The machine your firm currently uses produces a unit of good at a cost of $5 per unit and a profit per unit of $3

Finance Nov 24, 2020

The machine your firm currently uses produces a unit of good at a cost of $5 per unit and a profit per unit of $3. The current machine costs $4,500, but is already paid for. A new machine can produce a unit of good at a cost of $3 per unit and a profit of $5. The new machine costs $10,000. In the capital budgeting analysis (NPV) the cost of switching to the new machine O Should include the $4,500 cost of the current machine since this is an opportunity cost. O Should NOT include the $4,500 cost of the current machine since this is a sunk cost. O Should only include the incremental cost of $5,500 ($10,000 - $4,500)

Expert Solution

The answer is

SHOULD NOT include the $4500 cost as it has already been incurred and is a sunk cost

Sunk costs are not relevant and hence, not taken

Full cost of $10,000 is relevant as it is an incremental cash flow

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