arden using her authority and po$er to further her o$n interests at the e(pense of others c. *s discussed in part XaY, the State could ha!e put in additional performance measures to capture other dimensions of reforming delin'uent youth. &he State also has to closely monitor the camp and the >arden !ia surprise !isits or formal grie!ance procedures. >ithout additional performance measures or monitoring, the >arden is free to do as she pleases. N"$&: &he mo!ie Shawshank 8edeption has a similar theme. In this mo!ie, a prison $arden abuses his authority to e(ploit prison labor and build his fortune.
1.-2. a. *ll else being e'ual, the partners in 7elipe’s firm $ould like to book the contract as early as possible. Belaying the order until the ne(t fiscal year sub=ects the firm to uncertainty albeit small" that the order may be canceled or delayed. *s the old adage goes, a bird in the hand is $orth t$o in the bush. 7urther, the sales shortfall for the year pro!ides additional moti!ation for the partners to book the sales no$ and meet targets. b. &he timing of the sale matters a great deal to 7elipe. If he books the sale this year, he $ill ha!e o!ershot last year’s performance by a substantial amount and he is already o!er last year’s target". More importantly, booking the sale this year $ill make it that more difficult for 7elipe to increase sales ne(t year. Moreo!er, if he books the sale this year, he $ill not start ne(t year $ith a bird in hand, but rather, in a hole. 8!erall, incenti!e considerations may $ell spur 7elipe to delay the paper$ork sufficiently so that the sale counts for the ne(t fiscal year. c. &his act falls in the gray +one of ethical beha!ior. &here is nothing illegal about the action and it is not clear that 7elipe’s firm $ill be ad!ersely affected by a fe$ $eeks delay in processing the order. Such massaging of last minute orders oftentimes it $orks the other %alakrishnan, Managerial *ccounting 1e, A 2665
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1?3) $ay around $ith managers $orking hard to pull ne(t year’s orders into this year’s numbers" is commonplace and una!oidable $ith budget?based performance measures. Most persons $ould !ie$ this act to be a natural outgro$th of the incenti!es in place and that it is neither unethical nor unprofessional for 7elipe to delay the sale until the ne(t fiscal year. 1.-3. a. Stefan’s ob=ecti!es are clear he likely $ill choose the option that ma(imi+es his bonus o!er the t$o?year period. &hus, to understand $hat Stefan likely $ill do, $e should calculate his bonus in t$o cases: 1" he undertakes the sales campaign/ 2" he does not undertake the sales campaign. 9otice that $e can ignore Stefan’s base salary of \1),666 per month as it is the same under both options. :1; Sales capaign undertaken*
Sales G \22 million this year and \12 million ne(t year. Stefan’s bonus this year G X\26 million \16 million" × .62Y F X\22 million \26 million" × .6)Y G ,,+,,,0 Stefan’s bonus ne(t year G X\12 million \16 million" × .62Y G .,+,,,0 &hus, Stefan’s bonus o!er the t$o years G .,+,,,0 :2; Sales capaign not undertaken*
Sales G \1- million this year and \1- million ne(t year. Stefan’s bonus this year G X\1- million \16 million" × .62Y G 1=,+,,,0 Stefan’s bonus ne(t year G X\1- million \16 million" × .62Y G 1=,+,,,0 &hus, Stefan’s bonus o!er the t$o years G =.,+,,,0 &he net increase in Stefan’s bonus from undertaking the campaign G \166,666 G \3#6,666 \2#6,666. Stefan clearly should undertake the sales campaign time !alue of money considerations also $ould suggest adopting the campaign". b. &he firm’s ob=ecti!es also are pretty clear to ma(imi+e !alue, the parent company likely $ould $ant Stefan to pursue the intensi!e sales campaign only if it increased t$o?year profit. 7rom the firm’s !ie$point, $e can calculate the increased benefits and costs associated $ith the campaign: Increase in profit less: incremental campaign costs less: increase in commission to Stefan 9et decrease %alakrishnan, Managerial *ccounting 1e, A 2665
