Relevant Analysis - 1
RELEVANT ANALYSIS
FOR
TACTICAL DECISIONS
Which one do
we choose???
X
Y
Z
Relevant Analysis - 2
RELEVANT ANALYSIS
 Relevant items
– Items (either revenues or costs) that
DIFFER across alternatives
– Items relating to FUTURE courses of action
 Irrelevant
– Past items (“sunk costs”)
– Future items that DO NOT differ across
alternatives
Relevant Analysis - 3
SUNK COSTS
 Costs of resources that have already
been committed, and regardless of what
decision is made by managers, cannot
be changed. These costs are irrelevant
in decision making.
 Significance of historical costs
– Basis for determining cost behavior
– Tax implications
Relevant Analysis - 4
EXAMPLES OF RELEVANT COSTS
AND REVENUES
Cost increases &
cash outflows
 Down payment on
a new machine
 Monthly lease
payments on a
new machine
Cash savings and
cash inflows
 Disposal of old
machine
 Monthly cost
savings
– Materials
– Labor
– Overhead
Relevant Analysis - 5
OPPORTUNITY COST
The potential benefit sacrificed
when, in selecting one alternative,
another alternative is given up
Relevant Analysis - 6
RELEVANT ANALYSIS MODEL
Recognize and define problem
Identify feasible alternatives
Identify relevant items
Total relevant costs and benefits
for each alternative
 Assess qualitative factors
 Select alternative with greatest
overall benefit




Relevant Analysis - 7
RELEVANT ANALYSIS &
CONTRIBUTION ANALYSIS
 Contribution analysis is normal
first step in relevant analysis
 Cost behavior and relevance are
NOT identical
Relevant Analysis - 8
ADDITIONAL CONSIDERATIONS
 When determining “costs,” what
costs are relevant?
– All?
– Only short-term variable?
 How flexible are the capacities of
the firm’s resources?
Relevant Analysis - 9
TACTICAL DECISIONS
 Make or Buy (Outsourcing)
 Retain or Drop Product Lines
 Special Orders
 Sell or Process Further
 Changes in Product Mix
Relevant Analysis - 10
SPECIAL ORDERS
Decision Rule
 Special orders that do not involve a
long-term contract should be
priced in relationship to available
capacity
Relevant Analysis - 11
AVAILABLE SURPLUS
CAPACITY
Decision Rule
 When capacity is available,
incremental revenues have to be
greater than incremental costs
Relevant Analysis - 12
DECISION RULE OPPORTUNITY COSTS
 The alternative that has the
greatest contribution margin per
unit of constrained resource should
be selected, thereby minimizing
the opportunity cost
Relevant Analysis - 13
NO AVAILABLE CAPACITY
Decision Considerations
 Additional capacity may be acquired
through:
– Overtime operations
– Subcontracting
 Which result in additional costs
 When capacity is not available,
incremental revenues have to be
greater than incremental costs
Relevant Analysis - 14
A Decision to Sell or Process Further
Product A
Joint Input
Joint
Costs
Should the company
process further?
Product B
Split-off
point
Separate
Processing
Joint products
Separate
Processing
Relevant Analysis - 15
Implications of
Relevant Analysis
• Short-term vs. Long-term
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January 1996
• Quantitative vs. Qualitative
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• Data probability
Sat
Fri
Thu
Wed
6
5
4
3
13
12
11
10
20
19
18
17
27
26
25 January 1996
24
Tue
2
9
Mon
Sun
1
8
7
16
15
14
23
22
21
30
29
28
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31
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