Recommend a Course of Action in Outsourcing (Relevant Cost)

Recommend a Course of Action in Outsourcing (Relevant Cost)
Intermediate Cost Analysis and Management

What will influence your decision?
Two cars: same model, same price, same engine, same features and accessories, same financing Introduction The types of things that would normally affect a decision to purchase a car are: Purchase price Operating cost (gas mileage, maintenance and repairs, insurance) Purchase terms Features and accessories When all of these things are the same, they become irrelevant to the decision. If the two cars are truly the same (model, price, engine, accessories, financing) then the only difference that would affect your decision is the color. Do you like red better, or green? Someone might bring up the idea that red cars get more tickets or that insurance premiums for red cars are higher. If this is true, then that would be relevant to the decision. One of the most important considerations in a cost analysis is deciding what costs are relevant to the decision.

Terminal Learning Objective
Task: Recommend A Course of Action in Outsourcing and Keep or Replace Decisions. Condition: You are training to become an ACE with access to ICAM course handouts, readings, and spreadsheet tools and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors Standard: With at least 80% accuracy: Explain relevant costs Identify relevant costs in an outsourcing decision Identify relevant costs in a keep-or-replace decision Introduction Task: Recommend a course of action in outsourcing and keep or replace decisions. Condition: You are a cost advisor technician with access to all regulations/course handouts, and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors. Standard: With at least 80% accuracy: Explain relevant costs Identify relevant costs in an outsourcing decision Identify relevant costs in a keep-or-replace decision

What is Relevant? Synonyms for relevant: pertinent, applicable, related, appropriate, significant, important We have access to more information than ever Not every piece of information is pertinent, applicable, or related to a decision Example: fuel economy on new car models is not pertinent to a decision about whether to pursue your Master’s degree Activity step 1 Explain relevant costs 1. Synonyms for relevant: pertinent, applicable, related, appropriate, significant, important 2. We have access to more information than ever 3. Not every piece of information is pertinent, applicable, or related to a decision 4. Example: fuel economy on new car models is not pertinent to a decision about whether to pursue your Master’s degree What information might be pertinent to such a decision?

What is Relevant? Some pieces of information can be easily dismissed as unrelated or irrelevant Other times it is more difficult to determine what is appropriate, significant, or important to the decision Especially when the information is printed on an official report from the accounting system Remember that the accounting system measures according to external requirements Activity step 1 Explain relevant costs 1. Some pieces of information can be easily dismissed as unrelated or irrelevant 2. Other times it is more difficult to determine what is appropriate, significant, or important to the decision 3. Especially when the information is printed on an official report from the accounting system 4. Remember that the accounting system measures according to external requirements

What is Relevant? Relevant costs are those costs that change as a result of a decision Identify the decision at hand Choice between two Courses of Action (COA) Frequently one of the options is status quo Identify related costs Which costs are the same for both courses of action? Which will change? Activity step 1 Explain relevant costs 1. Relevant costs are those costs that change as a result of a decision 2. Identify the decision at hand a. Choice between two Courses of Action b. Frequently one of the options is status quo 3. Identify related costs 4. Which costs are the same for both courses of action? Which will change?

Cost Definitions Acquisition cost – all costs related to purchasing an asset and placing it into service Operating cost – all costs related to operating an asset Opportunity cost – the value of what is given up when choosing a particular course of action Sunk cost – costs incurred in the past that cannot be recovered Incremental cost – the additional cost incurred as the result of a decision Activity step 1 Explain relevant costs 1. Acquisition cost – all costs related to purchasing an asset and placing it into service a. Include purchase price, shipping, installation, sales tax, etc. 2. Operating cost – all costs related to operating an asset a. include labor to operate, fuel or utilities, supplies, etc. 3. Opportunity cost – the value of what is given up when choosing a particular course of action a. Examples? What did you give up to be here today? 4. Sunk cost – costs incurred in the past that cannot be recovered a. include the original acquisition cost of an asset to be replaced 5. Incremental cost – the additional cost incurred as the result of a decision a. Example: if we take on additional business, we will incur additional variable costs.

Cost Definitions Avoidable cost – cost we currently incur that would be eliminated or avoided by choosing another course of action Unavoidable cost – cost we currently incur that would NOT be eliminated or avoided by choosing another course of action Activity step 1 Explain relevant costs 1. Avoidable cost – cost we currently incur that would be eliminated or avoided by choosing another course of action a. Example: If we outsource a function, we will avoid the variable costs for that function such as labor and supplies 2. Unavoidable cost – cost we currently incur that would NOT be eliminated or avoided by choosing another course of action a. Example: If we outsource a function, we will NOT avoid the fixed costs of that function.

