t relevant nor are egal and accounting de ent 1t 1s no hi pa rtment e xp en e f

T relevant nor are egal and accounting de ent 1t 1s

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t relevant, nor are egal and accounting de ent, 1t 1s no hi . partment expen e · f th ·n not change. T s IS clear enough. If they w ' h s s, I ey w1 on t c ange, they aren't relevant. But who is to say these expenses will not change •th th . d · b · WJ e new invest-ment? Indee , 1t appears to e an inexorable fact of life th . · d , I . at over time as comp~nies grow, pres1 ents sa anes _become larger while legal and ~c-counnng departments expand. The issue therefore is not whether ex-penses are allocated but whether they _vary with the size of the business. Although we ~nay be_unable to see a direct cause-effect tie between such expenses and mcreasmg_sales, a longer-run relation likely exists between the two. Consequently, It _does make sense to require all sales-increasing investments to bear a portion of those allocated costs that grow with sales. Remember, allocated costs are not necessarily fixed costs. A related problem arises with cost-reducing investments. To illustrate, many companies allocate overhead costs to departments or divisions in proportion to the amount of direct labor expense the unit incurs. Suppose a department manager in such an environment has the opportunity to in-vest in a labor-saving asset. From the department's narrow perspective, such an asset offers two benefits: (1) a reduction in direct labor expense and (2) a reduction in the overhead costs allocated to the department. Yet from the total-company perspective and from the correct economic per-spective, only the reduction in direct labor is a benefit because the total-company overhead costs are unaffected by the decision. They are simply reallocated from one cost center to another. Excess Capacity The most acrimonious debate over the proposed new product involved the Handheld Division's plan to use another division's excess production capacity. Three years earlier, the Switching Division had added a new production line that was presently operating at only 50 percent capacity. Handheld analysts reasoned that they could put this idle capacity to good use by manufacturing several subcomponents of their new phone there. As they saw it, using idle capacity avoided a major capital expenditure and saved the corporation money. They therefore had assigned zero cost to use of the excess capacity. The general manager of the Switching Division saw things rather differently. He argued vehemently that those as~ets were his, he had paid for them, and he damned sure wasn't going to give_them away. He demanded that the H andheld Division either purchase his idle capacity for a fair price or build their own production line. He eStimated \,
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256 Part Four Ev11/11ati11g lnvest111ent Oppo11u11itirs that the excess capacity was worth at leaSt $20 millio~. Handheld analysts responded that this was nonsense. The excess capa~i~ had already been paid for and was thus a sunk cost for the current dec1s10n.
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