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Differential Cost Analysis

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Whitney Rodolfo

on 11 July 2014

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Transcript of Differential Cost Analysis

Introduction
I. In short-run decision making, differential costs and revenues are generally the economic figures which should be compared when trying to decide between the various alternatives under consideration.

Differential Cost Analysis
(Short-Run Decisions)

by: Kim Anthony L. Labitad

Differential Cost
differential costs always relate to the specific alternatives being analyzed

any variable cost related to the activities being analyzed will makeup most of the differential costs.
Differential Cost
Examples:

(1) an increase in advertising expenditures.

(2) an increase in total supervisors' salaries and liability insurance because a special order has been accepted and can only be produced by starting up a third shift in the factory.
Differential Cost
But there are some types of fixed costs that are incremental in nature and will be part of the differential costs and must be considered in the decision
process.

Introduction
- differential revenues and costs are future costs and revenues which differ between alternatives.

- another term used for "differential" is "incremental"

- marginal costs or revenues,
refer to the increase in total costs resulting from the production and/or sale
of one more unit.
The Importance
The significance or importance of these costs is obvious, since finding costs that are lower than other alternatives can mean bigger profits for the firm.
a key tool in the decision-making process for most successful businesses.
Examples
Opportunity Cost
are fundamental costs in economics, and are used in computing cost benefit analysis of a project.

Economists also define it as the value of the next-highest-valued alternative use of that resource.
Opportunity Cost
Applications:

Consumer choice
Production Possibilities
Cost of Capital
Time Management
Career Choice
Analysis of comparative advantage
Sunk Cost
A cost that has already been incurred and thus cannot be recovered. A sunk cost differs from other, future costs that a business may face, such as inventory costs or expenses, because it has already happened.

Sunk costs are independent of any event that may occur in the future.
Sunk Cost
Case: ADVERTISING

From direct mail marketing to purchasing advertising placements through print and web media, small businesses use advertising to attract and retain customers. Money spent on advertising doesn't guarantee a return, but once the money is spent and the advertising effort runs, advertising expenditures are regarded as sunk costs.
Differential Revenue
- these are future revenues which differ between the alternatives
being considered.


- when comparing different alternatives, three distinct situations
may exist; these three basic situations are:

Differential Revenue

- simply compare the incremental revenues and cost of the different alternatives; no consideration of lost contribution which is presently being generated need be considered.

(1)
Operating at less than full capacity and the decision will have no effect on other product sales or revenue-generating activities
Differential Revenue
(2)
Operating at less than full capacity but the decision
will effect other product sales or revenue-generating
activities.
- must consider the revenues and costs of present
products and activities which willbe effected by the
decision made as well as the estimated results directly
generated from the decision.

Differential Revenue
(3)
Operating at full capacity and the decision will effect
other product sales or revenue-generating activities.

- must consider the revenues and costs of present
products and activities which will be effected by the
decision made as well as the estimated results directly
generated from the decision. (same as (2).)

Opportunity Cost
Example:
1. A graduate basketball player grabs the opportunity to go back to school and to be a better player in a different school for a few more years instead of working immediately. The opportunity cost is having a job and earning money.
Opportunity Cost
Example:
2. You decide to spend PHP 1800.00 on some great shoes and do not pay your electric bill. The opportunity cost is having the electricity turned off, having to pay an activation fee and late charges. You might also have food in the fridge that gets ruined and that would add to the total cost.
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