Chapter 12 - Chapter 12 Relevant Costs for Making Decisions...

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Unformatted text preview: Chapter 12 Relevant Costs for Making Decisions Suggested Homework: E12-2 thru E12-8 Cost Concepts for Decision Making A relevant cost is a cost that differs between alternatives. 1 2 Identifying Relevant Costs An An avoidable cost can be eliminated, in can be eliminated, in whole or in part, by choosing one alternative whole or in part, by choosing one alternative over another. Avoidable costs are relevant over another. Avoidable costs are relevant costs. Unavoidable costs are irrelevant costs. Unavoidable costs are irrelevant costs. costs. Two broad categories of costs are never relevant in any decision. They include: Sunk costs. Future costs that do not differ between the alternatives. Relevant Cost Analysis: A Two-Step Process Eliminate costs and benefits that do not differ between alternatives. Use the remaining costs and benefits that differ between alternatives in making the decision. The costs that remain are the differential, or avoidable, costs. Step 1 Step 2 Costs that are relevant in one decision situation may not be relevant in another context. Identifying Relevant Costs Annual Cost of Fixed Items Cost per Mile 1 Annual straight-line depreciation on car 2,800 $ 0.280 $ 2 Cost of gasoline 0.050 3 Annual cost of auto insurance and license 1,380 0.138 4 Maintenance and repairs 0.065 5 Parking fees at school 360 0.036 6 Total average cost 0.569 $ Automobile Costs (based on 10,000 miles driven per year) Cynthia, a Boston student, is considering visiting her friend in New York. She can drive or take the train. By car, it is 230 miles to her friends apartment. She is trying to decide which alternative is less expensive and has gathered the following information: $45 per month 8 months $1.60 per gallon 32 MPG $18,000 cost $4,000 salvage value 5 years Identifying Relevant Costs 7 Reduction in resale value of car per mile of wear 0.026 $ 8 Round-tip train fare 104 $ 9 Benefits of relaxing on train trip ???? 10 Cost of putting dog in kennel while gone 40 $ 11 Benefit of having car in New York ???? 12 Hassle of parking car in New York ???? 13 Per day cost of parking car in New York 25 $ Some Additional Information Annual Cost of Fixed Items Cost per Mile 1 Annual straight-line depreciation on car 2,800 $ 0.280 $ 2 Cost of gasoline 0.050 3 Annual cost of auto insurance and license 1,380 0.138 4 Maintenance and repairs 0.065 5 Parking fees at school 360 0.036 6 Total average cost 0.569 $ Automobile Costs (based on 10,000 miles driven per year) Identifying Relevant Costs Which costs and benefits are relevant in Cynthias decision? The cost of the car is a sunk cost and is not relevant to the current decision. However, the cost of gasoline is clearly relevant if she decides to drive. If she takes the train, the cost would now be incurred, so it varies depending on the decision....
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Chapter 12 - Chapter 12 Relevant Costs for Making Decisions...

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