Question

Management of Plascencia Corporation is considering whether to purchase a new model 370 machine costing $447,000 or a new model 220 machine costing $402,000 to replace a machine that was purchased 7 years ago for $435,000. 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 $402,000 in the new machine, the money could be invested in a project that would return a total of $432,000.

In making the decision to invest in the model 220 machine, the opportunity cost was:

A. $435,000

B. $402,000

C. $447,000

D. $432,000

Answer 1

Let us first try to understand what opportunity cost is

Opportunity cost is the cost of an opportunity foregone in favor of another alternative. In other words, it is what a business could have generated in another alternative.

In the given case, the management of Plascencia Corporation has an opportunity to drop the current product and invest in another project with a return of $ 432,000

So Opportunity cost is $ 432,000. Option D is correct