Classic Relevant Cost Problems
Outsourcing – Should we provide this service in-house or purchase from a contractor? Keep or replace – Should we keep the equipment we have or replace with more efficient equipment? These are the two most applicable to government entities Activity step 1 Explain relevant costs 1. Outsourcing – Should we provide this service in-house or purchase from a contractor? 2. Keep or replace – Should we keep the equipment we have or replace with more efficient equipment? 3. These are the two most applicable to government entities

Classic Relevant Cost Problems
Additional business at reduced price – Should we accept or reject additional business at a reduced price? Scrap or re-work – Should we invest additional resources to bring the item up to standards or cut our losses? While less common, these also have government applications Activity step 1 Explain relevant costs 1. Additional business at reduced price – Should we accept or reject additional business at a reduced price? 2. Scrap or re-work – Should we invest additional resources to bring the item up to standards or cut our losses? 3. While less common, these also have government applications. Additional business at reduced price would be applicable to revolving funds or Non-appropriated funding organizations.

A Template for Organizing the Data
Based on the Statement of Activities Item COA #1 COA #2 Δ Revenue or Benefit Revenue COA #1 Revenue COA #2 #2 - #1 Related Cost A Cost A from Related Cost B Cost B from Net Change (Rev – Cost) Rev – Costs Activity step 1 Explain relevant costs 1. Based on the Statement of Activities: Revenues – Costs = Net Change We will side-by-side compare the alternative courses of action, and note the difference between them as the “delta”

Based on the Statement of Activities Item COA #1 COA #2 Δ Revenue or Benefit Revenue COA #1 Revenue COA #2 #2 - #1 Related Cost A Cost A from Related Cost B Cost B from Net Change (Rev – Cost) Rev – Costs COA #1 may be the status quo Activity step 1 Explain relevant costs 1. The headings are: a. Item (may be a revenue or a cost) b. COA #1, which may represent the status quo (keep current equipment, continue to provide a service in-house, etc.) c. COA #2, the other alternative (replace equipment or outsource a service) d. Δ (Delta) represents the difference between the two or the change from choosing COA #2 over COA #1. This column will reflect the RELEVANT costs.

Based on the Statement of Activities Item COA #1 COA #2 Δ Revenue or Benefit Revenue COA #1 Revenue COA #2 #2 - #1 Related Cost A Cost A from Related Cost B Cost B from Net Change (Rev – Cost) Rev – Costs Define revenues or quantifiable benefits from each COA Activity step 1 Explain relevant costs Not all Courses of Action will have revenues or quantifiable benefits. Ignore non-quantifiable benefits. They will be discussed later.

Based on the Statement of Activities Item COA #1 COA #2 Δ Revenue or Benefit Revenue COA #1 Revenue COA #2 #2 - #1 Related Cost A Cost A from Related Cost B Cost B from Net Change (Rev – Cost) Rev – Costs Express Δ as Favorable or (Unfavorable) Activity step 1 Explain relevant costs Express Δ as Favorable or (Unfavorable) Favorable differences are those that would INCREASE the net change. More revenue is GOOD or favorable. Less cost is favorable. b. Unfavorable differences would DECREASE the net change. More cost is BAD or unfavorable. Less revenue is unfavorable.

Based on the Statement of Activities Item COA #1 COA #2 Δ Revenue or Benefit Revenue COA #1 Revenue COA #2 #2 - #1 Related Cost A Cost A from Related Cost B Cost B from Net Change (Rev – Cost) Rev – Costs If the item is the same for COA #1 and COA #2 the Δ will be -0- indicating the item is irrelevant to the decision Activity step 1 Explain relevant costs If the item is the same for COA #1 and COA #2 the Δ will be -0- indicating the item is irrelevant to the decision

Learning Check How are relevant costs defined?
How does the table format help to identify irrelevant costs? Q. How are relevant costs defined? A. Costs that change as the result of a decision Q. How does the table format help to identify irrelevant costs? A. By listing all related costs in the three-column format, it’s very easy to identify costs that do not change and are therefore irrelevant.

