Opportunity costs:

Opportunity cost is the potential benefit that is given up when one alternative is selected over another. For example: Suppose I worked in a company and it gives me 20,000 taka per month. But suddenly I leave that job and get admitted in North-South University for M.B.A. Then my salary 20,000 taka is my opportunity cost which I sacrificed for further education.

Role in decision-making

Opportunity cost is a very important item, which is playing an effective role in decision-making. By considering opportunity cost we can determine the real cost of production. We can give an example to clear this idea.

Direct material        : $3 (Avoidable)
Direct Labor           : $2 (Avoidable)
Supervisor salary    : $1 (Avoidable)
Factory rent            : $1 (Unavoidable)
Depreciation           : $2 (Unavoidable)
Allocated general
       Expense            : $3 (Unavoidable)
Total cost per unit   : $12

Avoidable cost        : (3+2+1) = $6
Unavoidable cost     : (1+2+3) = $6

Here we see that if we make the material the cost of per unit will be $12. Now we get an offer from outside at $8 per unit. If we want to buy we have to consider some other things because there are some unavoidable cost that we can’t ignore. It will add to the buying cost. Now we see that if we buy it will costs (8+6) =  $14 per unit. So we can easily determine that we will go for making not buying. In this case we have to consider opportunity cost. Suppose the room, where we will make our production, the rent of that room is $20,000 and we get an offer for 5,000 unit.

                                           Make                                    Buy
Unit cost                               $12                                      $14
For 5,000 unit                    $60,000                               $70,000
(+) Opportunity cost          $20,000                                   ------
Total cost                           $80,000                              $70,000

Here we see that if we go for making it will cost more and if we buy raw material from outside we can generate $10,000 as a profit. So, in this case we will definitely go for buy not make.

Sunk costs:

A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in the future. So, they should be ignored when making decision. Example: Suppose we buy a machine costs 50,000 taka to produce one kind of goods. But now there is no longer demand of that product. So we buy another new machine costs 70,000 taka. Now there is no use of old machine and we have already incurred that cost. So, here 50,000 taka is sunk cost, which was paid for purchasing of old machine.

Role in decision-making

Sunk cost does not play any role in decision-making. On the other hand it plays a great role in decision -making. Usually we deduct the sunk cost from both keep old machine & purchase of new machine. By this way we can show the proper fixed cost. Suppose our sunk cost is $50,000 but the salvage value of that machine is $20,000. Now if we don’t consider the sunk cost then it will show us $20,000 income and if we consider sunk cost, ultimately it will show us 30,000 losses. Thus sunk cost plays an effective role to show proper income. Sunk cost is also playing a great role in another criteria. If we don’t deduct the sunk cost from fixed cost then our fixed cost will be greater and our unit cost will increase also. In this case we cannot compete with our competitors. So we must deduct sunk cost from our account.