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Sunk Costs and Relevant Costs

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6. Pat, a Pizzeria manager, replaced the convection oven just six months ago. Today, Turbo Ovens Manufacturing announced the availability of a new convection oven that cooks more quickly with lower operating expenses. Pat is considering the purchase of this faster, lower operating cost, convection oven to replace the existing one they recently purchased. Selected information about the two ovens is given below:

EXISTING NEW TURBO OVEN
Original Cost $60,000 $50,000
Accumulated depreciation $5,000
Current salvage value $40,000
Remaining life 5 years 5 years
Annual operating expense $10,000 $7,500
Disposal value in 5 years $0 $0

a. What costs are sunk?
b. What costs are relevant?
c. What are the net cash flows over the next 5 years assuming the Pizzeria purchases the new convection oven?
d. What other items should Pat, as manager of the Pizzeria, consider when making this decision?

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Gaurav Agarwal, MS
Education
  • BE, Bangalore University, India
  • MS, University of Wisconsin-Madison
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