Relevant Costs

1. Relevant Costs For Decision-Making

2. What is meant by “Cost”? This is an example of “Opportunity Cost”. Opportunity Cost = £6,000 vs. Historical Cost = £5,000.

3. Example (cont.): Relevant vs. Irrelevant Costs Irrelevant Purchase Price = £10,000 Purchase Price = £5,000 Historic Cost Relevant Offer to Buy = £6,000 Opportunity Cost Value to self of usefulness, pleasure, etc. of keeping car Relevant £ ?????? So, what is relevant (important) and irrelevant (not important) ? Q: What if there was another offer to buy the car for £5,500 ? Q: What if the purchase price had been £10,000 instead of £5,000 ? Irrelevant

5. Outlay Costs and Opportunity Cost

10. Solution Procedure: Calculate the relevant cost for each input, and then add them up. • If an input is in frequent use and needs to be replaced, used replacement cost. • If an item will otherwise be sold off and not be replaced, used sales price. • If an item has an alternate use, use the opportunity cost (foregone income) as the relevant cost.

11. Solution: A: frequent use: use replacement cost B: otherwise sold: use sales price * Use replacement cost when an item must be replace; and sales value when the item would otherwise be sold. Never use historic cost!

13. Solution

15. Sunk Costs vs. Committed Costs

18. Quantitative vs. Qualitative Factors

21. Homework page 1

22. Homework page 2

23. Homework Answer

24. In-Class “Homework”: Extra: What is the relationship between a budget and opportunity costs?

25. Answers