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Unformatted text preview: Cost ECG 507 Professor Allen 9/8/05 1. Cost: Introduction The production function measures the relationship between input and output. Given the production technology, managers must choose how to produce. To determine the optimal level of output and the input combinations, we must convert from the output measurements to dollar measurements or costs. 2. Cost: definition Cost = what you give up Examples Cost of NC States MBA Cost of launching a new product Cost of running your own business Cost associated with inventory Cost associated with equipment 3. Measuring Cost: Which Costs Matter? Accounting Cost Consider only explicit cost , the out of pocket cost for such items as wages, salaries, materials, and property rentals 4. Measuring Cost: Which Costs Matter? Economic Cost considers explicit and imputed cost. Imputed cost is the cost associated with opportunities that are foregone by not putting resources in their highest valued use. Applies to all inputs: labor, equipment, structures, shareholders equity Opportunity cost = explicit cost + imputed cost Use cash flow comparisons to estimate 5. Present Discounted Value (PDV) Determining the value today of a future flow of income The value of a future payment must be discounted for the time period and interest rate that could be earned. Interest rate rate at which one can borrow or lend money 6. Present Discounted Value (PDV) Future Value (FV) One dollar invested today should yield (1 + R) dollars a year from now (1 + R) is the future value of the dollar today What is the value today of getting $1 a year from now? What is the present discounted value of the $1? 7. Present Discounted Value (PDV) future) the in dollar a have to today invest to have you would much (how ; (1 1 future the in received $1 of value dollar Present PDV future in year of Number n (1 today invested $1 of Value Dollar Future n ) ) n R + = = = + = R 8. Present Discounted Value (PDV) The interest rate impacts the PDV The lower the interest rate, the more you have to invest to reach your goal in the future We can see how different interest rates will give different future values 9.PDV of $1 Paid in the Future R 1 YR 5 YR 10 YR 30 YR 1% $0.990 $0.951 $0.905 $0.742 2% $0.980 $0.906 $0.820 $0.552 5% $0.952 $0.784 $0.614 $0.231 10% $0.909 $0.621 $0.386 $0.057 10. Sunk cost An expenditure that has been made and...
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 Fall '05
 Allen

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