Guillermo Senario

Introduction

Guillermo is facing a situation that can be the result of losing business because of recent events in the area; a new competitor has entered the furniture market, and an increase of the town’s population has contributed to an increase in the cost of labor. Guillermo has several choices he can choose from to be able to keep their business. They can become a representative for a Norway manufacturer looking to distribute their furniture in his area. He has the opportunity to enhance his handcrafted furniture in an effort to keep up with competitors, or he can focus on selling his patented flame retardant. In this paper we will discuss what Guillermo has to examine to make sure their business stays intact. We will look at the cost relationships and behaviors, decide what control systems should be used, determine decision-making prerogatives for the manager, create a break-even analysis on the current situation considering the alternative, and compute the return on investment, residual income, and economic value added for the current situation. 

Cost Relationships and Behaviors

Cost behavior is nothing more than the sensitivity of costs to changes in production or sales volume. The range of output or sales over which cost behavior patterns remain unchanged is called the relevant range. The relevant range comes into play when considering fixed costs as well.  Many fixed costs are only fixed for a certain level of production.  For example, a machine or manufacturing plant can reach capacity.  To increase production beyond a certain level, additional machinery (or a new plant, additional supervisors, etc.) must be deployed.  This will cause a major step upward in the fixed cost.  Fixed costs that behave in this fashion are also called step costs.  The key conceptual point is to note that fixed costs are only fixed over some particular range of activity, and moving outside that range can significantly alter the cost structure.

The...