Everything in this chapter consists of applications of one simple but powerful idea. Only those costs and benefits that differ between alternatives are relevant in a decision. All other costs and benefits are irrelevant and should be ignored. In particular, sunk costs are irrelevant as are future costs that do not differ between alternatives.
This simple idea was applied in a variety of situations including decisions that involve making or buying a component, adding or dropping a product line, accepting or rejecting a special order, processing a joint product further, and using a constrained resource. This list includes only a small sample of the possible applications of the relevant cost concept. Indeed, any decision involving costs hinges on the proper identification and analysis of the costs that are relevant. We will continue to focus on the concept of relevant costs in the following chapter where long-run investment decisions are considered.
In this chapter, the following learning objectives will be covered:
Identify relevant and irrelevant costs and benefits in a decision.
Prepare an analysis showing whether a product line or other business segment should be dropped or retained.
Prepare a make or buy analysis.
Prepare an analysis showing whether a special order should be accepted.
Determine the most profitable use of a constrained resource and the value of obtaining more of the constrained resource.
Prepare an analysis showing whether joint products should be sold at the split-off point or processed further.