Question

think about a company that sells clothes and the types of financial data that would be included and excluded in differential analysis.

Propose which specific revenues and costs should be considered in an evaluation to drop or keep a:

A)Customer and

B)Product line.

In addition, explain sunk and opportunity costs as they relate to your selected company.

Should these costs be considered in differential analysis? Why or why not?

Answer 1

Managers often use differential analysis to determine whether to keep or drop a customer .Revenues, variable costs, and fixed costs directly related to each customer is to considered. Fixed costs that cannot be traced directly to customers are allocated to customers.

Managers often use differential analysis to determine whether to keep or drop a product line. Direct fixed costs are typically eliminated if a product line is eliminated and are therefore considered differential costs. Allocated fixed costs are typically not eliminated if a product line is eliminated and are not differential costs. Managers compare sales revenue and costs for each alternative (keep or drop) and select the alternative with the highest profit.

A sunk cost is a cost that an entity has incurred, and which it can no longer recover

Opportunity costs represent the benefits an individual, investor or business misses out on when choosing one alternative over another.

Sunk cost should not  be considered in differential analysis since these cost cannot be recovered whereas opportunity cost must be considered in differential analysis as it helps in selecting a better alternative.