M4-14
1. Cost of new fire engine
2. Cost of old generators
3. Cost of new generators
4. Operating cost of old
generators
5. Operating cost of new
generators
6. Mayor's salary
7. Depreciation on old generators
8. Salvage value of old generators
9. Removal cost of old generators
10. Cost of raising dam
11. Maintenance costs of water plant
12. Revenues from sale of
electricity
Proposal 1
Irrelevant
Irrelevant
Relevant
Proposal 2
Irrelevant
Irrelevant
Irrelevant
Relevant
Irrelevant
Relevant
Irrelevant
Irrelevant
Relevant
Relevant
Irrelevant
Relevant
Irrelevant
Irrelevant
Irrelevant
Irrelevant
Irrelevant
Relevant
Irrelevant
Relevant
Relevant
M4-15
Relevant Costs Irrelevant Costs
Opportunity Outlay Outlay Sunk
1. The case will require three attorneys
to stay four nights in a Washington hotel.
The predicted hotel bill is $1,200.
2. Taylor, Taylor, and Tower's
professional staff is paid $2,000 per
day for out-of-town assignments.
3. Last year, depreciation
on Taylor, Taylor, and
Tower's office was $12,000.
4. Round-trip transportation
to Washington is expected to cost
$250 per person.
5. The firm has recently accepted
an engagement that will require
partners to spend two weeks in
Atlanta. The predicted out-of-pocket
costs of this engagement are $8,500.
6. The firm has a maintenance
contract on its computer
equipment that will cost $2,200 next year.
7. If the firm accepts the
engagement in Washington, it
will have to decline a conflicting
engagement in Hilton Head that would
have provided a net cash flow of $15,000.
8. The firm's variable overhead is
$80 per client hour.
9. The firm pays $250 per year for
Tower's subscription to a law journal.
10. Last year, the firm paid $3,500 to
increase the insulation in its building.
X
X
X
X
X
X
X
X
X
X
X
M4-18
Relevant cost analysis
Increase in revenues:
Sell complete sailboats
Sell sailboat hulls
Costs of masts, sales, and rigging
Advantage (disadvantage) of further processing
$6,000
(5,000)
$ 1,000
(1,500)
$ (500)
An alternative analysis treats the selling price of the uncompleted hulls as an
opportunity cost:
Revenues from complete sailboats
Costs:
Outlay costs of masts, sails, and rigging$1,500
Opportunity cost of not selling hull
Advantage (disadvantage) of further processing
$ 6,000
5,000
(6,500)
$ (500)
M4-19
a.
Contribution from special order
(($18 - ($16 - $1.50 + $2.00))  2,500 bags
Opportunity cost ($20 - $16)  400 bags
Profit from accepting order
$3,750
-1,600
$2,150
b.
Expansion into a new area
Larger market share
Lost sales to regular customers
Pressure from regular customers to receive the same price
Unhappy regular customers
c.
For a long-term relationship, management must consider all of the factors
raised in (b).
They must also realize that in the long run all costs are variable. Hence, the
profitability of the order might better be based on current average costs with
an adjustment for shipping expenses. When this is done, the long-run
average cost of $18 ($17.50 -$1.50 + $2.00) equals the selling price. It
appears that the order is not desirable in the long run.
Other considerations include the possibility of small crops in future years
and the risk of changes in costs.
E4-22
Cost to make:
Variable costs (10,000 units  $24.00)
Fixed costs (10,000 units  $5.00)
Rent income (opportunity cost)
Cost to buy (10,000 units  $32.00)
Advantage (disadvantage) of buying
Making has an advantage of $5,000.
$240,000
50,000
25,000
$315,000
320,000
$ (5,000)