Essay Week 4 Discussion Questions

1764 Words Nov 8th, 2014 8 Pages
From the scenario for Katrina’s Candies, determine the relevant costs for the expansion decision, and distinguish between the short run and the long run costs. Recommend the key decision-making criteria that Katrina’s Candies should use for expansion decisions in the short run and in the long run. Provide rationale for your response.
Relevant costs are those that are avoidable or can be eliminated by choosing one alternative over another. Relevant costs are also known as differential, or incremental, costs. In general, variable costs are relevant in production decisions because they vary with the level of production. Likewise, fixed costs are generally not relevant, because they typically do not change as production changes. However,
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c) Cash flow: Expenses such as depreciation are not cash flows and are therefore not relevant. Similarly, the book value of existing equipment is irrelevant, but the disposal value is relevant.
d) Common costs: Costs which will be identical for all alternatives are irrelevant, e.g. rent or rates on a factory would be incurred whatever products are produced.
e) Sunk costs: Another name for past costs, which are always irrelevant, e.g. dedicated fixed assets, development costs already incurred.
f) Committed costs: A future cash outflow that will be incurred anyway, whatever decision is taken now, e.g. contracts already entered into which cannot be altered.
g) Out-of-pocket cost requires future outlay of cash and results from management’s decisions; is relevant.
h) Opportunity cost is potential benefit lost by taking specific action when two or more alternative choices are available; consideration is important.
Relevant benefits are additional or incremental revenue generated by selecting a particular course of action over another; relevant to decision-making.
Short-run costs- Economists define the short run as being the time period when at least one of the factors of production is completely fixed. For example, for a particular company this might mean that they have reached full capacity in a warehouse or at a factory site. These short-run costs consist