\66,666 \1 million" \166,666" \366,666"
Increase in sales × O6.#6" Ji!en *s calculated in part XaY
784 I9S&4&84 S 89;<
1?3-
&hus, the sales campaign is not profitable from the firm’s !ie$point accordingly, the firm $ould prefer that Stefan not undertake the sales campaign. c. >e indeed see that there is a di!ergence of interest bet$een Stefan and his parent company. &his conflict stems from t$o sources. 7irst, Stefan is not held accountable for costs Stefan’s current compensation arrangement re$ards him strictly for increasing re!enues thus, Stefan XtheoreticallyY $ould undertake any action that increased re!enues regardless of the cost to the parent company. 7or e(ample, Stefan $ould ha!e an incenti!e to choose an option that increased sales by \1 million e!en if it increased o!erall cost by \2 million. learly, there is incenti!e misalignment and, to rectify this problem, the parent company should hold Stefan accountable for both re!enue and costs. Second, Stefan has clear incenti!es to manage sales across periods gi!en the structure of his contract i.e., the higher rate on sales o!er \26 million and the lo$er rate on sales under \16 million. &he company likely is using this non?linear contract in a belief that it moti!ates Stefan to $ork hard. Such contracts, though, may also engender gamesmanship and the company might $ish to consider alternati!e contracts, such as a linear specification. 1.-#. a. &he follo$ing table pro!ides some key decisions, o!er the life of the machine, corresponding to the four stages of the planning and control cycle. S$a& lan
D&$ai5 &he decision of $hether to buy the ne$ press or not is part of this stage. &he act of committing resources, be it money, time or space, is a critical piece of this stage. 8ther decisions might include choosing the products that $ill be produced $ith the ne$ press and the prices at $hich these products $ill be sold.
Implement
Implementation $ould include decisions about $hen and $here to install the press and ho$ best to schedule production of the !arious products. &his stage also includes control aspects, such as selecting performance targets for the ne$ press both 'uantity and 'uality" and ho$ best to moti!ate press operators to achie!e these performance targets.
!aluate
&his stage $ould include measuring the 'uality and 'uantity of the output and comparing it to the targets established in the implementation stage. Managers at @ulcan $ould seek to understand the reasons underlying significant de!iations bet$een planned and actual results. Managers $ould e!aluate numerous other results, such as repair statistics and operating costs.
4e!ise
@ulcan’s management $ill continually re!ise their beliefs about the $isdom of their choice as they gain e(perience using the press.
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1?30 !entually, this updated information $ill influence the type of press they buy ne(t, and might $ell influence $hen they buy the ne(t machine. 7or e(ample, they might decide to scrap the machine in t$o years if it breaks do$n more often than is e(pected. b. *s $e see, $e usually begin $ith a plan that is based on a set of assumptions in this case, the costs and benefits of replacing the current press $ith a ne$ press. &hese assumptions are our beliefs about the unkno$n future. >e then implement our choices and, as time passes, $e $ill gather more information about the actual costs and benefits of the ne$ press. 8!er a period, $e $ill accumulate enough information to re!ise our original set of assumptions, $hich $ill influence our ne(t purchase. &here are many smaller decisions $ithin this o!erall cycle. In many instances, the broad loop relating to a decision contains smaller loops $ithin it. 7or e( ample, $e can think of the schedule for any gi!en day as a decision this has its o$n loop $here $e commit machine time and e(ecute the plan. >e then figure out $hether the schedule indeed $orked as planned and the reasons for any de!iations. &his information feeds into the ne(t day’s schedule. &he o!erall efficiency, the outcome of numerous scheduling decisions, then becomes part of the e!aluation stage of the larger cycle. &he fundamental point is that e!ery decision has a natural cycle to it. 1.