HW 10 - Bolero

[Adi A]

Hi all,

What do I do when there are several options that are opportunity cost?
This is relevant for material D in Bolero and for the leather book
question.
Do we have to add them, or maybe choose the highest?

Adi.

[Sam]

I just started the problem but here is what I have so far for costs on
Bolero:

Cost to purchase material A for the job $16,000
Cost to purchase additional material B for the job (400 x $15) $6,000
Cost to purchase additional material C for the job (300 x $14) $4,200
Opportunity cost of using in-stock material B that must be replaced
(600 x $15) $9,000
Opportunity cost of using in-stock material D when it could be used in
place of E (300 x $15) $4,500
Total Relevant Costs: $39,700

[Sam]

For material D, I am looking at it from the perspective of what the
opportunity cost will be if they accept the job, so the opportunity
cost would come in the form of having to buy material E for the other
job at a cost of 300 units x $15/unit = $4500.

-Sam

[Adi Aloni]

What about opportunity cost of selling materials C and D and get market
price for them (replacement cost)?

[Sam]

The way I see it, Bolero is in the business of buying materials to
manufacture stuff, they are not a materials dealer, so I wouldn't
consider that an opportunity cost since it is not really an option for
them. I think it would be like McDonald's selling pickles instead of
putting them on burgers. The current inventories of C and D are sunk
costs and are sitting on a shelf, so the choice is either to use them
in this job, or wait for another job to come along and use them (D
could be used in place of E, but C has no readily apparent use).

I may be wrong about all this, but that's just how I understand it
from Heineke's lecture.

[Sam]

Adi,

I think we only choose the highest value alternative when counting
opportunity costs, which is what he says on slide 5 of the slides he
went over in class last week (Costs For Business Decisions).

I'm still stuck on the leather book problem though. The leather was
purchased years ago for and is just sitting there, so I think it is a
sunk cost and irrelevant for all of the options. With that, I think
the opportunity cost of either the chairs or selling the leather
depend on their revenues, not on the cost avoided buying leather for
the chairs. This is where I get stuck...

-Sam

[Carla Nunes]

Thanks for starting this thread.  I got same answer for part 1 (Bolero).

For leather case, this is what I will put:

$1000  - sunk cost

So, the cost of the leather for the book project is the opportunity cost of either using the leather to cover the chairs ($900) or selling it ($800).  Since the cost to cover the chairs w/ an alternative material is higher than the cost to sell the leather, the cost of the leather to the book project is $900.

[Adi Aloni]

The textbook defines opportunity cost as “the next best alternative” so I guess we indeed have to choose the highest value opportunity.

 

The following link says it in a very clear way: “When economists refer to the “opportunity cost” of a resource, they mean the value of the next-highest-valued alternative use of that resource”

http://www.econlib.org/library/Enc/OpportunityCost.html

 

 

From: econ_401_w...@googlegroups.com [mailto:econ_401_w...@googlegroups.com] On Behalf Of Carla Nunes
Sent: Thursday, February 24, 2011 11:06 PM
To: econ_401_w...@googlegroups.com
Cc: Sam
Subject: Re: HW 10 - Bolero

 

Thanks for starting this thread.  I got same answer for part 1 (Bolero).

[Ted_Li]

You assume the next best use of the resource. In Bolero D, you can see
200x19=3800 and 300x15=4500, comparing the two, you know you need to
select the 3800 since 4500 is for material E, it's not relevant to
your decision making here. In another hand, you would use the lowest
cost possible in any case (even considering E). So 3800 should be
used, not 4500 to calculate the relevant cost.

The leather case is similar. If you don't do book, you could use it
for chair which save you $900, this is your opp cost to book binding.
In this case, Relevant cost = implicit opp cost (since there is no
explicit opp cost). $900 should be your answer.

Ted

[alex smirnov]

Hey All,

I went to the review session:

My understanding of the Bolera problem is:

A: 1000*16

B: 1000*15 - the resource is regularly used, so that's the cost of replacing it (or you can think of it as 400*15 in direct costs plus 600*15 in opportunity cost

C: 300*13

D: 200*19 (this isn't like choosing the best alternative.  Your cost for this project is the lower of the two (200*29 vs 300*15)

Books:

$900 seems like the right answer:

Adv Tech:

a. All the costs are relevant except $6k (difference between $24k book cost and 18k market cost) - $1,193k

b. 1,193k-480 = 713k (because opportunity cost for an under-utilized factory is no longer there)

c. 1400k-1193k = 207k (part a)

    1400-713k = 687k (part b)

[Sam]

Alex, for ATI part a.

