unit 10 | relevant costs & benefits

Question 1

How to determine the relevance of a cost & benefit analysis

Answer 1

Only need to consider the revenues & costs that “change” if one alternative is chosen over the other

Question 2

If 2 alternatives generate the same revenue

Answer 2

Not relevant to analysis

Question 3

Relevant benefit - Revenue

Answer 3

Incremental revenue → additional revenue one alternative generates over the other

Question 4

Relevant Cost (opportunity cost) - Revenue

Answer 4

Revenue lost → the decrease in revenue of one alternative compared to the other

Question 5

If 2 alternatives incur the same costs

Answer 5

Unavoidable Cost → not relevant to analysis

Question 6

Relevant Cost - Cost

Answer 6

Incremental cost → additional cost one alternative incurs over the other

Question 7

Relevant Benefit (Avoidable Cost)

Answer 7

Cost saving → reduction in cost of one alternative compared to the other

Question 8

Differential Revenue

Answer 8

Difference in revenues between 2 alternatives in a relevant cost/benefit analysis

Question 9

Differential Cost

Answer 9

Difference in costs between 2 alternatives in a relevant cost/benefit analysis

Question 10

Sunk Cost

Answer 10

Cost already incurred in the past → not relevant to analysis

Question 11

2 Step Process to Perform Analysis

Answer 11

1. Eliminate irrelevant costs (unavoidable & sunk costs), & irrelevant benefits/costs (same between alternatives)
2. Analyze the remaining costs & benefits (ie. relevant) & make decision

Question 12

Relevant Cost & Benefit Analysis used for 3 Main Scenarios:

Answer 12

1. Keep or drop a product (or business segment)
2. Choosing a new location
3. Accepting or rejecting a special order

Question 13

Keep or Drop a Product (or Business Segment)

Answer 13

Relevant costs:
- Contribution margin (CM) lost on discontinued product/segment
- Lost revenue, savings of variable costs related

Relevant benefits:
- Fixed costs avoided if a product is discontinued/store closed
- CM gained on the other products/segments as a result of repurposing the space

Question 14

Keep or Drop a Product (or Business Segment) - Calculation & Decision

Answer 14

Calculation:
CM lost - (Fixed cost avoided + CM gained elsewhere) = Continue/(Discontinue)

Decision:
- CM lost > fixed costs… = product/segment analyzed should be kept
- CM lost < fixed costs… = product/segment analyzed should be discontinued

CM only lost on the thing considered discontinuing

Question 15

Choosing a New Location

Answer 15

Doesn’t always include relevant benefits:
- May not result in incremental revenues/no cost savings to be compared to the pre-decision position
- Ultimately comes down to choosing the option w/ lowest cost

Relevant costs:
- Incremental costs → variable & fixed costs (based on each location)
- Opportunity costs → any potential foregone sales as a result of relocation

Relevant benefits:
- Incremental revenue → new sales in the geographical territory of the new location
- Variable & fixed costs avoided if status quo location is closed/lease terminated

Question 16

Special Order

Answer 16

An order not within the parameters of what a company considers normal business operations & not recurring

Question 17

Accept or Reject a Special Order (common)

Answer 17

Relevant costs:
- Incremental costs → variable & fixed costs (of accepting the order)
- Opportunity costs (of accepting the order) → potentially foregone sales of other products to accommodate the special order

Relevant benefits:
- Incremental revenue from the order

Question 18

Accept or Reject a Special Order - Calculation & Decision

Answer 18

Calculation:
Incremental revenue - total relevant costs = Accept/(Reject) special order

Decision:
- Inc. rev. > total rel. costs associated w/ the order = accept
- Inc. rev. < total rel. costs associated w/ the order = do not accept