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Chapter 13 - Relevant Costs for Decision Making

# Chapter 13 - Relevant Costs for Decision Making - Chapter...

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Chapter 13: Relevant Costs for Decision Making - Relevant Cost – A cost that differs between alternatives - Identify Relevant Costs o An avoidable cost can be eliminated (in whole or part) by choosing one alternative over another o Avoidable costs are relevant costs o Unavoidable costs are irrelevant costs o Two broad categories of costs are never relevant in any decision and include: Sunk costs Future Costs that DO NOT DIFFER between the alternatives - Relevant Cost Analysis – 2 Step Process o Step 1: Eliminated costs and benefits that do not differ between alternatives o Step 2: Use the remaining costs and benefits that do not differ between alternatives in making the decision. The costs that remain are the differential or avoidable costs. - Different Costs for Different Purposes o Costs that are relevant in one decision situation may be not relevant in another context - Identifying Relevant Costs – EXAMPLE o Cynthia, a Boston student, is considering visiting her friend in NY. She can drive or take the train. By car it is 230 miles to her friend’s apartment. She is trying to decide which alternative is less expensive and has gathers the following information:

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- Annual parking fee cost at school = \$per month fee * School Year Term - Cost of Gasoline per Mile= Cost per gallon/Miles per gallon - Annual straight-line depreciate on car = Cost – Salvage Value/Amount of years o Which costs and benefits are relevant in Cynthia’s decision? The cost of the car is a sunk cost and is not relevant to the current decision. The annual cost of insurance is not relevant. It will remain the same if she drives or takes the train. The cost of gasoline is clearly relevant if she decides to drive. If she takes the drive the cost could now be incurred, it varies depending on the decision. The cost of maintenance and repairs is relevant. In the long-run these costs depend upon miles driven. The monthly school parking fee is not relevant because is must be paid if Cynthia drives or takes the train. At this point, we can see that some of the average cost of \$0.569 per mile is relevant and others are not. The decline in resale value due to additional miles is a relevant cost. The round-trip train fare is clearly relevant. If she drives the cost can be avoided.
Relaxing on the train is relevant even though it is difficult to assign a dollar value to the benefit.

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Chapter 13 - Relevant Costs for Decision Making - Chapter...

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