Why would Overhead and Required Profit Margin be relevant economic
costs? These costs are there whether or not they accept the job so
should they be counted in the decision of whether to take the job or
not?

-Sam

[Sam]

Nevermind. When I re-read part b about an under-utilized factory,
part a made sense. Thanks.

[alex smirnov]

and there I was drafting a lengthy response  ;)

I think it makes sense this way, but I could be wrong.

[Sam]

Yes it makes sense. What don't make sense are his long notes about
notes at the end of each problem... More confusing than helpful.

On Feb 27, 8:51 am, alex smirnov <alex.smir...@gmail.com> wrote:
> and there I was drafting a lengthy response  ;)
>
> I think it makes sense this way, but I could be wrong.
>

[Carla Nunes]

Hey guys,

Why would the 400,000 of labor cost apply to part a?  Wouldn't this cost be there for another project?  I thought that only differential costs would be relevant to be counted for a particular project.

Similarly, the overhead and profit margin makes sense to be included, but only if the same cannot be obtained by another project.  I thought that because the 8000 hours would be charged to other project(s) - we're in a good economy case - these other projects could earn the same profit margin and overhead contribution as the project being considered.  In fact, he says that the percentages are "typically" earned by a job with 8000 hours.

Or am I very confused here?

Carla

[Carla Nunes]

Another thing, for Bolero,  don't you need to charge C at market cost? For D, I think we charge the highest opportunity cost, which is buying 300 of 15, rather than 200*19.

[alex smirnov]

ups, for C, it is supposed to be the market cost so total is

16,000+15,000+4,200+3,800 = 39k

for D you charge the lowest (200*19) because this is a slightly different concept I think.  

If you are a business, and you have resource "D" that you could use in process X for $100 or process Y for $150, you'll choose the cheapest........i struggled with that one too, but pretty much have a hard confirmation from the TA that the lowest cost is used in this type of situation

[Carla Nunes]

My question on part a of ATI is based on this reading:

Relevant costs: These are costs that are relevant with respect to a particular decision. A relevant cost for a particular decision is one that changes if an alternative course of action is taken. Relevant costs are also called differential costs.

So, my understanding is that I don't need to charge the 400,000 of labor cost because this same amount would be charged to another project too, and we know that the economy is good and another project will be taken.

As far as the opportunity cost, maybe I need to include that one because the percentages given by the professor are "typical" and may not be the case in another project, so we have to consider as an opportunity that would be foregone if we don't take this project?

I think I should have gone to this TA session!  :)

Carla

[Gabriel Bowers]

Just to add to Alex's explanation:

There is another project that could use 200x units of D or 300x units of E. 

1. The first decision is whether to use E at all.  The cost of D material is cheaper than E.

2. Then if both projects use D material, then Bolero has to consider purchasing new material at $19 instead of $15 which equals $3800 or $2800+$1000.

 

One item that I'm wondering is whether it's best to simply state the differential cost is $3800 or to break it up as saying $2800 (current inventory) + $1000 (opportunity cost).

Gabriel

[Gabriel Bowers]

My answers are different from Alex.  I'll explain how I've looked at this problem with logic similar to Carla's.  I'm referencing the hints on page 21...

 

It would be good to know if I'm missing the boat here. :-)

 

part a.

The company is at capacity so the direct labor and manufacturing overhead costs will not change between taking this project or a different one.  So the total relevant (differential) costs will be purchased materials, steel, and equipment rentals ($250 + $18 + $45 = $313).  I'm also classifying the cost of "storing the steel" ($4k) as a sunk cost.

 

One other note is that I replaced the steel's value of $20k with it's book value of $18k.

The part that I've wrestled with here is the required profit margin.  I'm thinking that this should be considered a revenue charge.  Even so, the $400k will not change for part A since the charge that it is derived from (direct labor) is the same.  I may be wrong here...

 

part b.

In this case I'm assuming that the project would be an increase in labor.  So I added in the direct labor and manufacturing overhead.  The relevant cost is now $783 (=$313 + $80 + $400).

 

part c.

I assumed that the revenue earned for part A was $1.4M less the $400k implicit profit since that $400k would have been earned from another project. 

 

a) ($1.4M - $400k) - $313K =  $687K

 

For part B, I assumed that the project was not replacing another one and left the $400k in.

