Costs and Opportunity Cost

* Nobel Prize–winning economist Ronald Coase noted,“The cost of doing anything consists of the receipts that could have been obtained if that particular decision had not been taken.” For example, the opportunity set for this Friday night includes the movies, a concert, staying home and studying, staying home and watching television, inviting friends over, and so forth. The opportunity cost of taking job A included the forgone salary of $102,000 plus the $5,000 of intangibles from job B.

Opportunity cost is the sacrifice of the best alternative for a given action.

Public accounting firms confront this issue.

The car’s opportunity cost in the decision to keep it for resale is $7,200, but in matching expenses to revenues, the accounting expense is $6,500.

Several examples illustrate opportunity costs. The first four examples pertain to raw materials and inventories.

P 2–1: Darien Industries
Darien Industries operates a cafeteria for its employees. The operation of the cafeteria[kæfɪ’tɪərɪə] requires fixed costs of $4,700 per month and variable costs of 40 percent of sales. Cafeteria sales are currently averaging $12,000 per month. Darien has an opportunity to replace the cafeteria with vending [vend] machines. Gross [grəʊs] customer spending at the vending machines is estimated to be 40 percent greater than current sales because the machines are available at all hours. By replacing the cafeteria with vending machines, Darien would receive 16 percent of the gross customer spending and avoid all cafeteria costs. How much does monthly operating income change if Darien Industries replaces the cafeteria with vending machines?

Current cafeteria income
Sales$12,000
Variable costs (40% × 12,000)(4,800)
Fixed costs(4,700)
Operating income$2,500

Vending machine income
Sales (12,000 × 1.4)$16,800
Darien’s share of sales
(.16 × $16,800)2,688
Increase in operating income$ 188

P 2–2: Negative Opportunity Costs
Can opportunity costs be negative? Give an example.

Yes，if your house basement have broken and need spend you 1000 dollars to repair. If you decide to buy it to someone who do like use the basement. You opportunity cost is -1000 dollars. P 2–5: J.P. Max Department Stores

J.P. Max is a department store carrying a large and varied stock of merchandise. Management is considering leasing part of its floor space for $72 per square foot per year to an outside jewelry company that would sell merchandise. Two areas currently in use are being considered: home appliances (1,000 square feet) and televisions (1,200 square feet). These departments had annual profits of $64,000 for appliances and $82,000 for televisions after allocated fixed occupancy costs of $7 per square foot were deducted. Allocated fixed occupancy costs include property taxes, mortgage interest, insurance, and exterior maintenance for the department store. Required:

Considering all the relevant factors, which department should be leased and why?

[Opportunity cost of retail space]
Home Appliances Televisions
Profits after fixed cost allocations $64,000 $82,000
Allocated fixed costs 7,000 8,400
Profits before fixed cost allocations 71,000 90,400
Lease Payments 72,000 86,400
We would rent out the Home Appliance department,
P 2–10: Emrich Processing

Emrich Processing is a small custom stainless steel parts processor. Customers send new and used stainless steel parts to Emrich for cleaning in various acid baths to remove small imperfections or films on the surface. These parts are used in a variety of applications, ranging from nuclear reactors to chemical and medical applications. Depending on the foreign substance to be removed, Emrich chooses the acid bath mixture and process. Such chemical cleaning operations require highly skilled technicians to handle the dangerous acids. Environmental Protection Agency (EPA) and Occupational Safety and Health Administration (OSHA) regulations are closely followed. Once the part is treated in the proper chemical bath using other chemicals, a benign waste solution results that can be disposed of via the city sewer system. On May 12, Emrich ordered a 50-gallon drum of a specialty acid known as GX-100 for use in a May 15 job. It used 25 of the 50 gallons in the drum.

The 50 gallons cost $1,000. GX-100 has a shelf life of 30 days after the drum is opened before it becomes unstable and must be discarded. Because of the hazardous nature of GX-100 and the other chemicals Emrich uses, Emrich works closely with Environ Disposal, a company specializing in the disposal of hazardous wastes. At the time of ordering the GX-100, Emrich anticipated no other orders in the May–June time period that could use the remaining 25 gallons of GX-100. Knowing it would have 25 gallons remaining, it built $1,000 into the cost of the job to cover the cost of the GX-100 plus an additional $400 to cover the cost of having Environ dispose of the remaining 25 gallons. On June 1, a customer called and asked for a price bid for a rush job to be completed on June 5. This job will use 25 gallons of GX-100. Emrich is preparing to bid on this order. What cost amount for the GX-100 must be considered in preparing the bid? Justify your answer. 1000 dollars is sunk cost-no need to consider

