Considering Relevant Costs When Conducting Differential Analysis

Differential Analysis
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Differential Analysis
When doing a differential analysis for a large purchase, it is crucial to consider only relevant expenses since doing so gives a more precise and accurate portrayal of the prospective effect of the choice. Costs that will shift due to the selection and affect future cash flows are considered relevant. Decision-makers may benefit from better information by removing irrelevant costs (sunk or inescapable regardless of the decision) (McGregor, 2016). Consider a factory that must decide whether to invest in a new machine to replace an aging one. The money spent on the old equipment is a sunk cost, meaning it can only be recouped if you try. The cost of the old equipment is irrelevant to the decision-making process since it cannot be altered.
Decision-makers are less likely to be persuaded by future expenses that will occur regardless of the choice when they narrow their attention to relevant costs. For instance, if the expense of maintaining the previous computer was high, it should not factor into the choice of whether or not to get a new one. Including such unnecessary costs might deter investment in a new piece of machinery that could result in long-term savings. The decision-making process may be distorted, and poor decisions may be made if irrelevant expenses are in...