 

b) $1.4M - $783K = $607K

[Gabriel Bowers]

I think this question is poorly worded.  I am wondering if it is implying that the company will be covering chairs regardless of the considered "book" project.

 

If this was the case, then the relevant costs would be straightforward.  It would be the extra $900 that would be purchased to cover the chairs and the books.

 

I'll email the TA...  :-)

 

Gabriel 

[Daniel Tsui]

Carla,

I did what you did-- exclude $400,000 Direct Labor because it's non-differential. Overhead is excluded because it's fixed, and Required Profit Margin is not a real cost. However, I added these all back in a different way--as lost revenue product, $880,000, which matches the sum of the accounting costs (100% DL + 20% OH + 100% profit margin). We aren't given a "next best alternative," but we are given a standard cost, which I'm interpreting as a standard opportunity cost.

In the Recession case, Direct Labor becomes relevant as a variable cost, $400,000. Overhead and Required Profit Margin are still irrelevant, and there is no opportunity cost in foregone revenue product.

By the way, is there some key, exact phrasing for "economic profit" he wants us to use, like he did for the meaning of elasticity?

Dan

On Sun, Feb 27, 2011 at 7:55 PM, Gabriel Bowers <gabrie...@gmail.com> wrote:

I think this question is poorly worded.  I am wondering if it is implying that the company will be covering chairs regardless of the considered "book" project.

 

If this was the case, then the relevant costs would be straightforward  It would be the extra $900 that would be purchased to cover the chairs and the books.

 

I'll email the TA...  :-)

 

Gabriel 

On Thu, Feb 24, 2011 at 11:06 PM, Carla Nunes <ccrn...@gmail.com> wrote:

Thanks for starting this thread.  I got same answer for part 1 (Bolero).

For leather case, this is what I will put:

$1000  - sunk cost

So, the cost of the leather for the book project is the opportunity cost of either using the leather to cover the chairs ($900) or selling it ($800).  Since the cost to cover the chairs w/ an alternative material is higher than the cost to sell the leather, the cost of the leather to the book project is $900.

On Thu, Feb 24, 2011 at 5:29 PM, Sam <samjf...@gmail.com> wrote:

Adi,

I think we only choose the highest value alternative when counting
opportunity costs, which is what he says on slide 5 of the slides he
went over in class last week (Costs For Business Decisions).

I'm still stuck on the leather book problem though.  The leather was
purchased years ago for and is just sitting there, so I think it is a
sunk cost and irrelevant for all of the options.  With that, I think
the opportunity cost of either the chairs or selling the leather
depend on their revenues, not on the cost avoided buying leather for

the chairs  This is where I get stuck...

-Sam

[Carla Nunes]

Hi Dan,

For part b, you're correct, the 400,000 becomes relevant, but also the profit margin and overhead.  These last two are opportunity costs.  Because the economy is not doing well, if we don't take the proposed job, we are loosing the opportunity to make this extra money, as we don't know if another project will come along.

For part c, there is a formula in the book.  Economic Profit = Revenue - Economic Costs (implicit and explicit)

I won't include the 400,000 in part a, just because that definition that I saw about differential cost... but I still don't know whether this cost becomes part of the economic costs that is needed for the profit calculation....

Carla

[Carla Nunes]

Ops, sorry, there is no opportunity cost for part b.  I messed up in my previous email.

So, for part a, we don't have the 400,000, but we do the profit margin and overhead because (and I'm not 100% sure) the percentages made in another project may not be the same as in this one.
 
For part b, we do have the 400,000, but not the overhead and profit margin.

Sorry abt that.  I need a few cups of coffee.  :)

Carla

[Gabriel Bowers]

The reply that I got from the TA is that the project with the chairs is not an on-going project. 

 

She mentioned that this should be a simple problem of understanding implicit costs.

 

On Sun, Feb 27, 2011 at 7:55 PM, Gabriel Bowers <gabrie...@gmail.com> wrote:

[jonathan car]

Hi all,

 

Where is the costdata.xls located?

Jonathan

---

From: Gabriel Bowers <gabrie...@gmail.com>
To: econ_401_w...@googlegroups.com
Sent: Mon, February 28, 2011 9:12:53 AM

Subject: Re: HW 10 - Bolero

[Alex Khalfen]

It was uploaded to eres a moment ago.

[Robert Binkley]

 

Did anyone get this hw right? I missed both problems and did not get the answers at the review session. 

