Benefits, Costs, and Decisions Flashcards
A good decision
considers all costs, including any losses.
Average costs are
a lousy indicator of performance.
Problem arise when
incentives of the business are not aligned with goals
Total costs increase
as you produce more, but factory capital costs are fixed.
Capital costs
are fixed.
Labor or ingredients (Variable) costs
vary with output.
Costs that change with output level are
variable costs
Factory costs (Fixed)
do not vary with the amount of output.
Variable costs
change as output changes.
Economic Value Added (EVA)
is a financial performance metric that charges each division within a firm for the amount of capital it uses.
The main difference between ordinary accounting profit and EVA i
s a 15% capital charge.
Accounting costs do not include
capital costs where as economic costs do.
Economists are interested in
all relevant costs for decision making, including implicit costs.
Interest
is the charge creditors charge for use of their capital.
Economic profit tells investors
if they should keep investing.
Economic profit recognizes
explicit and implicit costs of capital.
Negative economic profit means
that the firm is earning less than equity holders expect to make from their investment.
Opportunity costs is
of one alternative as the forgone opportunity to earn profit from the other.
Relevant costs and benefits
of a decision consider all costs and benefits that vary with the consequence of a decision but only costs and benefits that vary with the consequence of the decision.
Fixed or sunk cost fallacy
considers costs and benefits that do not vary with the consequences of your decision. You make decisions using irrelevant costs and benefits.
One of the most frequent causes of sunk-cost fallacy in business is
overhead allocated to various activities within a company.
Depreciation is another common cause
of sunk-cost fallacy.
Straight-line depreciation
is when the asset depreciates each year based on usage charges.
Accounting profit does not necessarily correspond
to economic profit.
Hidden-cost fallacy
occurs when you ignore relevant costs-those that vary with the consequences of your decision.
When trying to make a hard decision:
first recognize the relevant benefits and costs; second, remember to consider the consequences of the decision from your company’s point of view.
If you begin with the costs, you will get confused.
If you begin with the decision, you won’t get confused.
Costs are associated
with decisions.
