chp 8 instructor manual

chp 8 instructor manual - Chapter 8 COST ANALYSIS AND...

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Chapter 8 COST ANALYSIS AND ESTIMATION QUESTIONS AND ANSWERS Q8.1 What advantages or disadvantages do you see in using current costs for tax and stockholder reporting purposes? Q8.1 ANSWER 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 impossible. 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. Q8.2 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. Q8.2 ANSWER 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 future. Q8.3 Southwest Airlines offers four flights per weekday from Cleveland, Ohio to Tucson, Arizona. 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 trial period. What is the marginal cost? In this case, is incremental cost or marginal cost relevant for decision making purposes?
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190 Chapter 8 Q8.3 ANSWER Marginal costs are the cost effect of one-unit changes in output. Incremental cost is the cost effect associated with a given managerial decision. Incremental costs may also relate to output changes, but the output change involved is that of a relevant block or increment of service. In this instance, the incremental cost associated with a decision to go ahead with a fifth flight per day for a minimal 60-flight trial period is $900,000 (= $15,000 × 60). The marginal cost per passenger is only $110. In this case, the incremental cost of $900,000 is the relevant cost for decision making purposes. With expected revenues in excess of $900,000, Southwest should go ahead with the planned expansion. Q8.4
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This note was uploaded on 03/08/2011 for the course ECONABA 635 taught by Professor Leiter during the Summer '10 term at Andrew Jackson.

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chp 8 instructor manual - Chapter 8 COST ANALYSIS AND...

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