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Unformatted text preview: Pic tu re 1 Chapter 13 Relevant Costs for Decision Making A relevant cost is a cost that differs between alternatives. Cost Concepts for Decision Making An avoidable cost is a cost that can be eliminated, in whole or in part, by choosing one alternative over another. Avoidable costs are relevant costs. Unavoidable costs are irrelevant costs. Two broad categories of costs are never relevant in any decision: o 1. A sunk cost is a cost that has already been incurred and cannot be avoided regardless of what a manager decides to do. o 2. A future cost that does not differ between alternatives is never a relevant cost. Relevant cost analysis is a two-step process. The first step is to eliminate costs and benefits that do not differ between alternatives. These irrelevant costs consist of sunk costs and future costs that do not differ between alternatives. The second step is to use the remaining costs and benefits that do differ between alternatives in making the decision. The costs that remain are the differential, or avoidable, costs. Costs that are relevant in one decision situation may not be relevant in another context. Thus, in each decision situation, the manager must examine the data at hand and isolate the relevant costs. Identifying Relevant Costs She has also gathered additional information to aid in her decision, such as the reduction in resale value per mile driven, round-t rip train fare, benefits of relaxing on the train, cost of putting her dog in the kennel, benefits of having a car in New York, hassle of parking in New York, and the per day cost of parking in New York. Some of these items can be measured in dollars and some cant. Which costs are relevant to her decision? o The cost of the car is irrelevant to the decision because it is a sunk cost. o The annual cost of auto insurance is irrelevant because it does not differ between alternatives. o The cost of the gasoline is relevant because it is avoidable if she takes the train. The cost of maintenance and repairs is relevant because in the long-run these costs depend upon miles driven. The parking fee at school is irrelevant because it is not a differential cost. At this point, we can see that some of the average cost of $0.619 per mile are relevant and others are not. The decline in resale value is relevant due to the additional miles driven. The round t rip train fare is relevant because it is avoidable if she drives her car. Relaxing on the train is relevant, but difficult to quantify. The kennel cost is irrelevant because it is not a differential cost. The cost of parking in New York is relevant because it is avoidable if she takes the train....
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- Spring '07
- • Lovell