ABC Inc has spent $153,000 on research developing a new type of snowshoe. For th
ID: 2733262 • Letter: A
Question
ABC Inc has spent $153,000 on research developing a new type of snowshoe. For this snowshoe to now be manufactured, the firm will need to expand into an empty building that it currently owns. The firm was offered $329,000 last week for that building. An additional $282,000 will be required for new equipment and building improvements. Labor and material costs are estimated at $24.98 per pair of snowshoes. Interest expense on the loan needed to finance the production of this new snowshoe will be $175,000 a year. Which one of these correctly identifies the sunk costs?
All of the costs are sunk costsExplanation / Answer
________
Explanation:
A sunk cost is a cost which has been incurred in the past and and which has no connection with the value of future cash flows/benefits expected from the project. Such a cost should, therefore, not be considered relevant for the purposes of making decisions relating to acceptance/rejection of a proposed project. The costs expected to occur in the future once the project has been accepted are relevant for decision making purposes and should not be treated as sunk costs. Therefore, Option A and C are incorrect.
$329,000 for building would represent an opportunity cost. Therefore, Option D is incorrect.
$153,000 for research (which is Option B)