3.1. Cash Flow Diagram for Defender

Try these first

1. 1.

   What is the annual operating cost of the challenger?

   Hint

   Look for the lowest annual cost between defender and challenger.

2. 2.

   Define what a sunk cost is.

   Hint

   Think about costs that can no longer be altered.

3. 3.

   What is the annual operating cost of the defender?

   • $135,000
   • $90,000
   • $600,000

   Hint

   It's the higher of the two costs discussed.

4. 4.

   True or False: Sunk costs should be considered in replacement analysis.

   • True
   • False

   Hint

   Remember what sunk costs represent.

5. 5.

   Given that the initial cost and book value of the defender are $3,800,000, what would be the sunk cost if the current trading value is$2,250,000?

   Hint

   Sunk cost is only relevant to current losses, not future income.

6. 6.

   If the interest rate were to increase from 10% to 12%, recalculate the EAC for both equipment and determine the preferred option.

   Hint

   Remember that increased rates affect future value definitions.