Here is what I think it should be, please let me know if you see any flaws in the logic.

 

A: Bolero: Take Job?

 

Explicit costs:

MatA: 16000

MatB: 15000 (even though there is 600 units in stock, they would have to be replenished, so buy 1000)

MatC: 4200 (700 hundred units are available as a sunk cost with no alternative so only buy 300)

 

Implicit costs:

MatD: 4500 (should be a sunk cost, however, there is an opportunity cost of using the material for this job instead of as material E for other job which is the next best alternative)

No other implicit costs included.

 

Total cost: 39,700

Economic Profit: 60,000 – 39,700 = 20,300 - Take Job.

 

B: Leather:

$1000 = Sunk costs of purchasing the leather

$2000 = Replacement cost of leather, irrelevant

 

Explicit Costs: 0

Implicit Costs: 900 (best alternative to using the leather for books instead of selling the leather)

Total Economic cost of making book: $900.

 

ATI:

A:

Ignore overhead all discussion of overhead and profit margin – fixed costs, or accounting costs.

Explicit Costs:

45000 – Equipment

250,000 – Supplies

18,000 – mkt price of steel if we sold it instead of used it

 

Implicit Costs:

480,000 - Revenue Forgone (from 8000 x 60 – Approximate profit from labor hours – ignore cost of labor since that happens regardless)

No other opportunity costs included (i.e. alternative use of capital)

Total Cost: 793,000.

Economic Profit: 1,400,000 – 793,000 = 607,000.  Take Job.

 

B:

Everything is exactly the same as above except:

Now you have to pay the workers at $50 per hour.

There is no Revenue forgone because the factory is not at capacity, so remove 480,000.

Add in opportunity cost of using the factory space for something else – not given.

So it becomes:

 

Explicit Costs:

45000 – Equipment

250,000 – Supplies

18,000 – mkt price of steel if we sold it instead of used it

400,000 – Cost of Labor

 

Implicit Costs:

0 - Opportunity Cost of using excess factory capacity for space for some other purpose – Not provided

0 – Opportunity cost of using financial capital in other capacity – not provided.

 

Total Cost: 713,000.

Economic Profit: 1.4 - .713 = 687,000 – Take Job.

 

 

-Rob

 

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[alex smirnov]

Robert,

I got full credit on this problem.  Bellow are my answers

Bollero:

A: There are no units in stock, so all 1000 units @$16/unit must be purchased for a total cost of $16,000

B: Because B is regularly used, all 1000 @ a replacement cost of $15/unit must be counted – total cost is $15,000

C: 700 units are sunk costs (no other use for material C) and need not be counted.  300 units must be bought and counted @ $14/unit for a cost of $4,200

D: It is likely that the manager would like to use D for this special job at a cost of 200 units @ $19/unit rather than convert it into E which would cost him/her more.  Hence the relevant cost is 200x19 = $3800

Total cost is: $16,000+$15,000+$4,200+$3,800 = $39,000

 

Book:

The relevant cost of the leather to the book project is the cost of the next best alternative, which is $900.  The original price or replacement cost do not enter into the calculation of opportunity cost

 

ATI:

a)      ATI’s economic cost is is $1,193,000 for a fully utilized factory.

$400k of direct labor + $250k of purchased materials + $18k market value of steel + $45k Equipment rental + $480k opportunity cost

 

b)      If the factory is not fully utilized, $480k in opportunity costs need not be counted, because the “typical project” that would be earning this contribution to overhead and required PM would no longer be earning this money in a slow econoy (or at least a portion of it).  Thus economic cost is $1,193k-$480k = $713,000

c)       Economic profit for (a) is $1,400k-$1,193k = $207,000                                                                          Economic profit for (b) is $1,400k-$713k = $687,000

The economic profits are what ATI expects to earn over the next best alternative.

[Robert Binkley]

Hi Alex,

 

Thanks for the confirmation. 

On the ATI problem, I am surprised that you include the cost of labor for part A since it is not changing as a result of the decision, but I am getting used to being confused for this class… *sigh*.

 

-r

[alex smirnov]

getting used to it?  i figured we all got used to it a while back  ;)

I think the whole "changing as a result of a decision" concept is a bit misleading.  Just think as an owner of a company which is trying to determine the cost of taking a particular job.  Direct labor costs have got to be a "relevant" cost in such a decision, right?

having said that, if you assume that your labor force is fixed, there would be no reason to include it in the relevant cost, as you would have to add the same exact amount to every other project you do