Cost Concepts

Question 1

What are the major elements of a firm’s capital (or capital structure)?

Answer 1

Long-term debt, Preferred stock and Common stock.

Question 2

Define “cost” as used in accounting.

Answer 2

Amount paid or obligation incurred for a good or service; may be unexpired or expired. An unexpired cost is an asset. An expired cost is an expense.

Question 3

Define “expired cost.”

Answer 3

The benefit to an entity from the good or service that has been used up and is of no future value to the entity. An expired cost is an expense (.e.g., cost of wages and salaries) or a loss (e.g., cost of goods destroyed by fire).

Question 4

Define “opportunity cost.”

Answer 4

Benefit lost from an opportunity as a result of choosing another opportunity. It is measured as the discounted value of the cash flow or other benefit foregone and is relevant in making current decisions.

Question 5

How is a firm’s cost of capital determined?

Answer 5

It is the rate of return that must be earned by prospective investors in order for a firm to attract and retain their investments.

Investors’ expected rate of return is determined primarily by the rate of return that could be earned on other opportunities with comparable risk.

Question 6

Define “weighted-average cost of capital.”

Answer 6

Cost of each element of capital weighted by the proportion (percentage) of total capital provided by each element, with the resulting products summed to get the weighted average cost for all elements of capital.

Question 7

Define “unexpired cost.”

Answer 7

An asset; it has future value to the entity (e.g., the cost of a 3-year insurance policy would be an asset during the period covered).

Question 8

Define “differential cost.”

Answer 8

Costs which are different between two or more alternatives. Differential costs are relevant in making decisions between the alternatives. For example: In deciding whether or not to accept a special order for a product, only the new costs that would be incurred in accepting the order would be relevant. Fixed costs that would not change whether or not the order is accepted would not be relevant.

Question 9

Define “sunk cost.”

Answer 9

Costs incurred in the past that cannot be changed by current or future decisions and, therefore, are irrelevant to current decisions.

Question 10

___ is the monetary measure of a resource; it is the money amount paid or obligation incurred for a good or service.

Answer 10

Cost

Question 11

___ ___ are irrelevant to current and future decision-making

Answer 11

Sunk costs

Question 12

The ___ ___ cost of capital generally is more appropriate for economic analysis than the cost of individual capital elements.

Answer 12

weighted average

Question 13

The rate of return investors can earn in the market on securities with comparable risk determines a firm’s ___ ___ ___.

Answer 13

cost of capital.

Question 14

___ ___ and ___ ___ are relevant to current and future economic decisions.

Answer 14

Differential Costs & Opportunity Costs

Question 15

Differential costs and ___ ___ mean the same thing.

Answer 15

incremental costs

Question 16

The cost of common stock usually is greater than the cost of ___ or ___ ___.

Answer 16

debt or preferred stock

Question 17

An expired cost is an ___.

Answer 17

expense.

Question 18

The use of a company-wide cost of capital to evaluate new capital investments will result in high-risk divisions ___ ___ in new projects and low-risk divisions ___ ___ in new projects.

Answer 18

over-investing; under-investing

Question 19

An entity should accept projects which have an estimated return (equal to or) greater than the entity’s ___ ___ ___ of ___ (___).

Answer 19

weighted average cost of capital (WACC)

Question 20

___ ___ is the cost assigned to goods that were either purchased or manufactured for resale.

Answer 20

Product cost

Question 21

Product cost also is often referred to as “___ ___.”

Answer 21

inventoriable cost

Question 22

___ ___ are those that are different between two or more alternatives under consideration.

Answer 22

Incremental costs

Question 23

___ ___is the benefit lost from an opportunity (selling the land) as a result of choosing another opportunity (developing the land).

Answer 23

Opportunity cost

Question 24

A company will seek to ___ its weighted-average cost of capital (WACC).

Answer 24

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