Past experience indicates a 60% probability that a reported overhead cost varian
ID: 3268707 • Letter: P
Question
Past experience indicates a 60% probability that a reported overhead cost variance is not due to a specific cause (i.e., is attributable to random fluctuations). Past experience also shows that the average cost to investigate the underlying cause of a variance is $1,280 and that the cost to correct an out-of-control process is, on average, $4,200. If the underlying variance is systematic and management decides not to investigate the cause of the variance, the costs are thought to be significant: $28,800.
#2)
Prepare a payoff table that summarizes the above information. (Hint: Your table should include cells for combinations of management actions (investigate vs. do not investigate) and states of nature (systematic cause vs. random event), plus cells to represent the expected cost of each management action. (Round your answers to nearest whole dollar amount.)
Given the above information, what is the probability level, p, for nonrandom variance that makes management indifferent between the two courses of action: investigate versus do not investigate? (Hint: You can use the formula in the text to calculate p. You could also use the Goal Seek function from the Tools menu in Excel to calculate this number.) (Do not round intermediate calculations. Enter your final answer as a whole percentage rounded to two decimal places (i.e., .1234 = 12.34%).)
Required:
Explanation / Answer
Expected value of the decision to investigate the variance: E(Investigate) = [(I x (1-p)] + [(I+C) x p] 1280*(1-0.4)+(1280+4200)*0.4 768+2192 = 2960 States of Nature (prob.) Management Action Random (60%) Systematic (40%) Expected Value Investigate 768 2192 2960 Don’t Investigate 0 11520 11520 Indifference probability p = I/(L-C) p = 1280/(28800-4200) 5.20%