Outsourcing Decision: Outsource HR function for $200,000 per year or keep in-house? Direct labor cost = four $50,000 per employee annually Two would be laid off, two would be transferred to another command Unemployment taxes would increase $10,000 per year due to the layoffs Facilities and equipment cost = $35,000 per year Would remain idle Other operating costs = $15,000 per year Would be eliminated Activity step 2 Identify relevant costs in an outsourcing decision 1. Decision: Outsource HR function for $200,000 per year or keep in-house? 2. Direct labor cost = four $50,000 per employee annually a. Two would be laid off, two would be transferred to another command b. Unemployment taxes would increase $10,000 per year due to the layoffs 3. Facilities and equipment cost = $35,000 per year - Would remain idle 4. Other operating costs = $15,000 per year - Would be eliminated

Outsourcing Item In-house Outsource Δ Revenue or Benefit -0-
Direct labor $200,000 Cost of HR contract (200,000) Unemployment tax 10,000 (10,000) Facilities/Equipment 35,000 Other operating cost 15,000 Net Change -250,000 -245,000 5,000 Activity step 2 Identify relevant costs in an outsourcing decision Students will have the blank slide. We will go over each line item and they can fill out their table as you

Direct labor $200,000 Cost of HR contract (200,000) Unemployment tax 10,000 (10,000) Facilities/Equipment 35,000 Other operating cost 15,000 Net Change -250,000 -245,000 5,000 Activity step 2 Identify relevant costs in an outsourcing decision Direct labor will be eliminated by outsourcing. a. Two employees will be laid off (and hopefully hired by the contractor!) and two will be transferred to another command, eliminating the cost from our books. 2. This is shown in the delta column as $200,000 favorable.

Direct labor $200,000 Cost of HR contract (200,000) Unemployment tax 10,000 (10,000) Facilities/Equipment 35,000 Other operating cost 15,000 Net Change -250,000 -245,000 5,000 Activity step 2 Identify relevant costs in an outsourcing decision 1. The cost of the HR contract is $200,000. 2. If we choose to keep the function in-house, we will avoid this cost. This is shown as an unfavorable delta ($200,000) . a. Remember to use parentheses to identify unfavorable deltas.

Direct labor $200,000 Cost of HR contract (200,000) Unemployment tax 10,000 (10,000) Facilities/Equipment 35,000 Other operating cost 15,000 Net Change -250,000 -245,000 5,000 Activity step 2 Identify relevant costs in an outsourcing decision The increase in unemployment tax from laying off employees is $10,000. If we choose to keep the function in-house, we will avoid this cost. This is shown as an unfavorable delta. ($10,000)

Direct labor $200,000 Cost of HR contract (200,000) Unemployment tax 10,000 (10,000) Facilities/Equipment 35,000 Other operating cost 15,000 Net Change -250,000 -245,000 5,000 Activity step 2 Identify relevant costs in an outsourcing decision The facilities and equipment will remain idle. This is a cost of $35,000 per year that is unavoidable. We may have a long-term lease that can’t be cancelled. Since this cost will be incurred regardless of which course of action we choose, this cost is considered irrelevant. Unavoidable costs, by definition, are irrelevant. If we could find another use for the facilities and equipment and charge the cost to that program, we could then consider this an avoidable, and therefore relevant, cost.

Direct labor $200,000 Cost of HR contract (200,000) Unemployment tax 10,000 (10,000) Facilities/Equipment 35,000 Other operating cost 15,000 Net Change -250,000 -245,000 5,000 Activity step 2 Identify relevant costs in an outsourcing decision The other operating costs will be eliminated, therefore are shown as a 15,000 favorable delta.

Direct labor $200,000 Cost of HR contract (200,000) Unemployment tax 10,000 (10,000) Facilities/Equipment 35,000 Other operating cost 15,000 Net Change -250,000 -245,000 5,000 Activity step 2 Identify relevant costs in an outsourcing decision Finally, the net change. The net change from in-house operations is -250,000. (revenue of zero minus all costs). The net change from outsourcing is -245,000 (revenue of zero minus all costs). The delta is 5,000 favorable.

Direct labor $200,000 Cost of HR contract (200,000) Unemployment tax 10,000 (10,000) Facilities/Equipment 35,000 Other operating cost 15,000 Net Change -250,000 -245,000 5,000 Activity step 2 Identify relevant costs in an outsourcing decision Notice that, if you treat the unfavorable deltas as negative numbers and favorable deltas as positives, the sum of all deltas is equal to the delta for the net change. 2.+200,000 – 200, , ,000 = 5000 3. We say that this “foots” (accounting term for summing a column of numbers) and “cross-foots” (accounting term for summing a row of numbers). This is also a way of checking your work.

