sec C Flashcards
1
Q
Cost-Volume-Profit (CVP) Analysis * Assumptions:
A
- Costs = Fixed or Variable.
- Revenues/costs are linear within relevant ranges.
- Focus on production/sales volume.
2
Q
Unit Contribution Margin =
A
Selling Price − Variable Cost
3
Q
CMR =
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CM / Selling Price or
TCM / Sales Revenue
4
Q
VCR =
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(VC/Units) / SP or VC / Sales
5
Q
CMR =
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1-VCR and
VCR = 1- CMR
6
Q
Breakeven Sales (Units) =
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TFC ÷ CM/Units
7
Q
BreakevenRevenue =
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BreakevenSalesVolume × SellingPriceperUnit or
TFC / CMR
8
Q
Target Sales (Units) =
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(Fixed Costs + Pre tax Target Profit) ÷ Contribution Margin per Unit
9
Q
At BEP:
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TFC = TCM
10
Q
TCM > TFC
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= Profit
11
Q
TCM < TFC
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= Loss
11
Q
Margin of safety units =
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Units sold after breakeven
11
Q
Additional units to Breakeven =
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Loss/ CM per unit
11
Q
Profit =
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Margin of Safety Units * CM/u
11
Q
Quantity Changes:
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Affect total revenue and total VC but not ratios like CMR or VCR.
12
Q
SP or VC/u Changes:
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Directly affect both CMR and VCR, altering the profitability dynamics of each unit sold
13
Q
At breakeven, Operating Income
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Operating Income = $0
14
Q
Required Sales Volume (Units) =
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TotalFixedCost+TargetPretaxIncome / ContributionMarginPerUnit
15
Q
Required Sales Revenue =
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TotalFixedCost+TargetPretaxIncome / ContributionMarginRatio
16
Q
Convert After-Tax to Pretax: Formula: TargetPretaxIncome =
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TargetAfter-TaxIncome / 1−TaxRate
17
Q
📊 Target Pretax Income as a % of Sales Revenue
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- Adjusted Contribution Margin Per Unit = Selling Price − Variable Costs − Target Pretax Income Per Unit(SP* percentage)
- Required Sales Volume (Units) = TotalFixedCosts / AdjustedContributionMarginPerUnit
- Required Sales Revenue = TotalFixedCosts / AdjustedContributionMarginRatio
✅ Adjust profit as a “variable cost” for accurate calculations.
18
Q
Adjusted Contribution Margin Ratio =
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AdjustedContributionMarginPerUnit / SellingPricePerUnit
19
Q
Weighted Average Method
A
- Weighted Average Contribution Margin Per Unit: ⚠️ CM per Unit of product 1 * weight of the product 1 + CM per Unit of product 2 * weight of the product 2 +…
- Units per Product: ⚠️ Multiply total breakeven volume by each product’s sales mix percentage.
20
Q
💵 Breakeven Sales Revenue with a Sales Mix
A
⚠️ Formula: TotalBreakevenRevenue= FixedCosts / WeightedAverageCMRatio
Revenue per Product:Multiply breakeven
revenue by each product’s revenue mix %.
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Two Methods for Calculating Breakeven Revenue (BER)
:Fixed Costs / Weighted Average CM per Unit
then,
Then Multiply each product's breakeven units by its Selling Price (SP) to get the Breakeven Revenue for each product. And the total of this will be BER
2nd method = 2. Find out WACMR = WACM / WASP
3. BER = Fixed Costs / WACMR
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Composite Units
Represent a "basket" of products sold in fixed proportions.
1. CM per Basket: Sum the CM for all products in the basket.
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Composite Units: 1. CM per Basket: Sum the CM for all products in the basket.
Breakeven Baskets:?/???
Breakeven Baskets= Fixed Costs / CM per Basket
1. Units per Product: Multiply breakeven baskets by the number of each product in a basket.
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✅ Key Tip: Sales mix changes affect breakeven revenue and volume but not always in the same way.
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Increase in Sales Mix Towards Higher Contribution Margin Products
Breakeven Units ⬇
Breakeven Revenue ⬇
Operating Income ⬆
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Sensitivity Analysis
Evaluates how changes in variables (e.g., costs, sales) affect income. ✅ Identifies key risk factors like cost increases or sales drops.
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what is Margin of Safety
Measures how much sales can drop before losses occur. ✅ Higher margin = lower risk.
