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Chapter 12 - Relevant Costs - 12-1 MGT223 Relevant Costs...

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MGT223 Relevant Costs for Decision Making Chapter Twelve Cost Concepts for Decision Making A relevant cost is a cost that Identifying Relevant Costs An An avoidable cost can be eliminated, in whole or in part, by choosing one alternative over in part, by choosing one alternative over another. Avoidable costs are relevant costs. another. Avoidable costs are relevant costs. Unavoidable costs are irrelevant costs. Unavoidable costs are irrelevant costs. Two broad categories of costs are never Two broad categories of costs are never relevant in any decision. They include: relevant in any decision. They include: n costs. costs. o costs that do not differ do not differ between the alternatives. alternatives.
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Relevant Cost Analysis: A Two-Step Process Eliminate costs and benefits that do not differ between alternatives. Use the remaining costs and benefits that differ between alternatives in making the decision. The costs that remain are the differential, or avoidable, costs. Step 1 Step 2 Identifying Relevant Costs Annual Cost of Fixed Items Cost per Mile 1 Annual straight-line depreciation on car 2,800 $ 0.280 $ 2 Cost of gasoline 0.050 3 Annual cost of auto insurance and license 1,380 0.138 4 Maintenance and repairs 0.065 5 Parking fees at school 360 0.036 6 Total average cost 0.569 $ Automobile Costs (based on 10,000 miles driven per year) Cynthia, an Ottawa student, is considering visiting her friend i n Waterloo. She can drive or take the train. By car, it is 230 mil Waterloo. She can drive or take the train. By car, it is 230 mil es to her es to her friend’s apartment. She is trying to decide which alternative is friend’s apartment. She is trying to decide which alternative is less less expensive and has gathered the following information: expensive and has gathered the following information: $45 per month $45 per month × 8 months $1.60 per gallon ÷ 32 MPG $18,000 cost $18,000 cost – $4,000 salvage value $4,000 salvage value ÷ 5 years 5 years Identifying Relevant Costs 7 Reduction in resale value of car per mile of wear 0.026 $ 8 Round-tip train fare 104 $ 9 Benefits of relaxing on train trip ???? 10 Cost of putting dog in kennel while gone 40 $ 11 Benefit of having car in Waterloo ???? 12 Hassle of parking car in Waterloo ???? 13 Per day cost of parking car in Waterloo 25 $ Some Additional Information Annual Cost of Fixed Items Cost per Mile 1 Annual straight-line depreciation on car 2,800 $ 0.280 $ 2 Cost of gasoline 0.050 3 Annual cost of auto insurance and license 1,380 0.138 4 Maintenance and repairs 0.065 5 Parking fees at school 360 0.036 6 Total average cost 0.569 $ Automobile Costs (based on 10,000 miles driven per year)
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Identifying Relevant Costs Which costs and benefits are relevant in Cynthia’s decision? decision? The cost of the car is a cost and is not relevant to the current decision. However, the cost of gasoline is clearly if she decides to drive. If she takes the train, the cost would now be incurred, so it varies depending on the decision.
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