2.3. Sunk Cost Explanation

Try these first

1. 1.

   Define sunk cost in your own words.

   Hint

   Think about how past investments affect current choices!

2. 2.

   What is the current operating cost of the challenger?

   Hint

   Refer back to the discussion on operating and maintenance costs.

3. 3.

   What defines a sunk cost?

   • A cost that can be recovered
   • A cost that has already been incurred and cannot be recovered
   • A projected future cost

   Hint

   Remember the definition we discussed in class.

4. 4.

   True or False: Salvage value of equipment should be considered in replacement analysis.

   • True
   • False

   Hint

   Think about how salvage value impacts overall costs.

5. 5.

   A company has incurred a cost of 5,00,000 on their current equipment, and its current salvage value is 3,00,000. Explain whether they should consider this cost in a decision about replacing this equipment with a new one costing 4,00,000 with a projected salvage value of 1,00,000.

   Hint

   Consider how ignoring past costs could lead to better decision-making.

6. 6.

   Given the defender and challenger, if the annual operating costs are reduced by 50% with the challenger, calculate the savings over 5 years, ignoring any sunk costs.

   Hint

   Calculate the difference first, then multiply by the number of years.