Question

Warner Corporation purchased a machine 7 years ago for $319,000 when it launched product P50. Unfortunately, this machine has broken down and cannot be repaired. The machine could be replaced by a new model 300 machine costing $313,000 or by a new model 200 machine costing $275,000. Management has decided to buy the model 200 machine. It has less capacity than the model 300 machine, but its capacity is sufficient to continue making product P50. Management also considered, but rejected, the alternative of dropping product P50 and not replacing the old machine. If that were done, the $275,000 invested in the new machine could instead have been invested in a project that would have returned a total of $374,000.

Required:

1. What is the total differential cost regarding the decision to buy the model 200 machine rather than the model 300 machine?

2. What is the total sunk cost regarding the decision to buy the model 200 machine rather than the model 300 machine?

3. What is the total opportunity cost regarding the decision to invest in the model 200 machine?

Answer 1

1. The differential cost is computed as follows:

Cost of a new model 300 (a).............................. $313,000

Cost of a new model 200 (b).............................. $275,000

Differential cost (a) ‒ (b) ................................... $38,000

2. The sunk cost is the cost of the machine purchased seven years ago for $319,000.

3. The opportunity cost is the $374,000 that could have been earned by pursuing the forgone option. 

1. The differential cost is computed as follows:

Cost of a new model 300 (a).............................. $313,000

Cost of a new model 200 (b).............................. $275,000

Differential cost (a) ‒ (b) ................................... $38,000

2. The sunk cost is the cost of the machine purchased seven years ago for $319,000.

3. The opportunity cost is the $374,000 that could have been earned by pursuing the forgone option.