- When choosing between launching Alpha or Beta, which statement correctly identifies the relevant costs?
Answer: Alpha requires $110,000 additional investment while Beta requires $90,000, with all prior costs being irrelevant
When analyzing investment decisions, you need to distinguish between relevant and irrelevant costs. Relevant costs are future costs that differ between alternatives, while sunk costs (money already spent) should never influence your decision since they can't be recovered regardless of what you choose.
The correct approach focuses only on additional investments needed going forward. For Alpha, you'd need $80,000 for equipment plus $30,000 for marketing, totaling $110,000. For Beta, you'd need $90,000. These are the only costs that matter for your decision because they're the only ones you can still control.
Answer A incorrectly includes the $200,000 R&D and $50,000 market research as relevant costs. These are classic sunk costs—money already spent that won't change regardless of which product you launch. Including sunk costs inflates the apparent cost of continuing with Alpha and can lead to poor decisions.
Answer B suggests allocating prior investments between the options, but this allocation approach is fundamentally flawed. Sunk costs remain irrelevant regardless of how you divide them up.
Answer C specifically calls the $50,000 market research relevant to Alpha. While this research may have provided useful information, the money is already spent. The research findings might influence your decision, but the cost itself shouldn't.
Remember this key principle: ignore all sunk costs in decision-making and focus only on incremental costs and benefits going forward. This prevents the "throwing good money after bad" trap that catches many managers.
- For the machine replacement decision, what represents the relevant cost of keeping Machine A for three years?
Answer: $170,000 representing operating costs plus opportunity cost of foregone sale proceeds
When analyzing machine replacement decisions, you need to focus on relevant costs—those that will differ between alternatives. The key insight is identifying what costs you'll actually incur by keeping the existing machine versus replacing it.
For keeping Machine A, the relevant costs include: the three years of operating costs ($45,000 × 3 = $135,000) plus the opportunity cost of not selling it immediately ($35,000). This totals $170,000. The opportunity cost matters because by keeping Machine A, you're giving up the $35,000 you could receive today from selling it.
Let's examine why the other options miss the mark:
Option A ($135,000) correctly includes operating costs and foregone sale proceeds but calculates the foregone proceeds incorrectly—it should be the full $35,000 sale value, not some other amount.
Option B ($180,000) incorrectly includes the book value ($60,000). Book value represents a sunk cost from past depreciation and isn't relevant to future decisions. You can't recover this amount regardless of your choice.
Option C ($95,000) focuses only on book value and opportunity cost while completely ignoring the three years of operating costs—the largest component of keeping the machine.
Option D correctly captures both the future operating costs you'll pay and the immediate sale proceeds you're forgoing by not selling today.
Study tip: In replacement decisions, always exclude sunk costs (like book value) and include opportunity costs (like foregone sale proceeds). Focus on what cash flows will actually differ between your alternatives.
- What represents the incremental cost per unit for the special order decision?
Answer: $28.33 per unit including current variable costs plus additional fixed costs
Incremental costs include all costs that change due to the decision. Variable costs are $25 per unit ($12 + $8 + $5). Additional fixed costs are $10,000 monthly ($6,000 equipment + $4,000 supervisor) ÷ 3,000 units = $3.33 per unit. Total incremental cost is $28.33 per unit. Choice A omits additional fixed costs. Choice C includes existing fixed overhead that won't change. Choice D omits the equipment lease cost.
- If RetailCorp drops product line Alpha, what is the relevant opportunity cost of this decision?
Answer: $80,000 representing Alpha's current contribution margin before any other considerations
Opportunity cost represents the benefit foregone from the next best alternative. By dropping Alpha, the company foregoes Alpha's contribution margin of $80,000 ($200,000 - $120,000). The candy expansion represents a benefit of the decision, not an opportunity cost. Choice A confuses the benefit with the opportunity cost. Choice B incorrectly deducts allocated common costs that will continue regardless. Choice D incorrectly nets the opportunity cost against the decision's benefits.
- For the make-or-lease equipment decision, how should the original equipment be evaluated?
Answer: Include $45,000 as an opportunity cost of using the owned equipment
The relevant cost of using owned equipment is its opportunity cost - what could be obtained by selling it ($45,000). This represents the economic sacrifice of using rather than selling the equipment. Choice A incorrectly treats book value as relevant when book value represents a sunk cost. Choice C uses historical cost, which is also sunk. Choice D creates a fictional disposal cost and uses irrelevant book value.
- Which costs should be classified as relevant for the outsourcing decision?
Answer: Vendor cost $50,000, avoidable internal costs $45,000, and opportunity cost $15,000 of not reassigning clerk
Relevant costs are future costs that differ between alternatives. The vendor cost ($50,000) is a new cost if outsourcing occurs. The clerk salary ($45,000) is avoidable if outsourced. The opportunity cost ($15,000) represents foregone benefits of not reassigning the clerk to customer service. Allocated costs (rent, IT support) continue regardless and aren't relevant. The software license is a sunk cost that continues either way. Choice A incorrectly describes the revenue as foregone rather than an opportunity from reassignment. Choice B includes non-avoidable allocated costs. Choice D includes the non-cancellable software license.
- When evaluating this special order decision, which cost should be treated as a relevant cost?
Answer: The $33 per unit total variable cost including special packaging for the order
Relevant costs are future costs that differ between alternatives. The $33 per unit ($30 regular variable + $3 special packaging) represents the incremental cost that will be incurred if the order is accepted. Choice B incorrectly includes allocated fixed costs that won't change with the decision. Choice C incorrectly includes sunk costs already spent. Choice D incorrectly excludes the additional packaging cost that is required for this decision.