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Formula: Margin of Safety
= Actual or Planned Sales−Breakeven Sales
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Margin of Safety Ratio: =
Margin of Safety / Actual or Planned Sales
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Margin of safety Ratio =
MOS (R or Units) / Planned Sales (R or Units) :expressd as % planned Sales
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MOS (U,R) =
Planned Sales (U)- Break Even(U) or PS(R) - BE(R)
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MOS (R) = (with SP)
MOS (U) * SP
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what is MOS Ratio
MOS Ratio is the maximum % sales a company can afford to loss before it stops being profitable
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Margin of Safety Key Relationships
- [x] Profit Formula (Based on Margin of Safety):
- [x] Profit = MOS Units × CM/u
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Profit Formula (Based on Margin of Safety):
Profit = MOS Revenue × CMR
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MOS Units when Profit is given
MOS Units = Profit / CM/u
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- MOS Revenue when Profit and CMR given
- MOS Revenue = Profit / CMR
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CM/u from MOS
- [x] CM/u = Profit / MOS Units
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CMR from MOS
- [x] CMR = Profit / MOS Revenue
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Expected Value:
Weighs possible outcomes by their probabilities.
⚠️ Formula: Expected Value = ∑(Probability of Outcome×Outcome Value)
1. ✅ Helps make probabilistic decisions.
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2. Deterministic Approach
* Uses the most likely outcome for decisions, ignoring variability. ✅ Simple but may overlook rare risks.
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Limitations of CVP
1. Production Units is equal to Sales Units Assumption
2. Certainty Assumption : CVP assumes that SP, VC/u TFC are known
3. Sales mix is constant assumption in multiple products situation
4. CVP assumes that all costs are either Fixed or Variable
5. Time Value of money is ignored
6. Linearity assumption: TC and TR are assumed to be Linear
* CVP assumes that TC and TR will only change due to the change in Units.
* SP,VC/u and TFC remains Constant
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1. Choosing Between Two Cost Options
Compare cost structures to find the sales level where costs are equal.
* Option 1: Option 1: Commission-only = 0.06 S
* Option 2: Salary + lower commission = 2,000×45+0.03S, Equating the two options: 0.06S=(2,000×45)+0.03S = 90,000.03 s
* Break-even sales = $3,000,000.
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2. Choosing Between Two Production Options
Compare products' cost structures to determine equal revenue or volume points.
✅ Use formulas to find break-even points based on contribution margins and fixed costs.
* Treadmill A: CM = $1,040/unit, Fixed Cost = $450,000.
* Treadmill B: CM = $750/unit, Fixed Cost = $300,000. Finding Equal Volume: 1,040V−450,000=750V−300,000 = V=518 units (rounded up)
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4. Product-Mix Decisions Under Constraints
Prioritize products with the highest CM per unit of constraint when resources are limited.
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3. Fixed vs. Variable Inputs
* High Fixed/Low Variable Costs: Better at higher volumes. Low Fixed/High Variable Costs: Better at lower volumes.
Indifference Point: Sales volume where costs are equal for both options.
* Machine A: 25,000+0.5X. — Machine B:10,000+2.5X
* Indifference point = 7,500 units. ✅ Above 7,500, choose Machine A; below, choose Machine B.
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CM per Constraint =
Contribution Margin per Unit / Constraint per Unit
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* Relevant Information:
Future costs/revenues that differ between alternatives.
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* Relevant Revenues:
Future revenues differing between options.
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Relevant Costs:
Future costs differing between options. avoidable
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* Irrelevant Information:
Includes sunk costs or identical costs/revenues across options. Sunk Costs: Past, irrecoverable costs—ignore them.
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* Differential Costs:
Differences in cost between alternatives.
Replacing a broken machine involves differential costs;
Differential costs can be part of relevant costs, but relevant costs also consider non-cost factors like opportunity costs.
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Incremental Costs:
Additional costs incurred from an activity or decision.
Example: upgrading a functioning machine incurs incremental costs.
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* Avoidable Costs:
Eliminated if a decision is made (e.g., labor costs when outsourcing). Relevant
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* Unavoidable Costs:
Persist regardless of the decision (e.g., fixed leases). Not Relevant
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* Accounting Costs:
Explicit, recorded costs (e.g., material expenses).- Out of Pocket Cost
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* Economic Costs:
Include both accounting costs and Implicit (opportunity costs).
