Cost Analysis in Business Decisions

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Questions and Answers

Which of the following is a sunk cost in the given example?

Direct wages

Direct material cost for the part purchased from outside (correct)

Other Material cost

Fixed overheads

What is the opportunity cost of using the remaining 20% capacity for manufacturing the part?

The profit that could be earned by using the capacity for another product (correct)

The variable overheads that would be incurred on the remaining 20% capacity

The fixed overheads that would be incurred on the remaining 20% capacity

The direct material cost for the part purchased from outside

If the company decides to increase production to 120,000 units, how would this affect the sunk cost?

The sunk cost would decrease proportionally to the increase in production

The sunk cost would remain the same (correct)

The sunk cost would be eliminated

The sunk cost would increase proportionally to the increase in production

What is the formula for calculating opportunity cost?

Opportunity cost = return on option not chosen - return on option chosen (A) Signup and view all the answers

Which of the following scenarios describes a sunk cost?

A company invests in a new product line that fails to generate enough sales to cover its costs (A) Signup and view all the answers

Which of the following is NOT a sunk cost?

The cost of advertising a new product (D) Signup and view all the answers

Which of the following best describes the concept of opportunity cost?

The cost of doing something instead of something else (C) Signup and view all the answers

How are sunk costs typically treated when making business decisions?

Sunk costs are usually ignored when making decisions, as they are irrelevant to future outcomes. (B) Signup and view all the answers

What is the primary purpose of analyzing differential costs?

To understand the difference in costs between two or more alternatives. (A) Signup and view all the answers

In the context of differential costs, what does 'step costing' refer to?

A situation where producing an additional unit may incur significant additional costs. (A) Signup and view all the answers

A company is deciding between investing in a new factory or upgrading an existing one. How would the differential cost be calculated?

The difference in costs between the new factory and the existing one (A) Signup and view all the answers

Which of the following best describes a variable cost?

A cost that changes in proportion to the level of business activity. (C) Signup and view all the answers

Which of the following is an example of a fixed cost?

Rent expense (B) Signup and view all the answers

What is a mixed cost?

A cost that includes both fixed and variable elements (D) Signup and view all the answers

A hotel is deciding whether to renovate a space into a guest bedroom or a gift shop. What would the differential cost analysis focus on?

The difference in expected costs between the guest bedroom and the gift shop. (C) Signup and view all the answers

A company is choosing between different marketing strategies (newspapers or social media). What is the 'differential cost' in this scenario?

The difference between the costs of the newspaper strategy and the social media strategy. (D) Signup and view all the answers

What is the primary purpose of calculating marginal cost?

To optimize production volumes and set prices for maximum revenue. (B) Signup and view all the answers

How is marginal cost calculated?

Change in total costs divided by change in quantity. (B) Signup and view all the answers

Which of the following best describes a relevant cost in decision-making?

A cost that is relevant to a specific business decision and can be avoided. (B) Signup and view all the answers

Which scenario best represents the application of relevant costs?

Deciding whether to continue a construction project based on expected revenue. (C) Signup and view all the answers

What is differential cost?

The difference in cost between two alternative decisions. (A) Signup and view all the answers

A company is deciding whether to automate a production line. Which amount represents the differential cost in this scenario?

The difference in cost between operating the current production line and the automated one. (A) Signup and view all the answers

A clothing store is deciding whether to close 50 of 100 stores and rebrand. Which of these is the least relevant cost to consider in this decision?

The historical cost of rent on the 50 stores they are considering closing. (C) Signup and view all the answers

A company must choose between accepting a special order with excess capacity or using its resources for routine operations. What should the company consider regarding differential costs?

The difference in costs between using excess capacity for the special order and not using the resources. (D) Signup and view all the answers

What is the total cost estimated for manufacturing the part?

Rs. 22 (A) Signup and view all the answers

If the part is manufactured in-house, what will be the cost per unit?

Rs. 9.40 (D) Signup and view all the answers

Which option provides the most cost-effective approach for ash Ltd. to secure its part?

Buy the part from outside (C) Signup and view all the answers

What is the effective annual cost of purchasing the machine if bought instead of leased?

Rs. 4,000 (A) Signup and view all the answers

What is the marginal cost component for the fixed costs if the total fixed costs are Rs. 160,000?

Rs. 32,000 (B) Signup and view all the answers

What should be the sales units of Product A for maximum profitability according to the marginal cost assessment?

900 units (D) Signup and view all the answers

How many units of Product B should be sold for maximizing profitability along with Product A in a recommended mix?

200 units (D) Signup and view all the answers

If leasing the machine costs Rs. 2,000 a month, what is the total annual leasing expense?

Rs. 20,000 (D) Signup and view all the answers

What is the total fixed overheads for Product A for the year?

Rs.10,000 (D) Signup and view all the answers

Calculate the total direct labor cost for Product B given that it requires 30 hours of labor at 50 paise per hour.

Rs.15 (C) Signup and view all the answers

What is the selling price surplus for Product A?

Rs.40 (D) Signup and view all the answers

If the company opts to produce 800 units of Product B only, what will be the total direct material cost?

Rs.24,000 (D) Signup and view all the answers

What are the total variable costs related to the new machine in terms of power, consumables, and other expenses?

Rs.18,000 (B) Signup and view all the answers

How many total units can be produced per year with the new machine?

30,000 units (B) Signup and view all the answers

What is the total cost price of the existing machine compared to the new machine?

Rs.30,000 less (D) Signup and view all the answers

If the directors choose to discontinue the existing machine, what is its book value?

Rs.10,000 (A) Signup and view all the answers

Study Notes

Marginal Cost

Marginal cost is the change in total production cost when producing one more unit.
Calculated by dividing the change in production costs by the change in quantity.
Businesses use marginal cost to determine ideal production volume and pricing.
Requires separating fixed and variable costs in cost accounting.

Relevant Costs

Relevant costs are costs pertinent to a specific business decision and avoidable.
Eliminate unnecessary data for more efficient decision-making.
Examples include deciding whether to complete a construction project or close stores.
Consider costs of closing stores (e.g. lost revenue) versus keeping them open.
Crucial for evaluating special orders: order profitability.

Differential Cost

Differential cost is the difference in costs between two alternative decisions.
Businesses use it when faced with multiple options.
Involves selecting one option and discarding others.
Particularly useful when producing one additional unit necessitates significant additional costs.
Examples: Marketing strategy decisions (social media vs. newspaper ads).
Examples: Restaurant deciding to renovate into a guest bedroom or a gift shop.
Examples: Choosing between driving or taking the bus to work.

Sunk Costs

Sunk costs are past expenditures that can't be recovered.
Management accounting considers sunk costs irrelevant when making future decisions.
Examples include driving to a concert where the performer no-shows.
Examples include buying a movie ticket for a disappointing film.
Examples include investing in research and development if the product fails.

Opportunity Cost

Opportunity cost refers to the value of the best alternative forgone when making a decision.
A key consideration in business decision-making.
Part of the cost-benefit analysis (CBA) process.
Formula: Opportunity Cost = Return on Option Not Chosen - Return on Option Chosen.
Important for informed decision-making, for example, investing in new equipment or investing in the stock market.

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Description

Explore key concepts in cost analysis including marginal cost, relevant costs, and differential cost. Understand how these concepts influence production decisions and financial outcomes for businesses. This quiz will help clarify the importance of cost categorization in effective decision-making.