Chapter 2 Notes

Chapter 2 Notes - Cost Behavior Operating Leverage...

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Cost Behavior, Operating Leverage, & Profitability Analysis

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Cost Behavior Manner in which a cost changes as a related activity changes. Classifications of Cost Behavior Variable Costs Fixed Costs Mixed Costs
Summer Vacation Let’s say you and 2 friends are going to Cancun for 4 nights. You are going to fly down there and stay in a hotel. The hotel charges \$100 per night regardless of how many people stay in the room. TOTAL Expected Lodging Cost = \$400

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Two days before you leave one more friend decides to come along. How does this affect your hotel bill? No change – total lodging is still \$400 This is a fixed cost – The total cost does not change.
Two days before you leave one friend comes down with chicken pox and can’t go. What happens to your hotel bill now? No Change This is a fixed cost – The total cost does not change

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How does all this affect you? Total Hotel Bill = \$400 How much do you have to pay? Fixed Cost Behavior # of People (a) 2 people 3 people 4 people Total Lodging (b) \$400 \$400 \$400 Lodging per person (b / a) \$200 \$133 \$100

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What about the airfare? You were able to get plane tickets for \$200 roundtrip per person. Variable Cost Behavior # of tickets (a) 2 3 4 Total Airfare (a * b) \$400 \$600 \$800 Cost per ticket (b) \$200 \$200 \$200
Under a variable cost structure the cost per unit stays the same and the total cost changes Using the Variable Cost Structure avoids Fixed Cost Risk

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Whether a cost is fixed or variable depends on the underlying circumstances. Let’s look back at our lodging for spring break. What if we decide to stay 5 nights instead of 4? What if we come home a day early? # of Nights (a) 3 4 5 Total Lodging (a * b) \$300 \$400 \$500 Cost per night (b) \$100 \$100 \$100
Here the lodging is a variable cost. The cost per night stays the same and the total cost changes. # of Nights (a) 3 4 5 Total Lodging (a * b) \$300 \$400 \$500 Cost per night (b) \$100 \$100 \$100

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Relevant Range What happens if three more friends decide to come along and you have a total of 6 people?
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