Question

Vickery Machining Company is nearly finished constructing a specially designed piece of machining equipment when the customer declares bankruptcy and cannot pay for the equipment. Vickery estimates that the cost associated with making the uncompleted equipment was $1,800,000. Since the machining equipment was specially designed for the customer, there are no other buyers for the equipment unless it is rebuilt. The cost to rebuild is $600,000, after which the product can be sold for $750,000, or the equipment can be scrapped for $100,000. a. Identify each of the costs in this scenario as a sunk cost, incremental cost, or incremental revenue. b. What should Vickery do?

Answer 1

Explanation:

As we know that

The sunken cost is the expense already incurred and will not be recovered in the future. And as well as, it's also called past cost. That cost at the time of decision-making is useless so it would be ignored.

The incremental cost is the cost that is incurred for producing the additional units  

Whereas the incremental revenue is the revenue that is earned for the sold of the additional units a. So according to the given description above, the categorization is shown below:

1. Vickery estimates that the cost associated with making the uncompleted equipment was $1,800,00 = Sunk cost

2. The cost to rebuild is $600,000 = Incremental cost

3. The sale value of the product = Incremental revenue b. As we can see that the rebuilding cost is $600,000 and the sale value is $750,000 plus the scrapped value is $100,000

So by this, he should not scrap it because it gives him an incremental profit of $150,000 ($750,000 - $600,000) if he rebuilds and sells to another buyer.