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A cloth mill spins its own yarn and then weaves it into cloth. While judging the profitability of the weaving department, the relevant cost of the yarn it consumes is best measured as:
AThe historical cost of buying the raw cotton
BThe price at which that yarn could otherwise be sold
CThe replacement cost of the spinning machinery
DThe fixed cost of running the spinning shed
Answer & Solution
Correct answer: B. The price at which that yarn could otherwise be sold
1. Opportunity cost is the value of the next best alternative foregone when a resource is used one way.
2. The next best use of the self-made yarn is selling it in the market.
3. So the yarn's relevant cost to the weaving department is the price at which it could have been sold.
4. Historical cotton cost (A) ignores the sacrifice of the sale; machinery replacement (C) and shed fixed cost (D) are unrelated to the yarn's alternative value. Hence the sale price of the yarn.
_Source: ICAI BoS CA Foundation Paper 4 Business Economics, Ch 3 Unit II "Theory of Cost", p.1–2_
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