Student Forums CMA Part 2 Section C: Decision Analysis C.2. Marginal Analysis Question ID: CMA 679 5.13 (Topic: Relevant Information for Decision Making)

Question ID: CMA 679 5.13 (Topic: Relevant Information for Decision Making)

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  • #242469

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    This forum is restricted to members of the associated course(s).

    shahana soasin
    Participant

    Hello. Why is the salvage value of equipment considered as fixed cost? Is it because question asks for breakeven units on cash flow basis or it would not be the case if breakeven units calculation is asked without cash flow basis?

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  • #242481

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    Lynn Roden
    HOCK international

    Hello shahana soasin,

    The value of the equipment will decrease by $18,000 if the company continues to use it for a year, and the money the company could have received by selling the equipment now will be forfeited. Therefore, on a cash flow basis, the opportunity cost of continuing to use the equipment for one year is the full $18,000 that the equipment could be sold for now.

    The difference between “cash flow basis” and “net income” in this question is that the full amount of the $18,000 salvage value is considered the opportunity cost on the cash flow basis because that is the cash that BE&H would receive. However, only the gain or loss on the sale of the equipment would appear on the income statement if it were sold now. Therefore, if breakeven were being calculated on the basis of the income statement, the amount that would be considered would be the amount of gain or loss that the company would report on its income statement if it were to sell the equipment now. We do not know what that amount of gain or loss is, though, because we are not told what the book value of the equipment is presently.

    Lynn

    #242993

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    shahana soasin
    Participant

    Thanks for explaining it so clearly about distinction between cash flow basis and net income when dealing with opportunity costs. what i didn’t understand or say I’m confused about is how opportunity cost of continuing to use the equipment i.e $18,000 is fixed cost here? As i know that opportunity cost is forgone benefit ($18,000 here) and not a cost of production, right? Could you please clear my confusion.

    #242995

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    Lynn Roden
    HOCK international

    Hello shahana soasin,

    An opportunity cost is the benefit that could have been gained from an alternative use of the same resource. If BE&H were to sell the special equipment now, they would receive $18,000 for it. Selling it for $18,000 is an alternative use of the equipment, and $18,000 is the benefit.

    The other alternative is to continue using the equipment in production for another year. However, if the company does that, they will give up that $18,000 in cash flow now, and the equipment will have no salvage value in one year. Therefore, the $18,000 is an opportunity cost of continuing to use the equipment for another year until its value is used up.

    Lynn

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