Unformatted text preview: MGMT 201 (Ganguly) MGMT
Lecture 14: Relevant Costs Relevant Information Relevant
Information is relevant to a decision Information problem when . . . problem
It has a bearing on the future, It It differs among competing alternatives. Identifying Relevant Identifying Costs and Benefits
Sunk costs Costs that have already been incurred. Costs They do not affect any future cost and cannot be changed by any current or future action. future S costs areirre vant to de unk le cisions. Relevant Costs Relevant
Worldwide Airways is thinking about replacing a three year Worldwide old loader with a new, more efficient loader. old
New loader List price Annual operating expenses Expected life in years Old loader Original cost Remaining book value Disposal value now Annual variable expenses Remaining life in years $ 15,000 45,000 1 $ 100,000 25,000 5,000 80,000 1 Relevant Costs Relevant If we keep the old loader, we will have depreciation costs of $25,000. If we replace the old loader, we will write-off the $25,000 when sold. There is no difference in the cost, so it is not relevant. no not Thene loade will bede ciate in oneye w r pre d ar. Relevant Costs Relevant The $5,000 proceeds will only be realized if we replace the old loader. This amount is relevant. relevant Relevant Costs Relevant We will only have depreciation on the new loader iif we replace the old loader. This cost is relevant. f relevant Relevant Costs Relevant The difference in operating costs is relevant relevant to the immediate decision. Relevant Costs Relevant
Here is an analysis that includes only relevant Here costs: costs Analysis of Special Decisions Analysis
Let’s take a close look at some special Let’s decisions faced by many businesses. decisions
We just received a special order. Do you think we should accept it? Accept or Reject a Special Order Order
A travel agency offers Worldwide Airways $150,000 travel for a round-trip flight from Hawaii to Japan on a jumbo jet. jumbo Worldwide usually gets $250,000 in revenue from Worldwide this flight. this The airlines is not currently planning to add any The new routes and has two planes that are idle and could be used to meet the needs of the agency. could The next screen shows cost data developed by The managerial accountants at Worldwide. managerial Accept or Reject a Special Order Reject Worldwide will save about $5,000 in reservation and ticketing costs if the charter is accepted. Accept or Reject a Special Order Order Since the charter will contribute to fixed costs and Worldwide has idle capacity, the company should accept the flight. What if Worldwide had no excess capacity? If What no If Worldwide adds the charter, it will have to cut its least profitable route that currently contributes $80,000 to fixed costs and profits. Should Worldwide still accept the charter? charter? Accept or Reject a Special Order Order Accept or Reject a Special Order Order Worldwidehas no e ss capacity, so it should re ct the xce je Worldwide spe charte cial r. spe Accept or Reject a Special Order Order
With excess capacity . . .
– Relevant costs usually will be the variable Relevant costs associated with the special order. costs Without excess capacity . . .
– Same as above but opportunity cost of using Same the firm’s facilities for the special order are also relevant. also Outsource a Product or Service Outsource
A decision concerning whether an item decision should be produced internally or purchased from an outside supplier is often called a “make or buy” decision. often Let’s look at another decision faced by the Let’s management of Worldwide Airways. management Outsource a Product or Service Outsource
An Atlanta bakery has offered to supply the in-flight An desserts for 21¢ each. desserts Here are Worldwide’s current cost for desserts: Outsource a Product or Service Outsource
Not all of the allocated fixed costs will be saved if Worldwide purchases from the outside bakery. Outsource a Product or Service Outsource
If Worldwide purchases the dessert for 21¢, If it will only save 15¢ so Worldwide will have a loss of 6¢ per dessert purchased. loss
Wow, that’s no deal! Outsource a Product or Service Outsource
Beware of Unit-Cost Data
For decision-making purposes, unitized For fixed costs can be misleading. fixed More of the same in the next class! class! ...
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- Spring '08
- relevant costs, Worldwide Airways, Special Order Order