Adding and Dropping a Segment
This is any part of an organization a manager seeks cost, profit, or revenue data from.
Segment
The maximum volume that a company can sustain with available resources.
Capacity
Which is not a reason companies use capital budgeting?
Companies do not have unlimited funds
Companies have overall goals
Evaluating short term decisions
Maintain efficiency and competitiveness
Evaluating short term decisions
When should a project be accepted?
When NPV is positive or zero.
Does SRR account for time value of money?
No
This type of cost will not be relevant when deciding to add or drop a segment.
Sunk Costs
What is one way to mitigate excess capacity?
Special orders
This approach does not use the time value of money.
Non-discounting methods: Payback and SRR (Simple Rate of Return)
What is the PV factor for cash flows that happen now?
1
(T/F) A company would outsource if it wants to maintain its competitive advantage.
False
Segment margin is the best gauge of what profitability?
Long-term profitability
Is there an opportunity cost when units of idle capacity>units in the special order?
No opportunity cost
The formula for calculating payback period.
Initial investment/Annual net cash flows
A project has an initial investment of $600,000. The PV of cash flows is $1,000,000. What is the profitability index?
1.66 or 1.67
PV of cash flows/Initial investment = 1,000K/600K = 1.66
Which metric calculates when we re-coup the initial investment?
Payback period
Short-term profitability is best gauged by what?
Contribution margin
Should Company A accept a special order if they do not have excess capacity and the special order is more profitable than the regular units?
They should accept the special order.
In order to calculate this rate, you have to determine the discount rate that causes NPV of the project to be zero.
IRR
A project has an initial investment of $33,000. The project will have annual net cash flows of $8,000 and no salvage value. The project will last for 5 years and the cost of capital is 15%. What is the NPV of the project?
-$6,184
33000-(8000*3.352)
Which is not a consideration when making a make/buy decision?
Control
Costs
Social responsibility
GAAP income
GAAP income
When should a segment be dropped?
It has negative segment margin
When you have a constrained resource, what metric should you focus on when deciding which products to make first?
Contribution margin per one of the constrained resource or contribution margin per one of the constraint.
We use sensitivity analysis to determine a range for this metric.
Expected value
Disadvantage of NPV method.
Cannot directly compare projects with different initial investments.
When NPV is positive, will IRR be higher or lower than the cost of capital?
Higher