Capital Budgeting, Breakeven analysis

Reviews the book `Creative and Innovative Approaches to the Science of Management,' by Yuji Ijiri.

A major limitation of traditional sales and profit variance analysis is that it neglects price-quantity relationships for firms not operating under conditions of perfect competition. This paper shows how data from sales and gross profit reports can be used to estimate price elasticities and cross elasticities of demand. Finally, the relationship of price elasticity to profit maximization is developed for a simple case.

This exercise examines the possibility of using shadow prices to calculate transfer prices between divisions of the multi-division or conglomerate firm and of basing divisional profit statements on transfer prices derived in this way. In order to demonstrate the proposal, a well known Harvard Buisiness School case is modified in two ways so that two different linear programming solutions can be derived. Divisional income statements are then computed which indeed do exactly distribute the total profit of the firm each time, but these statements are found to have several unsatisfactory features for purposes of income determination. The exercise concludes by suggesting extensions for study and problem solving for the student.

The article reports on a seminar on budget mix variances. After having attended to his instructor patiently for several quarters and after a review of the literature, Peter Griffin, second-year management student, overcame his own natural reticence and the spring lethargy spreading over the campus and questioned the general applicability of budget mix variances in gross profit analysis. His challenge invigorated discussion for almost a whole period. Whether he is right or not, this communique claims to take no position. Instead here is a scenario of the exchange he maneuvered, and it will be left to the reader to judge for himself the merit of Griffin's position. The point of computing a budget mix variance is that net income or contribution margin will differ from expectations as the quantity increases if the mix changes. The one occasion for which it seems reasonable to compute mix for budgets or sales is when production planning is pretty well locked in or fixed at some level and when later on deliberate substitution between products takes place at that level. Then there has to be a decision to change the mix and there should be a variance to measure the effect of that decision.

The article presents a comment on the article related to matrix theory and cost allocation by professor Neil Churchill that appeared in the October 1964 issue of the journal "The Accounting Review." Churchill's article provided an expanded version of the cost allocation model and then suggested other applications of linear algebra to cost accounting analysis. This comment will be directed at the Williams-Griffin model. As the article explained, the techniques of linear analysis with a helping hand from computers make the solution of reciprocally related systems quite simple in theory. This phrase, in theory, suggests two lines of thought, neither of which is to be construed as a basic criticism of the Williams-Griffin-Churchill material. The first, very briefly, is that what is in theory so simple still presents problems in practice. A different Net Services model predicates its approach on the assumption that service departments exist only to fulfill needs of operating departments and that their costs to these operating departments can only be determined after they have been charged by other services and credited for work done for other services.

There is often evidence of confusion between two forms of the constant percentage learning curve model: the cumulative average and the individual unit forms. Failure to distinguish between the two models can lead to their misuse and to potentially serious errors of estimation. A precise statement of the difference between the two clarifies the errors of misspecification. This note provides an analytical comparsion of the two models and addresses empirical estimation issues. Résumé. On a souvent la preuve de la confusion entre deux formules de modèle de la courbe d'apprentissage à pourcentage constant: celle de la moyenne cumulative et celle de l'unité individuelle. Le fait de ne pas distinguer les deux modèles peut conduire à une mauvaise utilisation et éventuellement à de sérieuses erreurs d'estimation. Un examen précis de la différence entre les deux peut clarifier les erreurs de spécification. Cet article présente une comparaison analytique des deux modèles et traite des questions d'estimation empirique.

Reviews the book "Measuring and Reporting the 'Replacement' Cost of Oil and Gas Reserves," by Glenn A. Welsch and Edward B. Deakin.

This paper extends the Baker and Taylor approach to the reciprocal service cost problem by allowing for the existence of nonvariable costs. A sample problem is developed to show how a mixed integer programming approach can be used to account for nonvariable costs in make-or-buy decisions. Also, in order to better calculate the opportunity costs of not meeting demand because of service department bottlenecks, the Baker and Taylor model is converted into a profit maximization model and combined with the mixed integer approach.