Question

Continuing with the company selected in Unit 2, think about 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:

Customer

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?

for a book publishing company, data from uni 2

NLC is a publisher of text books and decides to print an sell 8000 copies. The following variables will be included in the calculation of contribution margin and contribution margin ratio;

Fixe cost; training sessions6000, typesetting 36000, art work 2000, editing 4000

Variable expenses per book; printing and binding $3.00, book store discount 2.40, shipping cost $1.60, authors royalty $1

Each book sells at $ 20 per copy the contribution margin and contribution margin ratio will be calculated as follows;

Sales (8000 x $20). $160 000. 100%

Variable cost. (8000 x $8) $64 000……………40%

Contribution Margin. $96 000. 60%

Fixed cost. $48 000

Net income. $48 000

Answer 1

Types of financial data that would be included and excluded in differential analysis:

Differential cost analysis is the increase or decrease in total cost pf the change in specific elements elements of cost that result from any variation in operations. It represents an increase or decrease in total cost resulting out of -

1. Producing or distributing a few more or few less of the products

2. Change in the method of production or of distribution

3. An Addition or deletion of product

4. Selection of additional sales channel

In Differential analysis increase in revenues, variable costs and opportunity costs are considered. Fixed costs and fixed portion of semi-variable costs are ignored.

Differential analysis is used:

1. Dropping or adding a product line

2. Make or buy decisions

3. Continue or shutdown product or customer etc.

Specific revenues and costs should be considered in an evaluation to drop or keep a:

1. Contribution form unprofitable product should be considered

2. Specific fixed costs of the unprofitable product shall be considered

3. Contribution from other profitable products which is proposed to be produced with the spare capacity will be considered.

Avoidable fixed costs are considered, as these can be avoided when product or customer is shut down. Avoidable fixed costs divided by the pv ratio will give level of sales below which it is better to shut down.

Unavoidable fixed costs are ignored in considering in an evaluation to drop or keep. Because these costs will be incurred even though the product or customer is discontinued.

Shut down point =

Sunk Costs: A sunk cost is a cost that an entity has incurred, and which it can no longer recover. Sunk costs should not be considered when making the decision to continue investing in an ongoing project, since these costs cannot be recovered. As sunk costs are historical costs these are incurred in the past and notrelavent for decision making purpose. for example, R&D costs, Feasibility report costs etc.

Opportunity Costs: Opportunity costs arise from failure to unused resources efficiently. These are considered in decision making analysis. in simple terms opportunity cost means the loss of other alternatives when one alternative is chosen.

Loss arising from choosing one alternative instead of other alternative shall be considered in evaluating the project.

Computation of contribution margin ratio:

Particulars	Units	Price $	Amount $
Sales	8,000	$               20.00	$      160,000.00
Less: Variable costs	8,000	$                  8.00	$        64,000.00
(Variable expenses per book: printing and binding $3.00, book store discount 2.40, shipping cost $1.60, authors royalty $1)
Contribution			$       96,000.00
Less: Fixed costs			$        48,000.00
Net income			$       48,000.00

Contribution margin ratio = = = 60%

Variable cost ratio = = = 40%