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Discussing Relevant Costs for Decision Making

TATA Metals Company is considering the elimination of its Packaging Department. Management has received an offer from an outside firm to supply all Fusion's packaging needs. To help her in making the decision, Fusion's president has asked the controller for an analysis of the cost of running Fusion's Packaging Department. Included in that analysis is $9,100 of rent, which represents the Packaging Department's allocation of the rent on Fusion's factory building. If the Packaging Department is eliminated, the space it used will be converted to a storage space. Currently Fusion rents storage spaces in a nearby warehouse for $11,000 per year. The warehouse rental would no longer be necessary if the Packaging Department were eliminated.

1. Discuss each of the figures given in the exercise with regards to its relevance in the department closing decision.

2. What type of cost is the $11,000 warehouse rental, from the viewpoint of the costs of the Packaging Department?

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Relevant Cost:
An item is relevant if it is different between or among decision alternatives. That item is not relevant if it is the same between or among decision alternatives.

Here are some follow-up generalizations. As with all generalizations, there will always be exceptions.
1. In general, sunk costs are not relevant because they cannot be avoided in a decision. They have already been incurred or are committed to be incurred in the future. Remember that committed costs are a form of sunk ...

Solution Summary

In about 330 words, a discussion on relevant costs, in comparison to opportunity costs is provided. One reference is also given as a good source for further information.