Relevant Costs and Revenues

Managers often must choose between alternative courses of action in decision-making.
Interest lies in understanding the differences between alternatives, both financial and non-financial.
Focus on financial decisions involving costs and revenues through relevant-cost analysis.
Relevant-cost analysis enables managers to perform comparisons between alternatives.

Contribution Margin:
- Defined as sales revenue – variable costs.
Fixed Costs:
- Include fixed overhead and fixed marketing & administrative expenses.
Managers typically have more control over contribution margin than fixed costs, meaning they can adjust sales prices, sales volumes, and variable costs more easily than fixed costs.
Altering fixed costs is still possible but less controllable.
Relevant-cost analysis is applied in scenarios such as:
- Accepting special orders.
- Continuing or discontinuing services.
- Pricing strategies for products and services.

Identifying all costs and revenues that differ between actions is crucial.
The alternative yielding the best bottom-line profit (operating profit) should be chosen.

Case Study: Harbor View Bistro
- Operates two dining services: Lunch and Dinner.
- Revenue and costs (in thousands) for the past year are summarized as follows:
- Total Revenue:
  - Lunch Service: $850
  - Dinner Service: $1,300
  - Overall: $2,150
- Operating Costs:
  - Food & Labor (Variable): Lunch - $720, Dinner - $1,040, Total: $1,760
  - Rent, Salaries & General Overhead (Fixed): Total $280
  - Total Operating Costs:
  - Lunch: $880
  - Dinner: $1,160
  - Overall: $2,040
- Operating Profit (loss):
  - Lunch: $(30)
  - Dinner: $140
  - Overall: $110
Decision: Should Lunch Service be discontinued?
- Key understanding hinges on recognizing that fixed costs generally will not change.
- If Lunch Service was dropped, the contribution margin related to Lunch would be lost only.

Analysis relates to changes in contribution margins and fixed costs:
- Contribution Margin for Current State:
- Lunch: $850 - $720 = $130
- Dinner: $1,300 - $1,040 = $260
- Fixed Costs:
- Remain the same at $280.
- Impacts:
- Operating profit would decrease by $130,000 if Lunch Service is dropped (analysis based on contribution margin).

If dropping Lunch Service also saves $8,000 in salaries, calculate new impact.
If considering adding a Breakfast Service:
- Expected Revenue: $800, Variable Costs: $715, Fixed Costs: $25.
- New net impact calculated as follows:
  - Increase in income = $800 - $715 - $25 = $60

Produces stainless-steel water bottles, with projected figures before any special orders:
- Sales Revenue: $15,000,000
- Manufacturing Costs: $10,500,000
- Gross Profit: $4,500,000
- Marketing Costs: $1,500,000
- Operating Profit: $3,000,000
Fixed Costs consist of $5,000,000 in manufacturing and $600,000 in marketing, these remain unchanged upon accepting new orders.
EcoBottle has idle capacity to take on a special order for 60,000 bottles at $14 each.
This impacts contribution margin without affecting fixed costs:
- Contribution Margin (CM) Impact:
- Sale of 60,000 units at $14 = $840,000
- Variable Manufacturing Cost per unit on existing products = $11/unit
- Total Incremental Contribution Margin from special order: $ ext{Total CM} = $840,000 - 660,000 = $180,000$
EcoBottle should accept the special order since it increases operating profit by $180,000.

Minimum Acceptable Selling Price?
If fixed costs increase by $50,000 upon accepting the order, recalculate:
- Operating profit changes to $180,000 - $50,000 = $130,000.
If 15,000 units of regular sales are lost due to the order, impact as:
- $180,000 Gain in CM - $258,000 Loss in regular sales = total decrease in operating profit of $78,000.

Scenario: Should you continue making a product component or buy from an external supplier?
Analyze variable manufacturing costs versus outsource costs.
Case Study: VoltRide Mobility
- Annual production: 40,000 battery modules.
- Manufacturing costs:
- Direct Materials: $1,000,000
- Direct Labor: $520,000
- Variable Manufacturing Overhead: $320,000
- Fixed Manufacturing Overhead: $360,000
- Total Costs: $2,200,000.
External Supplier Offers Cost: $48/unit.
Total outsourcing cost calculated as:
- Cost of purchasing = $1,920,000.
- Savings noted from not needing variable costs leads to a loss of $80,000 if transitioned to buying modules, hence continuing to manufacture is advisable.
If VoltRide buys the modules and repurposes production for fast chargers making $3.60 per unit CM capable of producing 30,000 chargers:
- Analyze total contribution margin gain:
- Purchase cost savings vs. opportunity cost from new production output.

Case Study: Sweet Valley Orchards
- Processes joint products:** Fresh Apples, Apple Cider, and Apple Sauce**.
Selling prices and costs following the split-off:
- Anticipated Production:
- Apples: 10,000 lbs at $14 for 5 lbs; additional processing costs: $6 produce $22 selling price after processing.
- Cider: 8,000 lbs at $10; $8 additional to sell for $20.
- Sauce: 6,000 lbs at $6; $4 additional to sell for $12.
Incremental Value Calculation:
- Apples profit further processing: $16
- Cider profit: $12
- Sauce profit: $8
Sweet Valley should process all products further since each scenario yields added value.

Often, fixed costs are allocated but not necessarily relevant for decision-making.
Sunk Costs: Costs that have already been incurred and cannot be recovered; irrelevant for future decisions.
Relevant costs include variable marketing and administration costs.
Depreciation is generally not relevant unless pertaining to new asset addition.