MBA 201A

Section 2 - Costs

Overview

Cost Allocation: how to categorize and account for costs

Handling Assets and Loans

Using Costing Allocations for Production Decisions

Review PS2

Extra Problem from Old Midterm

Q&A

Exam Review: Wednesday 6:30-8:00pm in C210

Next Time: Demand and Pricing

Cost Allocation- back to the basics…

What is an Overhead (fixed) cost?

What is a Variable cost?

What is the “time horizon in question”?

A Fixed cost is an expense that does NOT vary with production levelfor the given time horizon in question. These may related to a particularactivity or not and may be sunk or not.

A variable cost is an expense that DOES vary with production levelfor the given time horizon in question.

Cost Allocation- back to the basics…

What’s the marginal cost? How do variable and marginal cost relate?

What’s the Opportunity Cost?

What is a Sunk Cost? How does it relate to a fixed cost?

What’s the Economic Cost?

The marginal cost of the nth product is simply the cost of producingThe nth product, minus the cost of producing the n-1 product

The net return on that asset or activity under its (next) best use

Economic Cost = period expenditures – sunk cost + opportunity cost

A cost that can’t be recovered or changed for the period in question

Cost Allocation – How do we do it?

Always Ask: decision time horizon shut down vs. + quantity decision sunk vs. not direct vs. not fixed vs. variable

How do we allocate Marketing?

Labor?

Equipment?

without a loan (maintenance, cost of capital, and depreciation (if any))

with a loan (maintenance, interest (but not principal), and depreciation (if any))

No real difference. Interest = cost of capital = opportunity cost of the value locked in the asset

The Production Decision

When do we produce one more unit of a product?

When do we shut down the production of a given product line?

When do we shut down the firm?

Produce an additional unit as long as marginal cost is less than marginal revenue

If all expenses that can be eliminated AND are caused by the line’s production exceedrevenue attributed to the product line, stop producing the product lineAKA: average cost exceeds average revenue >> SHUT DOWN LINE

PS #2 / Question #1

Part (a) What are the annual economic costs of operation?

Building is a sunk cost, why?

According to problem, building is already been depreciated as well

Total economics costs = $16mm (labor) + $20mm (packing / shipping)

Part (b) economic costs of each of the four lines?

Remember calculate the actual costs, not some proxy

$20mm (packing/shipping) / 5 mm units = $4 (problem assumes costs are same)

Puzzles costs = $4mm + (1mm * $4) = $8mm (same for Teddies, Dolls)

Guns costs = $4mm + (2mm * $4) = $12mm

Part (c) shut down guns…accounting allocation leads to wrong answers

List the costs….

Rental $600k ($50k/month * 12)

Interest Cost $240k (6%*4,000k)

Depreciation and Maintenance $80k

Materials $1,000k

Labor $800k

Utilities $280k

Total: $3,000k

What about the $940k of profits?

Those are already expected. All the costs we identified above are the additional costs. So additional revenue has to exceed additional costs to increase profits.

PS #2 / Question #2

PS #2, Question #2

In math terms:

PS #2, Question #3

Part (a), should you accept a $20k / year rental offer?

$100k of revenue (100k calls * $1) LESS $25k of overhead costs and LESS $45k of variable costs (100k calls * $0.45) = $30,000

Therefore, we should not lease out the building since $20k in lease payments are less than $30k in profits we make

What is the minimum we should accept lease-wise? What if we had financed our building?

What is the minimum we should sell our property for

Just like calculating a perpetual bond

2008 Midterm #2

2008 Midterm #2

Should FIFO stop serving breakfast? Are costs above revenue?

What are the costs?

Food $600

Labor (other direct costs): $4,800

Licensing fees $0.20 * 2,400*.5= $240

Other overhead?

What are the revenues?

$7,200

Recommendation?

Breakfast makes a marginal profit of $1,560

Fix the accounting system

Questions on anything else?

Next section: Demand and Pricing…