Question

Warner Corporation purchased a machine 7 years ago for $405,000 when it launched product P50. Unfortunately, this machine has broken down and cannot be repaired. The machine could be replaced by a new model 300 machine costing $396,350 or by a new model 200 machine costing $349,800. Management has decided to buy the model 200 machine. It has less capacity than the model 300 machine, but its capacity is sufficient to continue making product P50. Management also considered, but rejected, the alternative of dropping product P50 and not replacing the old machine. If that were done, the $349,800 invested in the new machine could instead have been invested in a project that would have returned a total of $450,600.
Required:
1. What is the total differential cost regarding the decision to buy the model 200 machine rather than the model 300 machine?
2. What is the total sunk cost regarding the decision to buy the model 200 machine rather than the model 300 machine?
3. What is the total opportunity cost regarding the decision to invest in the model 200 machine?
1. Differential cost
2. Sunk cost
3. Opportunity cost

Answer 1

Answer:

1. $46,550

2. $405,000

3. $450,600

Explanation:

1. Computation of differential cost regarding the decision to buy the model 200

Differential cost = Cost of a new model 300 - Cost of a new model 200

Differential cost = $396,350 - $349,800

Differential cost = $46,550

So, the differential cost regarding decision to buy model 200 is $46,550.

2. Sunk costs are the costs which are already incurred by the entity in the past and which are not relevant to decision made today. In this case, sunk cost is the cost of the machine purchased seven years ago for $405,000.

3. Opportunity cost is the profit forgone by chosen alternative course of action. In this case, the Opportunity cost regarding the decision to invest in the model 200 machine is $450,600.