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Opportunity Costs
represent the forgone benefits from not choosing the best alternative use of resources.
✅ Key Note: Opportunity costs exist only when resources are constrained.
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Decision-Making Guidance
1. Evaluate Incremental Changes: Focus on differing factors.
2. Exclude Sunk Costs: Past expenses don’t matter.
3. Consider Opportunity Costs: Include forgone benefits if resources are constrained.
4. Use Relevant Data: Analyze future, differential costs and revenues for informed decisions.
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Cost refers :
refers to the monetary value spent on resources, such as raw materials, labor, or overhead, to produce goods or services. Not all costs are expenses. Some represent payments for acquiring assets (e.g., purchase of machinery or land). These are capitalized and not immediately expensed.
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1. Types of Costs
* Explicit Costs: Tangible, recorded costs (e.g., materials, wages).
* Implicit Costs: Opportunity costs not in financial records. Imputed cost. Total Costs: Explicit + Implicit Costs.
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Cost Object: Any item or activity for which costs are measured (e.g., products, departments, or projects). Costs can be assigned directly or indirectly to a cost object.
Direct Costs: Directly traceable,
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indirect Costs:
Allocated
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Cost Assignment is
Cost Assignment is the general term that refers to both tracing and allocation
* Cost Tracing: Directly assigning costs to a cost object (e.g., raw materials to a product) Assign direct costs.
* Cost Allocation: Assigning indirect costs to a cost object using a predetermined method (e.g., allocating factory overhead to products). Assign indirect costs.
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Cost Tracing:
Directly assigning costs to a cost object (e.g., raw materials to a product) Assign direct costs.
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* Cost Allocation:
Assigning indirect costs to a cost object using a predetermined method (e.g., allocating factory overhead to products). Assign indirect costs.
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* Variable Costs:
Change with activity, constant per unit.
Fixed Costs: Constant in total, vary per unit.
* Mixed Costs: Combo of fixed and variable.
* Semi-Variable: Smooth increase (e.g., utility bills). Semi-Fixed: Step increase. (e.g., hiring additional nurse).
* A cost driver triggers costs whenever it occurs (e.g., machine hours, labor hours, units produced). Accurate cost drivers ensure effective cost control.
* Variable: Activity/volume-driven. Fixed: No cost driver in the short term but influenced by volume over the long term
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Fixed Costs:
Constant in total, vary per unit.
* Mixed Costs: Combo of fixed and variable.
* Semi-Variable: Smooth increase (e.g., utility bills). Semi-Fixed: Step increase. (e.g., hiring additional nurse).
* A cost driver triggers costs whenever it occurs (e.g., machine hours, labor hours, units produced). Accurate cost drivers ensure effective cost control.
* Variable: Activity/volume-driven. Fixed: No cost driver in the short term but influenced by volume over the long term
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* Mixed Costs:
Combo of fixed and variable.
* Semi-Variable: Smooth increase (e.g., utility bills). Semi-Fixed: Step increase. (e.g., hiring additional nurse).
* A cost driver triggers costs whenever it occurs (e.g., machine hours, labor hours, units produced). Accurate cost drivers ensure effective cost control.
* Variable: Activity/volume-driven. Fixed: No cost driver in the short term but influenced by volume over the long term
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* Semi-Variable:
Smooth increase (e.g., utility bills).
Semi-Fixed: Step increase. (e.g., hiring additional nurse).
* A cost driver triggers costs whenever it occurs (e.g., machine hours, labor hours, units produced). Accurate cost drivers ensure effective cost control.
* Variable: Activity/volume-driven. Fixed: No cost driver in the short term but influenced by volume over the long term
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Semi-Fixed:
Step increase. (e.g., hiring additional nurse).
* A cost driver triggers costs whenever it occurs (e.g., machine hours, labor hours, units produced). Accurate cost drivers ensure effective cost control.
* Variable: Activity/volume-driven. Fixed: No cost driver in the short term but influenced by volume over the long term
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A cost driver
triggers costs whenever it occurs (e.g., machine hours, labor hours, units produced). Accurate cost drivers ensure effective cost control.
* Variable: Activity/volume-driven. Fixed: No cost driver in the short term but influenced by volume over the long term
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* Marginal Revenue:
Additional revenue from one more unit.
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Marginal Cost:
Additional cost from one more unit.
