Assignment 1 OMDE 606 [Divine Eseh] Divine Mbong Eseh OMDE 606 Date: March 7, 2007 Assignment 1 1.

Classify the different cost items as either fixed or variable costs (matching row number to Fixed or Variable as appropriate).

Answer: All cost items under A and B are fixed costs and all cost items under C are variable costs. Fixed costs: Lines 3 4, 6 9, 11 12, 14, and 17 18 Variable costs: includes all cost items under line C. Line 23 25, and Line 27 - 31.. 2. Calculate the aggregate Fixed Costs of Development (FD) and the aggregate Fixed Costs of Maintenance (FM). Answer: FD=$ 631675 FM= $ 7800 F=FD+FM=$ 639475 3. Calculate the variable cost per student (V) Answer: V=$ 398.37

4. Calculate the depreciation rate on a basis of the lifetime of the presentation of the project (compare Rumble Table 6.1) and charge it to each year of presentation. (You may use the format of the attached spreadsheet.) Answer: Depreciation rate FD: $ 126335

Assignment 1 OMDE 606 [Divine Eseh] Depreciation rate FM: $ 3900 Depreciation rate total: For years 1-3 it is $126335 Depreciation rate total: For years 4-5 it is $ 126335 + $ 3900 = $ 130235

5. Following the template of Rumble Table 6.4, annualize the Fixed Costs of Development (FD) over the five years of presentation at 5% interest and the Fixed Costs of Maintenance (FM) over two years at the same rate. Answer Annualization rate FD: $ 145901 (5 years) Annualization rate FM: $ 4195 (2 years) Annualization rate total: For years 1-3 it is $ 145901 Annualization rate total: For years 4-5 it is $ 145901 + $ 4195 = $ 150096 F= 145901*3 + 150096*2 F= $437703 +$300192 = Total: $ 737895 = F (5 years annualized total)

6. Summarize in a short paragraph the reasons for and against annualization. Advantages and Disadvantages of Annualization
According to Rumble (1997b) the calculation of the overall cost of capital expenditures depends upon which of the following two (2) approaches is used; the basic approach to this problem is to spread the cost of goods over their lifetime. The cost of capital may be simply depreciated, or The cost may be annualized. Although arguments may be advanced for the adoption of either of these methods, Rumble(1997b) agrees that in general , economist prefer to annualize capital cost (p.43). The reasons for and against annualization are given below:

When to use annualization and advantages

Assignment 1 OMDE 606 [Divine Eseh]

1.

Unlike depreciation, Huelsmann(2007a) maintains that annualization means that capital costs are not simply depreciated but that the forgone interest on your initial investment is taken into account as well. For instance, if decisions on large capital investments are to be made and there are real alternative options (i.e. the money is not ring-fenced and could genuinely be used for something else ) - then it is sensible to annualize since these figures include the opportunity costs and might tip the balance towards an alternative option. Also, Huelsmann (2007a) says that annualization distributes the effects of the foregone interest in such a way that the annualization rate for each year is the same. This is very important because unlike the social discount method which charges starkly differing rates to different years while the value consumed is largely the same in each year. The Annualization method provides a consistent comprehensive measure of capital cost..

2.

Conclusion: The primary reason for annualizing an investment is that it more accurately represents the true opportunity cost of making that investment When not to use Annualization (disadvantage)
According to Rumble (1997b ) and Huelsmann (2007b) Annualization is not appropriate where the funds invested are restricted or earmarked for the program, and could not have otherwise have been invested at the designated rate of return. ), public bodies rarely have such an alternative, so annualization would not be appropriatedespite the prevailing opinion of economists.

Conclusion,
If, however, there is no real alternative and the institution is not allowed to use the money for other than the specific purposes under consideration, it does not make sense to annualize Good

7. Calculate the equation of total costs (TC=F+VxN) using the annualized figure of fixed costs and N=800 Answer: TC(N) = $ 737895+ $ 398.37*N For N = 800 TC(800) = $ 737895 + [$ 398.37 *800] = $ 737895+ $ 318696=$1056591 TC= $1056591 @ N = 800

8. Draw the graph of the total cost function using, as above, the annualized figure of fixed costs while N varies over the accumulated number of students (i.e. N= 200, 400, etc.)

Assignment 1 OMDE 606 [Divine Eseh] Answer: for the graph of the Total Cost function please see Cf spreadsheet attached

9. Calculate the equation of average costs (AC=F/N+V) using the annualized figure for fixed costs and N=800 Answer: AC (N) = ($ 737895/N) + $ 398.37 For N = 800 AC (800) = ($ 737895 / 800) + $ 398.37 = $ 922.36875 + $ 398.37=$1320.67

10. Draw the graph of the average cost function, using, as above, the annualized figure of fixed costs while N varies over the accumulated number of students (i.e. N= 200, 400, etc.) Answer: for the graph of the Average Cost function please see Cf spreadsheet attached

11. If the student is charged the per student fee specified, calculate the break-even point. (Use the equation TC=F+VxN and the income equation: I=SFxN (Income =Student fee x No of students). The break-even point is N=F/(SF-V) Answer: N= $ 737895/ ($ 1260-$ 398.37) =$ 737895 / $861.63=856 12. Represent the break even point graphically (Overlaying the graphs of TC and I). Answer: Please see Cf spreadsheet attached

Assignment 1 OMDE 606 [Divine Eseh]

13. Summarize in a short paragraph why it is believed that the TC and AC equations and the specific cost structure of DE suggests that DE may be more cost-efficient than conventional modes of educational provision. Answer:
The cost structure of distance education as described by Rumble (1997a) , involving the preparation of extensive resource materials, generates a higher level of fixed costs than conventional modes; However, by using less expensive tutors to grade student assignments and provide feedback, and by reducing the amount of contact between students and their instructors (or tutors), the variable costs (unit cost per student) can be significantly reduced. Given a long enough period of time to amortize course development costs and a large enough number of students (N) over which to spread these costs, the total cost per student in DE will eventually fall below the cost of teaching in a conventional setting. In order to achieve this economy, the number of students must be sufficiently large so that it can reach the point where average costs for DE are less than for CE. In short DE V(DE<V(CE) . According to Rumble(1997b) a system is cost efficient if , relative to another system, its outputs cost less per unit of output than that of the competitor.. The cost structure of conventional modes of education are driven by the labour cost of classroom teachers. They rise with increases in student numbers. This is not (or not to the same extent) the case with DE which is designed to achieve smaller aggregate unit cost (V) through economies of scale. Good

Conclusion

DE may be more efficient than conventional modes of education for this reason: while DE training has higher fixed costs(TC) than classroom based training these higher course development costs are offset by lower variable costs(AC) in course delivery. This is primarily due to the reduction in course delivery time (course compression) and the potential to deliver courses to a larger number of students than is possible in a traditional classroom without incurring significant incremental costs.

References: Huelsmann, T. (2007a) Capital Cost Social Discount, retrieved March 9

Assignment 1 OMDE 606 [Divine Eseh] http://www.uni-oldenburg.de/zef/cde/COLproject/web-col/

Huelsmann, T. (2007b), February 19), Re: Depreciating costs [Module 2, Thread 3] http://tychousa7.umuc.edu/OMDE606/0702/9040/class.nsf/Menu?OpenFrameSet&Login Rumble, G. (1997a). Volume and its relationship with fixed and variable costs. In The costs and economics of open and distance learning, (Ch. 5). Stirling, UK: Kogan Page Rumble, G. (1997b). The treatment of capital costs. In The costs and economics of open and distance learning, (Ch. 6). Stirling, UK: Kogan Page