k when we make a product decision. Thus, when we use the NPV method to value a project, the costs before a product decision are sunk costs and we should ignore them.
Part C
1. Cost classification
a) Usually, costs can be divided into two parts: variable and fixed.
VARIABLE COSTS are expenses that keep changing in proportion to the business activity. Variable cost is the total marginal costs over all units produced. Direct labor cost and direct material cost are typical variable cost while manufacturing cost is indirect cost though it is a variable cost. In certain period, they keep changing with a direct ratio as the business increases or decreases but the expense of unit product does not change.
For example, when a company pays for material, if the production runs less than before, the expense of material would be less. Also, if the production runs more than before, the expense of material would be larger.
According to the reason that variable cost occurs, we can divide it into two parts: Technical Variable Cost and Discretionary Variable Cost. Technical variable cost is based on the technology development. Unit cost is decided by the technology factor and total cost changes along the consumption of material. For the discretionary variable cost, it is decided by the management in a firm and it changes by the company policies.
FIXED COSTS refers to business expenses which are not based on the levels of services or goods produced by the business (Smith, 1996). They would not change as no matter how business activity runs well. They tend to be time-related, such as salaries or rents being paid per month, and are often referred to as overhead costs. It is in contrast to variable costs, which are volume-related (and are paid per quantity produced).For example, a retailer must pay rent and utility bills irrespective of sales. Therefore, if a firm sells more goods in a fixed period, the average fixed cost on unit product would be less. This is an example of scale of
Economics.
Fixed costs can be divided into two parts: Committed Fixed Cost and Discretionary Fixed Cost. Committed fixed costs such as rent, tax and insurance expenditure are that management layer cannot easily change its amount of expense, in order to maintain the operation activity and production activity. Discretionary fixed costs are those that the management layer can change the amount of expenses such as
advertising fees and employees training fares.
b) Variable Cost is opposite to the Fixed Cost.
Variable cost would change along the unit production while the fixed cost would not. Thus, when a firm produces more goods, usually, the average variable cost for each unit would not change and average fixed cost per unit becomes less.
For some employees, salary is paid on monthly rates, independent of how many hours the employees work. This is a fixed cost. On the other hand, the hours of hourly employees can often be varied, so this type of labor cost is a variable cost.
2. The classification of costs is not always appropriate to some extent. In short time, the cost can be divided into variable cost and fixed cost. However, in long time, since every factor of production would change, all the costs are variable cost and change in the long time (Williamson, 1996). Investments in facilities, equipment, and the basic organization cannot be signif
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