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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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See Also This Related BrainMass Solution

Operating Costs - A business is considering replacing its existing van with a new one.

The following information applies to all parts:

A business is considering replacing its existing van with a new one. The new van can offer considerable savings in operating costs. Information about the existing van and the new van follow:

Existing Van New Van
Original cost $100,000 $180,000
Annul operating cost $35,000 $20,000
Accumulated depreciation $60,000 ----
Current salvage value of the existing van $45,000 ----
Remaining life 10 years 10 years
Salvage value in 10 years $ 0 $ 0
Annul depreciation $4,000 $18,000 -

1) Sunk costs include____________.

the original cost of the existing van, the original costs of the new van, the current salvage value of the existing van, or the annual operating cost of the new van

2) Relevant costs for this decision include _________.

the original cost of the existing van, accumulated depreciation, the current salvage value, or the salvage value in 10 years

3) Costs are relevant to a particular decision if they ________.

are variable costs, differ across the alternatives being considered, are fixed costs, or remain unchanged across the alternatives being considered

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