Ch11 - 367 Chapter 11 Lecture Notes Chapter theme: Making...

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Unformatted text preview: 367 Chapter 11 Lecture Notes Chapter theme: Making decisions is one of the basic functions of a manager. To be successful in decision making, managers must be able to tell the difference between relevant and irrelevant data and must be able to correctly use the relevant data in analyzing alternatives . The purpose of this chapter is to develop these skills by illustrating their use in a wide range of decision-making situations. I. Cost concepts for decision making Learning Objective 1: Identify relevant and irrelevant costs and benefits in a decision. A. Identifying relevant costs and benefits i. A relevant cost is a cost that differs between alternatives. 1. 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 . ii. Two broad categories of costs are never relevant in any decision: 1. A sunk cost is a cost that has already been incurred and cannot be avoided regardless of what a manager decides to do. 1 3 4 2 368 2. A future cost that does not differ between alternatives is never a relevant cost. iii. Relevant cost analysis: a two-step process: 1. 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. 2. 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. iv. Different costs for different purposes 1. 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. B. An example of identifying relevant costs and benefits i. Assume the following information with respect to Cynthia, a Boston student who is considering visiting her friend in New York. Cynthia is trying to decide whether it would be less expensive to drive or take the train to New York. 5 6 7 4 369 1. She has assembled the following information with respect to her automobile. 2. She has also gathered the additional information as shown to aid in her decision. 3. Which costs and benefits are relevant to her decision? a. The cost of the car is irrelevant to the decision because it is a sunk cost. b. The annual cost of auto insurance is irrelevant because it does not differ between alternatives. c. The cost of the gasoline is relevant. It is avoidable if she takes the train. d. The cost of maintenance and repairs is relevant because in the long-run these costs depend upon miles driven....
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This note was uploaded on 12/08/2010 for the course ACG 3301 taught by Professor Wheatley during the Spring '08 term at FIU.

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Ch11 - 367 Chapter 11 Lecture Notes Chapter theme: Making...

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