Question

Management of Lee Corporation is considering whether to purchase a new model 370 machine costing $512,000 or a new model 220 machine costing $408,000 to replace a machine that was purchased 12 years ago for $455,000. The old machine was used to make product I43L until it broke down last week. Unfortunately, the old machine cannot be repaired. Management has decided to buy the new model 220 machine. It has less capacity than the new model 370 machine, but its capacity is sufficient to continue making product I43L. Management also considered, but rejected, the alternative of simply dropping product I43L. If that were done, instead of investing $408,000 in the new machine, the money could be invested in a project that would return a total of $485,000. In making the decision to buy the model 220 machine rather than the model 370 machine, the sunk cost was:

• $455,000

• $408,000

• $512,000

• $485,000

Answer 1

Answer: $455,000

Explanation:

$455,000 is a cost that is already incurred and hence is not relevant for the decision making on hand, which is, whether to replace the machine with the one of the two models available--models 220 and 370.

Sunk costs are costs that are already incurred due to which they do not affect the decision on hand.