-). Bre$’s first statement reflects some ignorance about ho$ to make effecti!e decisions. *ll decisions concern the future. &hus, most decisions include some uncertainty about future costs and benefits. !en $hat seems to be a simple decision, such as $hether to $atch a mo!ie a second tie, contains uncertainty because $e do not kno$ ho$ good the mo!ie $ill be the second time around. Some mo!ies age $ell $hile others do not. &he point is that $e make decisions $ith some e(pectations. *s the decision unfolds, $e obtain actual results and re!ise our e(pectations. &his is the planning?control cycle. &his cycle does not mean that people must regret or rethink their decisions. It =ust means that $e constantly e!aluate $here $e are relati!e to our e(pectations and ad=ust our plans accordingly. &his is true e!en $ith the most detailed plans]often, a $ar plan is discarded $ithin a fe$ hours of starting operations because the enemy does not al$ays do $hat you e(pect Bre$’s second comment is !alid. 7e$ decisions cleanly follo$ the #?stage I4 process. * comple( decision e.g., $ho to start, $hich machine to buy" usually contains many smaller decisions. >e can legitimately construct a I4 process for these smaller decisions as $ell. Ho$e!er, this ability does not remo!e our need to think about the larger decision as a I4 process. &he cycle is a $ay of sho$ing that e!ery decision follo$s a common template. 1.--. &he follo$ing are among the many items that &om and ;ynda might consider: 1. Increase in number of members. &his non?financial item relates to a benefit, increased re!enues. &he correct benchmark for the item is the number of members if yoga $ere not %alakrishnan, Managerial *ccounting 1e, A 2665
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1?3 offered. &he number has to be sub=ecti!ely estimated. (amining past da ta on classes offered pre!iously and the resulting membership might pro!e helpful in forming this estimate. 2. 7ee per member. &his financial item relates to a benefit. It is easily and ob=ecti!ely measured from the firm’s accounting systems. 3. Increase in cost of supplies and other member?related costs. &his financial item relates to a cost. sing data from Hercules’ managerial accounting system, &om and ;ynda can reasonably estimate this cost. Ho$e!er, there is ine!itably some sub=ecti!e element e.g., it is no clear $hether the gym $ill ha!e data on the !ariable costs connected $ith a yoga class e.g., number of mats to be replaced each month". #. Increase in instructor salaries and ad!ertising. &his financial item relates to a cost. &his item may ha!e to be estimated based on contract negotiations $ith the yoga instructor. Some amount of this item may also be discretionary e.g., ad!ertising". ). Image of gym. &his item relates to a long?term benefit. 8ffering yoga must fit $ith Hercules’ o!erall KimageL and Kbrand.L 7or e(ample, yoga might not be the best choice if Hercules primarily catered to men interested in $eight lifting and strength training.
1.-0. &he follo$ing are among the many items that you might consider: 1. Bemand for item. &his non?financial item relates to a benefit, increased re!enues. &he number has to be estimated using some ob=ecti!e data and some sub=ecti!ity. (amining past data on similar products and market research pro!ide 'uantitati!e input that is sub=ecti!ely con!erted to an estimated demand. 2. rice for item. &his financial item relates to a benefit. It is a choice !ariable. Ho$e!er, notice that this choice affects demand and therefore costs". 3. osts. &his financial item relates to a cost.