Outsourcing Conclusions
Going strictly by the numbers, we would save $5,000 by outsourcing What else should we consider? Are there non-quantifiable benefits from keeping the function in-house? From outsourcing? What if the cost of facilities and equipment increases? Would that change our decision? Activity step 2 Identify relevant costs in an outsourcing decision 1. Going strictly by the numbers, we would save $5,000 by outsourcing. A favorable overall delta means that outsourcing is the favorable course of action. 2. What else should we consider? Frequently there are non-quantifiable (or qualitative) issues to consider. 3. Are there non-quantifiable benefits from keeping the function in-house? From outsourcing? Perhaps we want to hold on to valued employees. Can you think of any others qualitative issues? 4. What if the cost of facilities and equipment increases? Would that change our decision? Since facilities and equipment are irrelevant, meaning they will not change as a result of the decision, it doesn’t matter if the cost of the facilities and equipment increases (or decreases, for that matter.) If the cost will not be avoided through outsourcing, it is not relevant to the decision.

Learning Check Which costs are irrelevant in outsourcing decisions?
How are unfavorable deltas identified? Q. Which costs are irrelevant in outsourcing decisions? A. Unavoidable costs are irrelevant, because they will not change as the result of the decision. Fixed costs are usually irrelevant. Q. How are unfavorable deltas identified? A. They should be identified in brackets

Keep or Replace Your command recently purchased a machine for $50,000. The annual operating cost of the machine is $100,000. An alternative machine to perform the same function has just become available. The new machine costs $70,000 and costs $75,000 per year to operate. We could sell the “old” machine today for $10,000 salvage. Either machine would have a useful life of three years from today, and would produce no revenues. Activity step 3 Identify relevant costs in a keep-or-replace decision 1. Your command recently purchased a machine for $50,000. The annual operating cost of the machine is $100,000. 2. An alternative machine to perform the same function has just become available. The new machine costs $70,000 and costs $75,000 per year to operate. 3. Either machine would have a useful life of three years from today, and would produce no revenues.

Keep or Replace Decision: Replace Old Machine with More Efficient New Machine? Item Keep Replace Δ Salvage of old (benefit) -0- $10,000 Cost of Old (Sunk) $50,000 50,000 Cost of New 70,000 (70,000) Operating Costs 3 yrs 300,000 225,000 75,000 Net Change -350,000 -335,000 15,000 Activity step 3 Identify relevant costs in a keep-or-replace decision 1. Students will have the blank slide. Give them time to fill in the blanks as you step through the table line by line. 2. Here is the completed table. We will discuss each line item.

Keep or Replace Decision: Replace Old Machine with More Efficient New Machine? Item Keep Replace Δ Salvage of old machine (benefit) -0- $10,000 Cost of Old (Sunk) $50,000 50,000 Cost of New 70,000 (70,000) Operating Costs 3 yrs 300,000 225,000 75,000 Net Change -350,000 -335,000 15,000 Activity step 3 Identify relevant costs in a keep-or-replace decision Even though neither machine produces revenue, the salvage value of the old machine is a benefit and is relevant. We would not receive this cash inflow if we kept the old machine. It is 10,000 favorable.

Keep or Replace Decision: Replace Old Machine with More Efficient New Machine? Item Keep Replace Δ Salvage of old (benefit) -0- $10,000 Cost of Old (Sunk) $50,000 50,000 Cost of New 70,000 (70,000) Operating Costs 3 yrs 300,000 225,000 75,000 Net Change -350,000 -335,000 15,000 Activity step 3 Identify relevant costs in a keep-or-replace decision The cost of the old machine is a sunk cost. That is, we will not recover it. Sunk costs, by definition, are irrelevant.

Keep or Replace Decision: Replace Old Machine with More Efficient New Machine? Item Keep Replace Δ Salvage of old (benefit) -0- $10,000 Cost of Old (Sunk) $50,000 50,000 Cost of New 70,000 (70,000) Operating Costs 3 yrs 300,000 225,000 75,000 Net Change -350,000 -335,000 15,000 Activity step 3 Identify relevant costs in a keep-or-replace decision The cost of the new machine is, of course relevant. We would not incur this cost if we kept the old machine. It is 70,000 unfavorable.

