Question

E-Teller manufactures ATM machines. Recently the company has begun manufacturing and marketing a machine that can recognize customer fingerprints. Demand for this machine is very strong, and the chief executive officer of E-Teller is considering dropping production of the company’s original model, which relies on bankcards and passwords. This will give the company increased capacity to devote to the new model. Which of the following items are relevant to the CEO’s decision to drop the old model machine?

a. The original cost of equipment used to manufacture the old model. (Relevant/Irrelevant)

b. Depreciation of the equipment used to manufacture the old model (ignore taxes). (Relevant/Irrelevant)

c. The CEO’s salary. (Irrelevant/Relevant)

d. The time it takes to manufacture each model. (RelevantIrrelevant)

e. The production manager’s salary. (IrrelevantRelevant)

f. The selling price of the new model. (IrrelevantRelevant)

g. The variable cost of producing the new model. (IrrelevantRelevant)

h. The cost of retraining personnel to make the newer model. (IrrelevantRelevant)

i. Depreciation of the factory building allocated to the old model. (IrrelevantRelevant)

Answer 1

a. The original cost of equipment used to manufacture the old model is irrelevant for decision making since it's a sunk cost i.e., the cost which is already incurred and thus does not effect decision making as it considered as Irrelevant cost.

b.  Depreciation of the equipment used to manufacture the old model is irrelevant for decision making as it is a non-cash expenditure item which does not impact cash flows of business.

c. The CEO's salary is irrelevant for decision making as it is a fixed cost which will be incurred in either of both cases i.e, even if a new model is manufactured or not.

d. The time it takes to manufacture each model effects the production level. For Example, if a Product A takes less time to manufacture than Product B, we choose to manufacture product A thereby increasing the production level considering the other factors such as market demand, price etc were satisfied . Thus, it plays a major role and is considered as Relevant for Decision making.

e. The production manager's salary is fixed cost and hence it is irrelevant for decision making as this costs incurs regardless of the outcome of the decision taken.

f.  The selling price of the new model shall be considered for deciding to drop the old model machine as it impacts our Revenue from Business. For Example, in case if sales price for Product A is greater than product B, we opt to sale Product A provided other factors such as variable costs were same as it yields high returns. Thus. sales price is relevant for decision making.

g. The variable cost of producing the new model is relevant for decision making as Variable costs are costs that change as the quantity of the good or service that a business produces changes i.e., it is a cost that varies with the level of output and will be incurred as a direct result of the decision taken.

h. The cost of retraining personnel to make the newer model is relevant for decision making since training costs are the costs incurred to improve the work skills of an employees to do particular job effectively in an efficient manner. Thus it effects the productivity and yields good returns.

i. Depreciation of the factory building allocated to the old model is irrelevant fro decision making as Depreciation is a non- cash expense item (irrelevant cost) and thus will not effect cash flows of the business.