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1?35 1.-. a. &o understand rofessor T’s moti!ation, consider $hat happens if fe$er than 32 students sho$ up and $hat happens if more than 32 students sho$ up. >ith too fe$ students, the e(periment must be cancelled. In addition to delaying his research, rofessor T no$ has the problem of inducing the ne(t set of students to sho$ up. rofessor T $ill incur substantial costs in time and effort to reschedule the e(periment and recruit ne$ students. 8n the other hand, consider $hat happens if too many students sho$ up. In this case, rofessor T has to pay the sho$?up fee to the e(cess students. rofessor T’s choice of the sho$ up fee amount tries to balance these t$o costs and minimi+e their total. &o see this, consider $hat $ould happen if he offers a sho$?up fee of O)66 and in!ites 32 students. 9ot many undergraduate students $ill pass up a chance to make O)66 for sure. If rofessor T in!ites 32 students, then he can be fully confident that all 32 $ill sho$ up. &his strategy, ho$e!er, implies that he $ill ha!e to pay O1-,666 G O)66 per student P 32 students" as a sho$?up fee. 9o$ suppose rofessor T offers no sho$ up fee and still in!ites only 32 students. &hen, a student may or may not sho$ up &he student only gi!es up the chance to spend an hour to make O26 or so. %ut, if less than 32 students sho$ up, the e(periment must be cancelled and re?scheduled. rofessor T’s cost of doing so may be, say, O#66 or so. If there is a 56D chance that fe$er than 32 students sho$ up, then rofessor T’s e(pected cost is O#66 P 6.5 G O3-6. rofessor T can reduce his e(pected cost by reducing the probability of ha!ing fe$er than 32 students sho$ up. He can do this by increasing the number of students in!ited still by keeping a O6 sho$?up fee". Ho$e!er, if he increases the number of students in!ited, $ord $ill soon get out that some if not many" of the students $ho sho$ up $ill go home $ith nothing for their trouble. rofessor T may then ha!e difficulty recruiting students for future e(periments. *s argued earlier, a sho$?up fee also reduces the probability of ha!ing fe$er than 32 students sho$ up but is costly to rofessor T. &he O) fee is a compromise bet$een in!iting many students and building up a reputation for $asting students’ time and incurring the cost of the sho$?up fee. 9ote: &his problem is useful in highlighting ho$ uncertainty shapes our decisions. 4eali+ed e!ents lead to actual costs and benefits. Ho$e!er, as $e do not kno$ the future, $e rely on e(pectations to compute the !alue and opportunity cost of decision options e.g., ^ of students to in!ite". Indeed, $e could characteri+e many decisions as finding the best balance bet$een the costs and benefits of alternate future possibilities. apacity choice is a salient business e(ample that balances the costs of buying too much capacity !ersus the costs of buying too little. b. &o assess opportunity cost, consider the student’s options. &he student could sho$ up or not sho$ up. &he opportunity cost of sho$ing up is the !alue of not sho$ing up and doing other things e.g., $atching &@, hanging out $ith friends, studying". >e do not ha!e a good !alue for this measure. Ho$e!er, if a student does sho$ up, then the student earns O) for sure. >ith a 16D probability, the student $ill be done. SChe can then spend the freed?up time as sChe $ishes. >ith 56D probability, sChe can earn O26 o!er the ne(t hour. >e can combine the t$o possible outcomes to get an e(pected !alue associated $ith sho$ing up. &his e(pected !alue %alakrishnan, Managerial *ccounting 1e, A 2665
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1?#6 must e(ceed the student’s sub=ecti!e !alue of not sho$ing up and doing other things. It is not possible to get a 'uantitati!e measure of the opportunity cost of sho$ing up. 9ote: &he opportunity cost is lo$er than the e(pected earnings of O23 G X.56 P O26Y F O)" for the student $ho does sho$ up, and is likely higher than O23 for the student $ho does not sho$ up. It is not possible, though, to get a more precise measure of the opportunity cost. c. Making the students’ earnings !ary is a mechanism to combat the incongruence in goals bet$een rofessor T and the students. rofessor T $ould like the students to take the decision task seriously so that he can get good 'uality data to study. &he students, on the other hand, $ould like to e(ert the least cogniti!e effort possible, all else being e'ual. >ith a flat $age, the student has no incenti!e to $ork at the problem and make good decisions. &his lack of attention degrades data 'uality and erodes the !alue of rofessor T’s study. ;inking pay to the 'uality of decisions ho$e!er measured" pro!ides incenti!es to make good decisions. &he student no$ has to tradeoff the cogniti!e effort $ith the e(pected increase in hisCher compensation. rofessor T $ill likely structure the pay scheme in a $ay that students find it beneficial to $ork hard for that hour. 9ote: 8ne can formally analy+e the student’s decision task as $ell. 7or simplicity, restrict the options to $orking hard and not $orking hard. &he decision to $ork hard trades off the cost of effort $ith the e(pected increase in take?home pay. 1.