Keep or Replace Decision: Replace Old Machine with More Efficient New Machine? Item Keep Replace Δ Salvage of old (benefit) -0- $10,000 Cost of Old (Sunk) $50,000 50,000 Cost of New 70,000 (70,000) Operating Costs 3 yrs 300,000 225,000 75,000 Net Change -350,000 -335,000 15,000 Activity step 3 Identify relevant costs in a keep-or-replace decision The operating costs are relevant, as they will change if we purchase the new machine. Over three years, this is 75,000 favorable. (ignoring time value of money, which we will address on day 7).

Keep or Replace Decision: Replace Old Machine with More Efficient New Machine? Item Keep Replace Δ Salvage of old (benefit) -0- $10,000 Cost of Old (Sunk) $50,000 50,000 Cost of New 70,000 (70,000) Operating Costs 3 yrs 300,000 225,000 75,000 Net Change -350,000 -335,000 15,000 Activity step 3 Identify relevant costs in a keep-or-replace decision The net change from keeping the old machine is -350,000 and the net change from purchasing the new machine is -335,000, for a delta of 15,000 favorable. Notice that the delta column foots and cross-foots.

Keep or Replace Conclusions
Replacing the “old” machine will save $15,000 over the three-year period What else should be considered? Any qualitative factors? What if the projected operating costs of the new machine are overly optimistic? What if the actual operating costs are $80,000 per year? $85,000? How would that change our decision? Activity step 3 Identify relevant costs in a keep-or-replace decision 1. Replacing the “old” machine will save $15,000 over the three-year period (again, ignoring time value of money, which we will cover on Day 7). Remember that our “old” machine was only recently purchased. Even so, the savings in operating costs justify purchasing the new machine. 2. What else should be considered? Any qualitative factors? These can vary. Some managers may consider replacing such a recently purchased machine to indicate a poor decision in the first place. They may see this as a loss of face. Can you think of any others? (such as, it may not be environmentally desirable to dispose of the machine.) 3. What if the projected operating costs of the new machine are overly optimistic? What if the actual operating costs are $80,000 per year? $85,000? How would that change our decision? An increase in costs of just $5000 per year makes the new machine a wash. If the actual costs turn out to be $85,000 per year, we would be better off keeping the old machine. Our decision hinges on this estimate.

Learning Check Which costs are always irrelevant in keep or replace decisions? Q. Which costs are irrelevant in outsourcing decisions? A. Sunk costs – the original acquisition cost of the machine.

Additional Business, Reduced Price
The dining hall can serve 200 for breakfast, but averages only 40 on weekends. Daily fixed costs for the morning shift (three employees for four hours, plus cost of facilities) are $500, and variable costs are $2 per breakfast. The regular price for breakfast is $5. A local community service group would like to use the dining hall on Sunday mornings for their meetings. They would pay $3 per person for breakfast. Average attendance at meetings is 75. Activity Step 4: Other relevant cost decisions 1. Here is an example of additional business at a reduced price that applies to military organizations: 2. The dining hall can serve 200 for breakfast, but averages only 40 on weekends. 3. Daily fixed costs for the morning shift (three employees for four hours, plus cost of facilities) are $500, and variable costs are $2 per breakfast. The regular price for breakfast is $5. 4. A local community service group would like to use the dining hall on Sunday mornings for their meetings. They would pay $3 per person for breakfast. Average attendance at meetings is 75.

Item Status Quo With Additional Δ Breakfast sales $5 $200 $5 + $3 $425 $225 Variable Costs $2 80 $2 230 (150) Fixed Costs 500 -0- Net Change -380 -305 75 Activity Step 4: Other relevant cost decisions Here is the table. We will go over item by item on the next slides.

Item Status Quo With Additional Δ Breakfast sales $5 $200 $5 + $3 $425 $225 Variable Costs $2 80 $2 230 (150) Fixed Costs 500 -0- Net Change -380 -305 75 Activity Step 4: Other relevant cost decisions The additional revenue from accepting the additional business at the reduced price is $225. That is equal to 75 breakfasts at $3. This is known as incremental revenue, the increase in revenue due to the additional business.

Item Status Quo With Additional Δ Breakfast sales $5 $200 $5 + $3 $425 $225 Variable Costs $2 80 $2 230 (150) Fixed Costs 500 -0- Net Change -380 -305 75 Activity Step 4: Other relevant cost decisions Variable costs will also increase, which is unfavorable. The delta is $150, which is equal to 75 breakfasts at $2 variable cost per breakfast. This is the incremental cost, the increase in cost due to the additional business.

