Question

Goodyear Company has spent $401,000 on research developing a new type of transformer. For this transformer to now be manufactured, the firm will need to expand into an empty building that it currently owns. The firm was offered $1,226,000 last week for that building. An additional $313,000 will be required for new equipment and building improvements. Labor and material costs are estimated at $37,500 per transformer. Interest expense on the loan needed to finance the production of this new transformer will be $56,000 a year. Which one of these correctly identifies the sunk costs?

$1,226,000 value of the building

$401,000 for research

$1,226,000 value of the building plus $313,000 for new equipment and building improvements

$56,000 for interest plus $401,000 for research

$1,226,000 for the building plus $401,000 for research

Answer 1

$401,000 for research will be considered as SUNK COST because it is a past cost which has already been incurred. The decision to accept or reject the project will not have any impact on the the cost incurred on research.

$1,226,000 value of the building is the replacement value of the building and this will be considered as an opportunity cost for using the said building for this project and hence the said cost will become relevant cost which means it will become relevant for decision making purposes with regards to acceptance of the project.

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