-400 dollars is depose of it-need to consider
P 2–13: Volume and Profits
Assuming the firm sells everything it produces and assuming that variable cost per unit does not change with volume, total profits are higher as volume increases because fixed costs are spread over more units. Required:

a. True or false?
false
b. Explain your answer in part (a).
total cost = FC + VC × Q =
We should asset depreciation as an opportunity cost. Suppose a delivery van used four days a week can be sold next year for $34,000. If additional business is taken and the delivery van is used six days a week, its market value next year will be $28,000. Depreciation due to use for the additional business is $6,000 ($34,000 – $28,000) and the FC is increase. Profit = Price*Q-total cost

Furthermore the total cost reducing is not mean the profit increasing. If as the number of productions increases the price decrease, the profit may be decrease too. P 2–26: Eastern University Parking

Eastern University faces a shortage of parking spaces and charges for parking. For nearby parking (e.g. behind the business school), faculty and staff pay $180 per year. Parking in lots Z and B, which are north and south of the campus and involve about a 10-minute walk to the business school, costs $124 per year. In setting these prices, the university seeks to recover the costs of parking and to manage the queue of people wishing to park on campus. The current $180 and $124 fees cover the costs of surface spaces. Lots Z and B have lower fees to compensate people for the longer walks and to encourage them to park in outlying lots. University officials say this fee structure, when multiplied by the number of parking stickers of each type sold, covers the cost of running the parking office and building new spaces. The cost of providing a parking space consists of costs of construction of the space, maintenance, and security. The construction cost is the annual amount required to repay the cost of grading, draining, and asphalting the space.

Maintenance includes snow removal, line painting, fixing the gates after the arms are broken by irate faculty members searching for a space, and patching the asphalt. Security costs include all costs of the parking officers who ticket the cars of staff and students parked illegally. The university recently evaluated a proposal to construct an enclosed, multifloor parking facility. Design estimates place the construction cost at $12,000 per enclosed space. The equivalent cost of a surface space is $900. The university uses a 10 percent cost of capital. (Assume that this is an appropriate interest rate.) To compensate the university for the cost of the capital involved in building parking garages, parking fees would have to be at least $1,200 per space per year, as opposed to $90 per space per year for the surface space. Because the university does not believe that faculty, staff, and students are willing to pay over $1,200 per year for a covered parking space, no plans exist to build a parking building. Required:

Critically evaluate Eastern University’s costing of parking permits. What do you think accounts for the university administration’s reluctance to build a parking garage? I think in this case the university should compare two programs opportunity cost. If do no build the parking building, the opportunity cost should includes the revenue of other utilization of parking area Z and B, the reducing maintenance and security fee. In addition, covered parking space will use less snow removal and line painting, so the owner should pay less fee.

P 2–44: Amy’s Boards
Amy Laura is opening a snowboard rental store. She rents snowboards for skiing on a weekly basis for $75 per week including the boots. The skiing season is 20 weeks long. Laura can buy a snowboard and boots for $550, rent them for a season, and sell them for $250 at the end of the season. The store rent is $7,200 per year. During the off-season, Laura sublets the store for $1,600. Salaries, advertising, and office expenses are $26,000 per year. On average, 80 percent of the boards in any given week are rented. After each rental, the boards must be resurfaced and the boots deodorized. Labor (not included in the $26,000) and materials to prepare the board and boots to be rerented cost $7. Required:

a. How many boards must Laura purchase in order to break even? FC= (7200-1600)+2600
VC= (550-260)*Q+0.8*Q*20*7
Income =0.8*Q*20*75
So we get:
0.8*Q*20*75 = (550-250)*Q+0.8*Q*20*7+ (7200-1600)+26000
1088Q = 300Q+31600
788Q=31600
Q=40.1
Should buy at least 41

b. Suppose that Laura purchases 50 boards. What profit does she expect? Profit= Income-TC=0.8*50*20*75-[(550-250)*50+0.8*50*20*7+ (7200-1600)+26000] =800*75-[300*50+800*7+31600]= 54400-15000-31600=7800

c. Laura purchases 50 boards. What fraction of her boards must she rent each week to break even (including covering the cost of the boards)? Profit= Income-TC=P*50*20*75-[(550-250)*50+P*50*20*7+ (7200-1600)+26000] =P*68000-[300*50+31600]= 68000P-46600=0 P=68.5%

d. Explain why the percentage utilization you calculated in part (c ) differs from the expected rental rate of 80 percent.
If you buy the board, this part purchase becomes the fixed cost. So you can not change it, and the number 50 is more than 41, and the rest part 9 will provide more interest. So even the rental rate decrease, the store will still break even.