Suppose that Allied West’s managers are evaluating the profitability of adding another customer, Loral, to its existing customer base of Vogel, Brenner, and Wisk. There is no other alternative use of the Allied West facility. Loral has a customer profile much like Wisk’s, so managers predict revenues and costs of doing business with Loral to be the same as the revenues and costs described under the Wisk column in Exhibit 12-8. In particular, Allied West would have to acquire furniture-handling equipment for the Loral account costing $9,000, with a 1-year useful life and zero disposal value. If Loral is added as a customer, warehouse rent costs ($36,000), general administration costs ($48,000), and actual total corporate-office costs will not change. Should Allied West’s managers add Loral as a customer?
Exhibit 12-9, column 2, shows relevant revenues exceed relevant costs by $6,000. The opportunity cost of adding Loral is $0 because there is no alternative use of the Allied West facility. On the basis of this analysis, Allied West’s managers recommend adding Loral as a customer. Rent, general administration, and corporate-office costs are irrelevant because these costs will not change if Loral is added as a customer. However, the cost of new equipment to support the Loral order (written off as depreciation of $9,000 in Exhibit 12-9, column 2) is relevant. That’s because this cost can be avoided if Allied West decides not to add Loral as a customer. Note the critical distinction here: Depreciation cost is irrelevant in deciding whether to drop Wisk as a customer because depreciation on equipment that has already been purchased is a past cost, but the cost of purchasing new equipment in the future that will then be written off as depreciation is relevant in deciding whether to add Loral as a customer.