Differential Analysis and Product Pricing.DOCVIP

Differential Analysis Costs: Relevant - estimated costs and revenues that are important in the decision making process. Sunk costs – that have been incurred in the past are not relevant to the decision. Differential revenue: Is the amount of increase or decrease in revenue expected from a course of action as compared with an alternative? Differential cost: Is the amount of increase or decrease in cost that is expected from a course of action as compared with an alternative? Differential income or loss: Is the difference between the differential revenue and the differential costs? Differential analysis: It focuses on the effect of alternative courses of action on the relevant revenues. Differential Revenue from alternatives Revenue from Alternative A $$$ Revenue from Alternative B $$$ Differential Revenue $$$ Differential cost of alternatives Cost of Alternative A $$$ Cost of B $$$ Differential cost $$$ Net differential income or loss from alternatives $$$ Types of Decision-making: 1. Lease or sell: management may have a choice between leasing or selling a piece of equipment that is no longer needed in the business. The relevant factors to be considered are the differential revenues and differential costs associated with the lease or sell decision. Example 1: A corporation can sell an asset for $200,000 less a 6% selling commission. An alternative would be to lease the asset for five years at $40,000 per year less $35,000 in costs over the five years. Which decision would you make? Differential Revenue from alternatives Revenue from selling $200,000 Revenue from leasing $200,000 Differential Revenue $0 Differential cost of alternatives Cost of selling: Commissions 6% of sales price $12,000 Cost of leasing: operating costs $35,000 Differential cost -$23,000 Net differential loss from leasing -$23,000 Therefore we should sell the asset and save $23,000 in additional costs. 2. Discontin