-5. a. >hat does Br. le!eland !alueQ &he problem suggests three factors: 1" her income, 2" pro!iding 'uality medical care to her patients, and 3" making her ser!ices a!ailable to all. *ll three components are important to her and shape her goals. Br. le!eland’s current situation seems to suggest a tradeoff among these factors. &he insurance companies allo$ her to reach out to many people but potentially compromise 'uality. >e note that there is !igorous debate regarding $hether the restrictions imposed by insurance companies and HM8s compromise 'uality. &he problem indicates that Br. le!eland percei!es a compromise/ therefore, $e assume that 'uality $ould increase if Br. le!eland $ere to s$itch to the patient pays billed charges approach". *dditionally, it is unclear ho$ much Br. le!eland’s income $ill be affected by her alternati!es. &he presence of a tradeoff among the factors that Br. le!eland !alues suggests that her relati!e preferences among these factors $ill play an important role. &hat is, Br. le!eland $ill ha!e to decide $hich factor she !alues most income, 'uality care, andCor making her ser!ices a!ailable to all. &he choice is not at all clear cut. b. &he follo$ing tables pro!ide the re'uired computations:
Item &ime per patient a!erage" atients per hour %alakrishnan, Managerial *ccounting 1e, A 2665
HM8’s and Insurance lans 1) minutes #
atient ays harges *pproach _ hour 2
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1?#1 9umber of hours in day atients per day 9umber of days $orked 8ffice !isits per year 4e!enue per patient Anna5 R&6&n&'
32 22) 0,266 O#6 *=+,,,
122) 3,-66 O0) *=;,+,,,
7rom a purely monetary perspecti!e, the current approach appears to be more profitable than s$itching to the patient pays billed charges approach. Ho$e!er, the abo!e comparison ignores any cost effects. It is possible that costs $ould decrease under a Kpatient pays chargesL approach. 7irst, Br. le!eland $ould be hal!ing the number of patients seen. &his reduction in !olume could lead to a reduction in the demand for nursing staff as $ell as a reduction in ancillary help such as receptionists and record clerks. Second, there $ill be fe$er hassles connected $ith follo$ing up $ith insurance firms, reducing the demand for accounts clerks. &he re!enue comparison also lea!es out some benefits. 8ften, clinics conduct many routine tests such as urinalysis. >ith reasonable assumptions about patient mi(, the re!enue from these tests depends on the number of patients seen. &his re!enue $ould decrease under the proposed plan as $ell. 8!erall, $e do not ha!e enough information to estimate fully the monetary impact on Br. le!eland’s practice from s$itching plans. &his is the topic of future chapters." c.
&echnically, one can think of more options. 7or e(ample, Br. le!eland can 'uit the practice of medicine altogether. *lternati!ely, she can de?list from some plans and not others. It is likely, ho$e!er, that Br. le!eland $ould eliminate such options because the aforementioned t$o options appear to dominate these hybrids. Becision makers often simplify the opportunity set to a fe$ choices, moti!ated in part by cogniti!e considerations. #osts - 'enefits* *s listed earlier, there are numerous costs and benefits to be considered:
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1?#2 •
•
•
Impact on income. &he t$o plans $ill yield different incomes. 8ne is a lo$?price high !olume plan $hile the other is a high price, lo$ !olume plan. In addition, the !olume differences may affect o!erall costs as $ell. Impact on 'uality. &he Kpatient pays billed chargesL approach potentially at least in Br. le!eland’s mind" allo$s her to pro!ide superior medical care. &his is an important factor to a committed physician. Impact on reach. Br. le!eland also belie!es that good 'uality medical care should be a!ailable to all. She can reach out to the under?pri!ileged and uninsured by, for e(ample, pro!iding free care three days in a $eek. Ho$e!er, doing so $ould reduce her income. She seems to ha!e struck a compromise by contracting $ith many HM8s and insurance plans this still lea!es out the uninsured". Joing to a patient pays charges approach $ould further reduce her reach. 7e$ among us can pay the balance not co!ered by the insurance payment $e still ha!e to pay the insurance premium". &he proposed approach is therefore likely to change her patient profile to$ard the more $ell to do. &his shift is in direct contrast to one of Br. le!eland’s core beliefs, and is the cru( of the dilemma.