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Applications of Marginal Analysis
1. Make-or-Buy: Compare insourcing vs outsourcing costs. AC, BC
2. Special Orders (One time): Focus on incremental costs/revenues.Special Price- Min SP = Inc P/L
3. Sell or Process Further: Compare benefits vs additional costs. IR-IC
4. Disinvestment(shutdown decision/ Drop or Not): Evaluate avoidable costs vs lost revenues. AFC-LCM
5. Add a Segment or Not ACM - AFC
6. Output Level: Adjust based on marginal benefits > marginal costs.
7. Limiting Factor Decisions and etc
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1. Make-or-Buy: Compare insourcing vs outsourcing costs.
If buy : Avoidable Cost - Buying Cost = Incremental Profit or Loss
Decision Criteria:
AC = Avoidable cost or the benefit getting from buying decision)
AC < BC - Make (or AC-BC -VE MAKE, AC - BC +VE BUY)
AC > BC - Buy
AC = ВС - Indifferent Point
if the question is silent about TFC and Selling cost then it is UN Avoidable
Note: if there is any Additional benefit other than Avoidable Cost, like Rent or Contribution margin from another product; it should be added to AC while computing Incremental profit/loss
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2. Special Orders (One time): Focus on incremental costs/revenues.
Special Price- Min SP = Inc P/L
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3. Sell or Process Further: Compare benefits vs additional costs.
IR-IC
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4. Disinvestment(shutdown decision/ Drop or Not): Evaluate avoidable costs vs lost revenues.
AFC-LCM
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5. Add a Segment or Not
ACM - AFC
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Make or Buy Decisions
If buy : Avoidable Cost - Buying Cost = Incremental Profit or Loss
Decision Criteria:
AC = Avoidable cost or the benefit getting from buying decision)
AC < BC - Make (or AC-BC -VE MAKE, AC - BC +VE BUY)
AC > BC - Buy
AC = ВС - Indifferent Point
if the question is silent about TFC and Selling cost then it is UN Avoidable
Note: if there is any Additional benefit other than Avoidable Cost, like Rent or Contribution margin from another product; it should be added to AC while computing Incremental profit/loss
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if the question is silent about TFC and Selling cost then it is
UN Avoidable (make or buy decison)
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Steps for Make or Buy Decision with Limiting Factor:
1.Calculate loss or saving per Unit if we buy (incremental profit/ loss) Formula: [AC - BC]
2. Calculate incremental profit/ loss per Limiting Factor Unit
Formula: [Step 1 ÷ Limiting Factor Unit per Product]
3. Rank the Products Based on Step 2 (High to Low).
If the result is loss from buying , select most loss from buying item for make. so that the lost will be less, less loss item from buy decision will buy
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Maximum Price(make or buy ) =
Maximum Price = Total Relevant Costs of In-house Production (Avoidable cost) + Opportunity Costs
OR
In-house Costs + Opportunity Costs − Unavoidable Costs
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MAKE OR BUY Relevant Cost to Produce
= Avoidable cost (VC + avoidable FC) + Opportunity cost.
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make or buy : Relevant Cost to Purchase
= Purchase price + Any cost incurred only if the item is purchased.
Difference = Relevant Cost to Purchase − Relevant Cost to Produce.
Impact on Operating Income = Difference × Number of units needed.
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MAKE OR BUY : Qualitative Factors:
Quality: Supplier’s ability to meet standards.
Reliability: Delivery deadlines.
Flexibility: Adapting to demand changes.
Key Takeaways: Focus on avoidable and opportunity costs., Ignore sunk and unavoidable costs., Consider qualitative factors for strategic alignment.
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Sell or Process Further Decisions
(IR - IC)
“If we Process Further”
Incremental Revenue(IR) - Incremental Cost (IC) = Incremental Profit / Loss
IR > IC Process Futher
IR = IC Indifferent Point
IR = (revenue form further processed - revenue at split off point) - IC(cost of further processb) = Incremental Profit / Loss
3. Obsolete Inventory:
Method 1 : revenue form scrap - Net Benefit (NRV: revenue form rework - Cost of Rework) = Incremental Profit / Loss
Method 2 : find IR first (revenue form rework and sell - revenue from scrap) - IC (cost of rework) = Incremental Profit / Loss
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3. Obsolete Inventory Under Sell or Process Further
Method 1 : revenue form scrap - Net Benefit (NRV: revenue form rework - Cost of Rework) = Incremental Profit / Loss
Method 2 : find IR first (revenue form rework and sell - revenue from scrap) - IC (cost of rework) = Incremental Profit / Loss
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Disinvestment Decisions( shutdown decision/ Drop or Not))
If we drop
AFC and LCM
Method 2 : AFC - Lost CM
AFC > LCM - drop (here benefit is higher than cost)
AFC < LCM - Continue (here cost is higher than benefit)
Method 1: — Avoidable Cost (AC:benefit if we drop,
(TVC + Avoidable fixed cost) - Lost Sales Revenue (LSR if we drop)
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If sales units increased or decreased by a certain %,
TCM also by same %
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Disinvestment and divestment
Disinvestment is broader than divestment, which specifically refers to the sale or disposal of an asset.
