4.2. Current Value and Sunk Cost Analysis

Try these first

1. 1.

   Define Equivalent Annual Cost (EAC).

   Hint

   Think about how costs can be distributed across years.

2. 2.

   What is a sunk cost?

   Hint

   Consider costs that have already been spent on prior decisions.

3. 3.

   What does EAC stand for?

   • Effective Annual Cost
   • Equivalent Annual Cost
   • Estimated Annual Cost

   Hint

   It relates to how costs can be annualized.

4. 4.

   True or False: Sunk costs should be included when making a decision about a future investment.

   • True
   • False

   Hint

   Remember what happens when money is spent.

5. 5.

   A firm is choosing between two different systems, System A with an upfront cost of $200,000 for a lifetime of 15 years, and System B costing$180,000 lasting 12 years. Account for salvage values of $20,000 for both. Which has the lower EAC at a discount rate of 5%? Show detailed calculations.

   Hint

   Focus on how future costs are transformed into annual costs!

6. 6.

   A manufacturer invested $1 million into machinery, with operating costs projected to be$150,000/year. After 7 years, they can sell the machinery for $100,000. If the EAC is higher than anticipated, discuss potential business strategies to mitigate losses.

   Hint

   Look towards future opportunities rather than past investments to make cost-effective decisions.