COST ANALYSIS AND ESTIMATION
QUESTIONS AND ANSWERS
What advantages or disadvantages do you see in using current costs for tax and
stockholder reporting purposes?
Theoretically, it would be preferable to use current costs for income tax calculations
and stockholder reporting.
On a practical level, however, this would be nearly
Estimation of current cost, based upon current market values, would be
a difficult task with a great deal of room for subjectivity.
This could result in many
arbitrary cost designations, and the "policing" of tax returns would become a much
more formidable task.
On a practical basis, the use of historical costs for tax and
stockholder reporting purposes has obvious advantages over the theoretically
superior current costs.
Assume that two years ago, you purchased a new Jeep Wrangler SE 4WD with a soft
top for $16,500 using five-year interest-free financing.
Today, the remaining loan
balance is $9,900 and your Jeep has a trade-in value of $9,500.
What is your
opportunity cost of continuing to drive the Jeep?
Discuss the financing risk
exposure of the lender.
The opportunity cost of continuing to drive the Jeep is $9,500.
If you sell the Jeep,
$9,500 can be generated to pay down your remaining loan balance.
It is the current
cost or replacement value of your current vehicle.
It is the relevant economic cost of
continuing to drive the Jeep.
Historical cost of $16,500 and the remaining loan
balance of $9,900 are irrelevant for decision-making purposes.
With a current
market value of only $9,500 against a remaining loan balance of $9,900, the lender
faces the risk of borrower default.
Aggressive interest-free financing offered by the
major automakers has the potential to create big debt collection problems in the
Southwest Airlines offers four flights per weekday from Cleveland, Ohio to Tucson,
If adding a fifth flight per weekday would cost $15,000 per flight, or $110
per available seat, calculate the incremental costs borne by Southwest following a
decision to go ahead with a fifth flight per day for a minimal 60-flight
What is the marginal cost?
In this case, is incremental cost or marginal cost
relevant for decision making purposes?