Question

can you explain in details how did we come up with this answer and how to answer similar

NO.148 Two years ago, the purchasing manager at a company spent $25,000 on a new machine that
would improve production efficiency at the company. The manufacturers of the machine release an
updated model that costs $35,000 and that promises to further improve production efficiency. Under
what conditions should the purchasing manager upgrade to the new model?
A. If the savings from the additional efficiency improvements are large enough to offset the $35,000
cost of the new machine
B. If the savings from the additional efficiency improvements are large enough to offset the $10,000
difference in price between the machines
C. If the savings from the additional efficiency improvements are large enough to offset the $60,000
spent on machines
D. If the efficiency improvements from the old machine did not result in enough savings to offset the
$25,000 purchase price
Answer: A

Answer 1

The machine was bought 2 years ago. The cost associated with its buying cannot be recovered today. It has already incurred. It is known as sunk cost. Whatever be the amount, it is not relevant. The amount has been spent.

The decision to be made is whether or not the new upgrade should be bought. This decision needs to be taken independent of whatever cost is already incurred. The cost for upgrading is $35000. Therefore, if savings is more than this, then it makes sense to invest in the upgrade. If savings is less than $35000, it would not add value to buy the upgrade.

Thus, the correct option is A and not b, c or d.

B. Is incorrect as savings should be atleast $35000 so that cost of upgrading is recovered at least.

C. Is wrong as amount $25000 is already spent. It cannot be recovered. This decision of upgrading is independent. If atleast $35000 can be saved from upgrading, it should be upgraded.

D. Is wrong as purchase price should not be looked into as it is sunk cost.

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