+aking a choice* &he final step is to pick the option $ith the highest !alue the option that gi!es Br. le!eland the best KbalanceL bet$een income, 'uality and reach.
d. &he opportunity cost of this decision is the !alue obtained from the ne(t best use of that time. &he problem states that Br. le!eland e(pects to be fully occupied e!en if she s$itches to the patient pays billed charges approach. &hus, if Br. le!eland de!otes three hours to indigent care, then she gi!es up the chance to see paying patients. >e are assuming that she is still $orking for hours per day. &he follo$ing paragraph rela(es this assumption." &hat is, she $ill see - fe$er patients during a $eek. *t the rate of O0) per office !isit, this translates to O#)6 per $eek. >hat happens if Br. le!eland does indigent care outside her regular office hours hours per day", such as during the early morning and late e!ening hoursQ Specifically, assume that she keeps the clinic open from ) M to M on >ednesday e!enings, de!oting the time only to indigent care. In this case, Br. le!eland is gi!ing up leisure time. She could be pursuing other acti!ities family time, reading, hobbies" during this time. Spending the time on indigent care reduces the time a!ailable for these other acti!ities. &he opportunity cost is then the !alue of these other acti!ities. &he !alue of regular patients not seen doe s not apply here because there $ould be no reduction in the number of paying" patients seen. e. If she de!otes only 2) minutes per patient, Br. le!eland can see 15 patients per day, or 15 P 22) G #,20) patients per year. &his !olume yields re!enues of O326,-2) #,20) P O0)" per year, a significant increase o!er the pro=ected re!enues of O206,666. &he key tradeoff here is the potential reduction in 'uality 2) minutes !ersus 36 minutes per a!erage !isit" $ith the increase in income patient reach also is affected". &he best decision from Br. le!eland’s perspecti!e is unclear. &his change goes against one of her ob=ecti!es of pro!iding 'uality care. Her =udgment about the 'uality loss due to the lo$er time spent $ith each patient is crucial as she assesses her options. &he potential loss in 'uality along $ith any associated loss in reputation is a long?term effect. It is likely that only one in many patients %alakrishnan, Managerial *ccounting 1e, A 2665
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1?#3 feels a significant decline in 'uality because of the lo$er time commitment. Ho$e!er, these instances build up o!er time and lead to the lo$er o!erall perception of 'uality. Jood managers consider both immediate and distant effects in their decision making, e!en if they cannot measure $ell many of the long?term effects. 1.06. a. &he Birectors ha!e fi!e options: 1.
Bo not fund any pro=ect that is, add the entire O)6,666 in remaining grant money to the 7oundation’s endo$ment.
2.
7und pro=ect * alone.
3.
7und pro=ect % alone, and add the remaining O32,666 to the 7oundation’s endo$ment.
#.
7und pro=ect alone, and add the remaining O2,666 to the 7oundation’s endo$ment.
).
7und pro=ects % and , and add the remaining O16,666 to the 7oundation’s endo$ment.
