Question

Mrs Johnston has taken out a lease on a shop for a down payment of €5000. Additionally, the rent under the lease amounts to €5000 per annum. If the lease is cancelled, the initial payment of €5000 is forfeit. Mrs Johnston plans to use the shop for the sale of clothing, and has estimated operations for the next 12 months as follows: Sales Less Value-added tax (VAT) Sales less VAT 115,000 15,000 100,000 50,000 12,000 10,000 Cost of goods sold Wages and wage-related costs costs Rent including the down payment Rates, heating, lighting and insurance Audit, legal and general expenses 13,000 2,000 Net profit before tax 87,000 13,000 In the figures no provision has been made for the cost of Mrs Johnston but it is estimated that one half of her time will be devoted to the business. She is undecided whether to continue with her plans because she knows that she can sublet the shop to a friend for a monthly rent of €550 if she does not use the shop herself. You are required to: A. Explain and identify the 'sunk' and 'opportunity' costs in the situation depicted above B. State what decision Mrs Johnston should make according to the information given, supporting your conclusion with a financial statement.

Answer 1

A.	Sunk costs	Downpayment made for lease amounting of $5,000 is a sunk cost.
	Opportunity costs	Rent forgo per month amounting to $550 and yearly $6,600 is opportunity cost.
B.	Net profit before tax	$13,000
	Add: sunk costs	$5,000
	Less: opportunity cost	$6,600
	Net profit after adjustments	$11,400
	Hence, Mrs. Johnston may accept the offer as it will lead to a gain of $11,400 per annum after considering all opportunity costs and sunk costs.