Cost Benefit Analysis and Short Term Decision Making - Noyon Lanka Pvt Ltd

COMPANY PROFILE

Noyon Lanka (Pvt) Ltd is a joint venture between apparel manufacturing giant MAS Holdings and French lace artisans Noyon Dentelles de Calais, France. Being in the industry for more than 10 years in Sri Lanka, it has achieved the status of South Asia’s leading premium lace manufacturer. Company was incorporated in October 2003 and subsequently entered in to BOI agreement for the manufacture and export of lace and covered yarn and is sited in Biyagama Export Processing Zone.

Noyon Lanka (Pvt) Ltd has positioned itself as the only knitted lace manufacturer in South Asia producing multiple forms of lace.It belongs to the Fabrics Cluster of MAS Holdings.

Technical

Product - Finished lace for apparel industry

Ancillary Operations - Dyeing and finishing of imported greige

- Finishing of imported lace

Machinery Portfolio - Knitting Machine - 40 machines

Dyeing Machines - 10 machines

Stentor - 10 chamber stentor

Number of employees - 850 shop floor

- 180 administration

Customers

Noyon Lanka (NL) has positioned itself as a strategic supplier to cater to the premium segment of the innerwear market in apparel manufacturing business.

NL’s Customers during 2014 -2015 are in two folds:

High to Mid-range customers - Victoria’s Secret, Intimissimi, Calvin Klein, Marks & Spencer, Chantelle, Eveden

Mid to value range - La Senza, Next, Platex and Amante

(News, 2008)

THEORETICAL MODEL OF COST BENEFIT ANALYSIS AND SHORT TERM DECISION MAKING

Decision Making can be explained as selecting the best alternative between two or more alternatives. Decision making process does compare strengths and weaknesses of each alternative based on available information in order to make the best possible decision.

Incremental Cost Benefit Analysis is a decision-making tool which compares relevant costs and Benefits. Incremental Cost Benefit analysis is also referred as Differential Costing, Marginal Costing or Relevant Costing.

In Cost Benefit Analysis, the incremental cost incurred by a particular alternative and the incremental benefit or the cost saving that would derive from the same alternative is listed and subsequently the net incremental benefit or the incremental cost is calculated. Since it compares difference in revenues and costs among alternatives, Cost Benefit Analysis can be stated as Differential Analysis as well.

Hence, the Cost Benefit Analysis could be used as an important tool to choose between alternatives, selecting the alternative with the least amount of relevant cost or with the greatest relevant benefit would be the favourable decision.

Cost benefit analysis could be used in following decision making situations:

• Additional Processing Decision

• Make or buy Decision

• Dropping a product line Decision

• Accept or reject special offer

• Open new territory

Important fact is that in cost benefit analysis only relevant costs must be identified and included. The costs that are irrelevant may always be ignored when deciding the best alternative between two.

Costs or Benefits generated in following situation are taken in to consideration in Cost Benefit Analysis:

• The additional Cost that would incur as result of selecting one alternative

• Difference in the revenue and the costs between the two alternative decisions.

• Benefit or cost saving as a result of selecting one alternative

Explained below are the costs that are relevant and irrelevant when using cost benefit analysis for decision making.

Sunk Cost:

Sunk cost are historical costs based on past expenditure. Since this expenditure is already made, cost will not have an impact as a result of the decision. Thus, Sunk Cost is not regarded as a relevant cost.

Example : Work already done, equipment purchased

Committed cost:

Committed cost is an obligations already made with regard to a monetary transaction. In other words it is a commitment made in past to pay in future. Selecting a particular alternative does not make any changes to the commitment. Therefore, committed cost too is not considered as a relevant cost.

Example: A person has purchased some kitchen equipment on credit basis with an intention of starting up a catering service. Later he decides to withdraw the idea of the business.

Cost of the kitchen equipment is not relevant to his decision with regard to continuing or discontinuing the idea of business.

Nevertheless, if there is a realizable value in the committed cost, the realizable potion of the cost will be considered as a relevant cost.

Example: In above example if the kitchen equipment could be sold to a third party at a certain value. That realizable value is a relevant cost.

Opportunity cost:

Opportunity cost is the amount of income foregone (given up) by selecting or not selecting one alternative over the other. Opportunity cost is always considered as a relevant cost.

Example: Rent foregone

Application of the decision making model

Generally the incremental Cost benefit analysis is used in many business related functions formally or informally due to its simplicity to understand and perform in complex business decision making situations.

It facilitates comparing two alternatives based on financial costs and benefits and identify estimated net incremental cost or benefit of a decision.

Even though a cost-benefit analysis as a simple and easy