Purchase Solution

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Sales................................................................\$950,000
Variable costs.................................................. 450,000
Fixed costs....................................................... 310,000

A proposed addition to Farrell's factory is estimated by the sales manager to increase sales by a maximum of \$750,000. The company's accountants have determined that the proposed addition will add \$320,000 to fixed costs each year.

A-Explain why the existing \$310,000 of fixed costs is a sunk cost, while the \$320,000 of fixed costs associated with the proposed addition is an out of pocket cost.

B-Calculate by how much the proposed addition will either increase or reduce operating income.

Solution Summary

The solution provides a incremental analysis and project addition.

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Solution A:
A sunk cost is a cost that has already been incurred, and for which the decision of the project addition would not be affected. In other words, a sunk cost has already been paid and cannot be recouped once paid. From the question, you will observe that the company pays ...

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• B. Sc., University of Nigeria
• M. Sc., London South Bank University
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