>ith the gi!en budget, it is not possible to fund pro=ect * and some other pro=ect. &his constraint remo!es the choice of funding ro=ects * and % or ro=ects * and " from the option set. In reality, pro=ects can and often are" funded at less than re'uested le!els. &his additional fle(ibility e(pands the number of options. 7or instance, the fle(ibility permits the option of funding ro=ect * at O3),666 and ro=ect % at O1),666. b. If pro=ect * is funded, then the other t$o pro=ects cannot be funded. &he opportunity cost depends crucially on $hether the Birectors belie!e ro=ect % andCor ro=ect $ill generate more !alue than the amount funded. If both ro=ects % and are percei!ed as !aluable i.e., the Birectors belie!e each pro=ect $ill generate more !alue than the amount of funding re'uested" then the opportunity cost is the lost benefit from not funding pro=ects % and plus the !alue of adding O16,666 to the endo$ment. Suppose pro=ect % is deemed to be !aluable $hereas pro=ect is not. &hen, the opportunity cost is the lost benefit from funding pro=ect % plus the !alue of adding O32,666 to the endo$ment. &he opportunity cost is the benefit deri!ed from option 3 in part XaY. *nalogous arguments apply if pro=ect is deemed $orthy but pro=ect % is not." Suppose neither pro=ect % nor pro=ect is deemed to be !aluable. &hen, the opportunity cost is the cost of holding O)6,666 in reser!e to fund future, yet to be determined, pro=ects. &his opportunity cost is the !alue attached to option 1 in part XaY.
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1?## c. &he approach has benefits and costs. &he benefit is that it makes the decision problem manageable. 4ather than consider combinations of pro=ects e.g., pro=ects % and , pro=ect by itself, pro=ect % by itself, and so on", the Birectors need e!aluate only one pro=ect at any gi!en time. &his reduces their cogniti!e load significantly. &he cost is that $e may poorly measure opportunity cost. Specifically, because ro=ect is e(amined in isolation $ithout reference to other pro=ects", the approach assumes that the opportunity cost of funding pro=ect is O22,666. It does not consider the other uses for the O22,666 e.g., that it may be used to fund ro=ects * or %". In particular, assume that the directors !alue pro=ect at O2),666. &hen, pro=ect $ill be funded. Ho$e!er, this decision implies that pro=ect * $ill be unfunded, regardless of its merit. 7or e(ample, pro=ect * may be !alued at O1)6,666 clearly, a better return for the foundation’s money relati!e to funding pro=ect . %ut, the se'uential decision rule leads to a poor decision. &he takea$ay point is that the best decision rule should consider all of the options. 4estricting the number of options considered, as the se'uential rule does, could therefore result in bad decisions. 9ote: * se'uential decision rule is sub?optimal in this setting because of limited resources. Suppose the foundation had an unlimited budget. &hen, it does not matter $hether the pro=ects are e!aluated se'uentially or simultaneously. &he opportunity cost of each pro=ect in this case is the cost of the funds e(pended, and not the !alue of a pro=ect that the selected pro=ect displaces. d. %ased on the Birectors’ assessments, ro=ects % and should not be funded because the !alue is less than the re'uested amount". &he decision boils do$n to $hether ro=ect * should be funded. &he opportunity cost of funding ro=ect * is the best other use for the O)6,666 i.e., the !alue of option 1". &his opportunity cost is likely greater than O)6,666. 4etaining the money allo$s the directors the fle(ibility of funding a future but $ith details currently unkno$n" pro=ect. &he !alue of this should be included in the opportunity cost of funding ro=ect *. *ttaching a dollar figure to the !alue of the fle(ibility, ho$e!er, is a difficult task. &he Birectors ha!e to use their =udgment to figure out the chance that a superior pro=ect $ould materiali+e if ro=ect * $ere not funded. >e con=ecture that a net !alue of O)66 G O)6,)66 O)6,666" is sufficiently small that the Birectors $ill not fund ro=ect * as $ell. 1.01. a. 7or simplicity, let us assume that management’s goals are the same as organi+ational goals. Management then has at least t$o broad goals. &he first goal is to make profit for the shareholders or at least breake!en if the o$ner is a not?for?profit entity. &he second goal is to pro!ide 'uality medical care to as $ide a population base as possible. Incenti!es from a profit ma(imi+ing perspecti!e are clear. rofit is a percent of cost, and management therefore $ill not take any effort to reduce cost. Indeed, gi!en its other goal of
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