Huntington Industries Cash Flows: Sunk Cost or Opportunity Cost
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Huntington Industries is developing the relevant cash flows associated with the proposed replacement of an existing machine tool with a new, technologically advanced one. Given the following costs related to the proposed project, explain whether each would be treated as a sunk cost or an opportunity cost in developing the relevant cash flows associated with the proposed replacement decision. Note: it is not sufficient to simply identify each item as sunk cost or opportunity cost. You must explain why the item is a sunk cost or an opportunity cost.
a) Huntington would be able to use the same tooling, which had a book value of $40,000, on the new machine tool as it had used on the old one.
b) Huntington would be able to use its existing computer system to develop programs for operating the new machine tool. The old machine tool did not require these programs. Although the firm's computer has excess capacity available, the capacity could be leased to another firm for an annual fee of $17,000.
c) Huntington would have to obtain additional floor space to accommodate the larger new machine tool. The space that would be used is currently being leased to another company for $10,000 per year.
d) Huntington would use a small storage facility to store the increased output of the new machine tool. The storage facility was built by Huntington three years earlier at a cost of $120,000. Because of its unique configuration and location, it is currently of no use to either Huntington or any other firm.
e) Huntington would retain an existing overhead crane, which it had planned to sell for its $180,000 market value. Although the crane was not needed with the old machine tool, it would be used to position raw materials on the new machine tool.
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Solution Summary
This solution defines sunk cost and opportunity cost and explains whether each consideration is one or the other and why. This solution is 258 words.
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Sunk cost refers to cost that already incurred and cannot be recovered regardless of future events. Opportunity cost is the cost of any activity measured in terms of the best alternative forgone and it's the sacrifice related to the second best choice. Sunk cost doesn't affect the decision while opportunity cost does.
a) Sunk cost. The cost of the tooling incurred ...
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