Chapter 16: Costs for Decision Making

Opportunity Cost

An economic concept relating to income forgone because an opportunity to earn income was not pursued

Allocated Cost

A cost that has been assigned to a product or activity using some sort of systematic process

Sunk Cost

A cost that has been incurred and that cannot be unincurred, or reversed, by some future action

Payback Method

A capital budgeting technique that calculates the length of time for the cash flows from an investment to equal the investment

Accounting Rate of Return Method

A capital budgeting technique that calculates the rate of return on the investment based on the impact of the investment on the financial statements

Internal Rate of Return (IRR) Method

A capital budgeting technique that solves for the time-adjusted rate of return on an investment over its life

Net Present Value (NPV) Method

A capital budgeting technique that uses a given cost of capital to relate the present value of the returns from an investment to the present value of the investment

Relevant Cost

A cost classification used in analyzing costs of decision alternatives; costs are relevant when they represent future differences between the alternatives

Target Costing

A cost management technique in which the firm determines the required cost for a product or service to earn a desired profit when the selling price is determined by the marketplace

Differential Cost

A cost that will differ based on the selection of an alternative activity

Interpolating

A mathematical term that describes the process of interpreting and relating two factors from a (present value) table to approximate a third factor not shown in the table

Cash Flows

In capital budgeting, the cash receipts and disbursements associated with a capital expenditure over its life

Cost of Capital

The ROI that must be earned to permit the firm to meet its interest obligations and provide the owners their expected return; the discount rate used in the present value calculations of capital budgeting

Outsourcing

The acquisition of resources or services from outside the organization as opposed to producing these resources or services internally

Full Capacity

The operating condition when all available production resources are being utilized

Idle Capacity

The operating condition when some available production resources are not being utilized

Capital Budgeting

The process of analyzing proposed investments in plant and equipment and other long-lived assets

Postaudit

The process of comparing the assumptions used in a capital project analysis with the actual results of the investment

Present Value Ratio

The ratio of the present value of the cash flows from an investment to the investment See profitability index

Profitability Index

The ratio of the present value of the cash flows from an investment to the investment; used for ranking proposed capital expenditures by profitability