This preview shows page 1. Sign up to view the full content.
Unformatted text preview: choose the third
3.
alternative?
alternative?
Opportunity cost is $60,000
Let us analyze the income effects of choosing alternative (3)
Let
Revenue
$500,000
Costs:
Costs:
Outlay Costs
(400,000)
Outlay
Financial benefit before opportunity costs
$100,000
Financial
Opportunity cost of machine
(60,000)
Net financial benefit
$ 40,000 Dr. Hussein Khasharmeh
Dr. Hussein Khasharmeh When considering only two alternatives, a manager
When
might use straight forward differential analysis or
opportunity cost analysis. The two approaches are
equivalent.
equivalent.
Example, consider Maria Movales, a certified public
accountant employed by a large accounting firm for
a salary of $60,000/year. She is considering an
alternative use of her time to have her own
independent accounting practice. The new business
will gain $200,000 a year and the additional outlay
(operating expenses) is 120,000. Show the income
effects?
effects?
Dr. Hussein Khasharmeh
Dr. Hussein Khasharmeh The answer:
Alternatives under consideration
Alternatives
Remain an open her independent difference
employee
practice
employee
Revenues
$60,000
$200,000
$140,000
Revenues
Outlay cost
120,000
120,000
120,000
120,000
Income effect/year $60,000
$80,000
$20,000
Income
$60,000
$80,000
$20,000
The income effect is $20,000 more than her salary with the firm.
The
Considering the term opportunity cost, the analysis is:
Alternative chosen
Alternative
Independent practice
Independent
Revenues
$200,000
Expenses:
outlay costs
120,000
outlay
opportunity cost
60,000
180,000
60,000
Income effects per year
$20,000
Note that each method produces the same answer $20,000.
Note Dr. Hussein Khasharmeh
Dr. Hussein Khasharmeh MakeorBuy Decisions
Managers often must decide whether to produce a product or Managers often must decide whether to produce a product or service within the firm or purchase it from an outside supplier.
service within the firm or purchase it from an outside supplier.
A key factor in deciding whether to make or buy is the A key factor in deciding whether to make or buy is the relevant cost and whether there are idle facilities..
relevant cost and whether there are idle facilities Dr. Hussein Khasharmeh
Dr. Hussein Khasharmeh Example for Make or Buy Decisions
Assume the following information:
Nantucket Nectars Company’s Cost of Making 1,000,000 12ounce glass Bottles are: Total Per unit Total Per unit Direct material
$ 60,000
$.06 Direct material
$ 60,000
$.06 Direct labor 20,000 .02 Direct labor 20,000 .02 Variable factory overhead 40,000 .04 Variable factory overhead 40,000 .04 Fixed factory overhead 80,000 .08 Fixed factory overhead 80,000 .08 Total costs $200,000 $.20 Total costs $200,000 $.20 Dr. Hussein Khasharmeh
Dr. Hussein Khasharmeh Assume another manufacturer offers to sell
Assume another manufacturer offers to sell
Nantucket the bottles for $.18/bottle.
Nantucket the bottles for $.18/bottle.
If the company buys the bottles, $50,000 of fixed If the company buys the bottles, $50,000 of fixed overhead cost would be eliminated and the capacity overhead cost would be eliminated and the capacity now used to make Bottles...
View Full
Document
 Spring '13

Click to edit the document details