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* Relevant Fixed Cost (RFC):
Direct, traceable, avoidable.
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Irrelevant Fixed Cost (IFC):
Indirect, allocated, unavoidable.
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Key Considerations Drop or not :
1. Profitability Is Not Always the Deciding Factor: A product may not need to be profitable if it helps cover overall fixed costs, making it worth maintaining.
2. Short-Term vs. Long-Term: In the short term, a product or segment may be continued even if marginal profits are low. long-term alignment with goals is essential.
3. Non-financial Factors: Consider employee, community impact, and CSR goals.
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If sale units increase / decrease by a certain percentage,
SR and CM will also increase / decrease by same percentage
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5- Add a Segment or Not
ACM - AFC - “If we Add”
Opposite of Drop a Segment or Not (Disinvestment Decision )
The decision is evaluated based on Benefit (Additional CM)minus Cost (AFC)
if SP cahnges Gain/Lost CM = Revenue * % change in SP
if slae unites changes Gain/Loss CM = TCM * % change in sales units
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Marginal Revenue (MR)
MR = TR(after) − TR(before)
or
MR = ΔTR / ΔQ
(Change in Total Revenue ÷ Change in Quantity Sold)
Incremental revenue generated from selling one additional unit of output.
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Marginal Cost (MC)
Incremental cost incurred from producing one additional unit of output. MC = TC(after) − TC(before)
or
MC = ΔTC / ΔQ
(Change in Total Cost ÷ Change in Quantity Produced)
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Marginal Profit (MP)
Difference between Marginal Revenue (MR) and Marginal Cost (MC); profit from one additional unit. MP = MR − MC Or Total Profit(after) − TP(before)
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Marginal Product (MP) or Marginal physical product
Additional output produced from using one more unit of input (e.g., labor, capital).
MP = TP(after) − TP(before).
or
MP = ΔTP / ΔInput
(Change in Total Product ÷ Change in Input)
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Marginal Resource Cost (MRC)
Additional cost of employing one more unit of a resource (e.g., labor, raw material).
MRC =TC(after) − TC(before).
Or
MRC=Δ Total Cost / Δ Quantity of Input Used
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Marginal Revenue Product (MRP)
Additional revenue generated by one more unit of a resource.
MRP = MP × MR
(Marginal Product × Marginal Revenue)
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Average Fixed Cost (AFC)
Fixed cost per unit of output. AFC = TFC / Q
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Average Variable Cost (AVC)
Variable cost per unit of output. AVC = TVC / Q
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Average Total Cost (ATC)
Total cost per unit of output. ATC = TC / Q or ATC = AFC + AVC
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Total Cost (TC)
Sum of total fixed costs and total variable costs. TC = TFC + TVC
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Average product
is average no of units produced by ’a resource'
Avg Product = Total Production Units / Total No of resource
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Profit Maximization
(MR = MC):
* The company maximizes its profit by producing up to the point where MR equals MC.
* Beyond this point, the cost of producing additional units exceeds the revenue generated, resulting in reduced profit.
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Law of Diminishing Returns:
Initial Increase: MP and MRP rise as more workers optimize production.
Diminishing Returns: MP and MRP decrease after adding too many workers due to overcrowding and resource limitations.
* When a fixed resource (e.g., machinery) limits production, adding more of a variable resource (e.g., labor) initially increases output but at a diminishing rate.
* This decline in additional output is reflected in the declining Marginal Product (MP) and Marginal Revenue Product (MRP).
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Stop resource expansion when
MRP < MRC.
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Total Cost (TC) =
TFC+TVC.
#Per Unit Costs: TFC/ Units (AFC = Average FC) + TVC/Units(AVC = Average VC) =TC/Units( ◦ AC = Average Cost)
