Incremental Analysis
by Darril Gaban
1. Opportunity Costs
1.1. Lost potential benefit that could have been obtained by following an alternative course of action.
1.2. Example: In a chance to increase sales, Amazon initiated "Prime" free-shipping subscription program. Amazon saw increase sales over 6 year period, but their shipping costs rose from 2.8% to 4% of sales.
1.3. Opportunity costs are calculated into incremental analysis estimates and added to expense costs to make comparisons from.
2. Sunk Costs
2.1. Costs that have already been incurred and will not be changed or avoided by any present or future decisions.
2.2. Fixed costs: E.g. fixed overhead costs
2.3. Objective is to eliminate unprofitable segments with no reduction in fixed costs
3. Relevant Costs and Revenues
3.1. Variable Costs Do Not Change under alternative courses of action. Fixed costs do change
3.2. Only factors that can be considered are the costs and revenues that differ across alternatives.
3.3. It is important to calculate the relevant costs and revenues when making decisions to either accept an order, change production styles, etc.
