An important concept in decision making is described as "the contribution to income that is forgone by not using a limited resource in its best alternative use." This concept is called
Answer(s): D
An opportunity cost is the maximum benefit sacrificed by employing a scarce productive resource in a specified manner. In other words, it is the value or worth of that resource in its next best alternative use.
American Coat Company estimates that 60,000 special zippers will be used in the manufacture of men's jackets during the next year. Reese Zipper Company has quoted a price of $.60 per zipper. American would prefer to purchase 5,000 units per month1 but Reese is unable to guarantee this delivery schedule. In order to ensure availability' of these zippers, American is considering the purchase of all 60,000 units at the beginning of the year. Assuming American can invest cash at 8%, the company's opportunity' cost of purchasing the 60,000 units at the beginning of the year is
Answer(s): A
The cost of 60,000 zippers is $36,000 (60,000 x $60). The monthly cost is $3,000 (5,000 x $60). Because the company wants to purchase the items monthly, it will invest at least $3,000 in January. Accordingly, the zippers to be used in January will be purchased at the first of the year even if no special purchase is made. Thus, the incremental advance purchase will be only $33,000, not $36,000. The incremental investment will decline at a constant rate of $3,000 per month, so the amount for February will be $30,000, for March $27,000, etc. Hence, the incremental investment for December will be $0. Accordingly, assuming consumption is uniform, the average incremental investment during the year will be $16,500 ($33,000 + 2) if the onetime purchase is made. Total opportunity cost is therefore $1,320 ($16,500 x 8% cost of capital).
In a decision analysis situation1 which one of the following costs is generally not relevant to the decision?
Management decision analysis is based on the concept of relevant costs. Relevant costs differ among decision choices. Thus, incremental (differential or avoidable) costs are always relevant. Opportunity cost is also relevant because it is the benefit forgone by selecting one choice instead of another. Historical costs, because they occurred in the past, are sunk costs and not relevant to most management decisions.
All of the following costs are relevant to a decision to accept or reject an order except
A sunk cost cannot be avoided because either the expenditure has occurred, or an irrevocable decision to incur the cost has been made. Sunk costs are irrelevant to management decision-making because they cannot vary with the option selected.
A cost that can be saved by not adopting a particular option is a(n)
Answer(s): B
An avoidable cost is one that can be saved by not adopting a particular alternative.
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