Item Status Quo With Additional Δ Breakfast sales $5 $200 $5 + $3 $425 $225 Variable Costs $2 80 $2 230 (150) Fixed Costs 500 -0- Net Change -380 -305 75 Activity Step 4: Other relevant cost decisions Fixed costs will not change. Fixed costs, by definition, do not change as number of units increases or decreases. We will still have to have the three employees (cook, server, dishwasher) and the use of the facilities. Therefore the delta is zero. The fixed costs are not relevant to our decision.

Item Status Quo With Additional Δ Breakfast sales $5 $200 $5 + $3 $425 $225 Variable Costs $2 80 $2 230 (150) Fixed Costs 500 -0- Net Change -380 -305 75 Activity Step 4: Other relevant cost decisions Where we were in a net loss of $380 before, we improve to a net loss of $305.

Assumptions: Excess capacity exists Proposed business will not detract from regular business Rules of thumb: As long as incremental revenue exceeds incremental cost, additional business is desirable Fixed costs are irrelevant Activity Step 4: Other relevant cost decisions 1. Assumptions: a. Excess Capacity Exists – in this case we have plenty of room to bring in the additional customers from the community group. b. Proposed Business will not Detract from Regular Business. There is no overlap between the community group and our regular customer base. 2. Rules of thumb: a. As long as incremental revenue exceeds incremental cost, additional business is desirable Fixed costs are irrelevant

What else should the dining hall management consider? Activity Step 4: Other relevant cost decisions What else should the dining hall management consider? Potential questions might be: a. Will the community group’s meeting disturb regular full-price customers? b. Is there any way to reduce fixed cost in the long run? c. Should regular breakfast prices be increased? d. Should the dining hall close altogether on weekends? 2. Are there intangible benefits of building a relationship with the community service group? Others? 3. Note that, assuming that the dining hall does not have the option of closing on the weekends, the loss of $305 is preferable to the loss of $380.

Scrap or Rework Should we sell an inferior product as scrap or invest the necessary resources to make the product salable? This has application to military in the area of training Should we discharge individuals who fail basic training or re-train? Activity Step 4: Other relevant cost decisions 1. Should we sell an inferior product as scrap or invest the necessary resources to make the product salable? 2. This has application to military in the area of training. Should we discharge individuals who fail basic training or re-train?

Discharge or Re-train Item Discharge Re-train Δ Benefit of trained soldier -0- X Cost of Basic Training Y Cost of Re-training Z (Z) Net Change -Y X – Y – Z X – Z Activity Step 4: Other relevant cost decisions We have not attempted to quantify the benefit of a trained soldier, but we can say for sure that there is no benefit to be received from a discharged soldier. Therefore the benefit of the trained soldier is a favorable delta “X”. If X (benefit of trained soldier) is greater than Z (cost to re-train) then re-training is desirable.

Cost of Basic training is a Sunk Cost and therefore irrelevant
Discharge or Re-train Item Discharge Re-train Δ Benefit of trained soldier -0- X Cost of Basic Training Y Cost of Re-training Z (Z) Net Change -Y X – Y – Z X – Z Cost of Basic training is a Sunk Cost and therefore irrelevant Activity Step 4: Other relevant cost decisions 1. We have also not attempted to quantify the cost of basic training, although that doesn’t really matter because it is a sunk cost, which is irrelevant. We have already invested this cost, and will not get it back if we discharge the soldier or if we re-train. 2. We also did not attempt to quantify the cost of re-training. This may differ with each individual. What is important to note is that the decision comes down to this: a. Is the benefit of the trained soldier greater than the cost to re-train the soldier? 1. If the answer is yes, then it is desirable to re-train. 2. If the answer is no, then it is not desirable to re-train. 3. The one thing that should NOT be considered in the decision is the investment in the soldier’s training to-date. That is a sunk cost, and is irrelevant. If X (benefit of trained soldier) is greater than Z (cost to re-train) then re-training is desirable.

Learning Check Which costs are irrelevant in deciding whether to accept additional business at a reduced price? What is the rule of thumb? Q. Which costs are irrelevant in deciding whether to accept additional business at a reduced price? A. Fixed costs. They will not change with the additional business. Q. What is the rule of thumb? A. If incremental revenue is greater than incremental cost, we should accept the business.

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Recommend a Course of Action in Outsourcing (Relevant Cost)

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