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Q. 2.SS.2

Approximating Opportunity Costs with Variable and Fixed Costs
Frank Choi, the president of Trace Products, understands product costs, but he feels that estimating opportunity costs for his gold ore processing plant is difficult. Instead, he tells his controller to worry only about fixed and variable costs. The controller estimates that the variable cost of processing gold ore is \$1,000 per ton of gold ore. The fixed costs are \$50,000.
a. What is the estimated cost of processing 60 tons of gold ore?
b. What is the danger of approximating activity costs with variable and fixed costs?

Verified Solution

a. The estimated cost of processing 60 tons of gold ore is:

(60 tons)(\$1,000/ton)+\$50,000=\$110,000

b. The danger of estimating opportunity costs with variable and fixed costs is being outside the relevant range. In the relevant range, the estimates from variable and fixed costs should be fairly close to the opportunity cost. If output levels are extremely low or near capacity, however, the fixed and variable cost estimate tends to differ from the opportunity cost.