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Rick buys a 1966 Mustang for $3,000, planning to restore and sell the car
Rick buys a 1966 Mustang for $3,000, planning to restore and sell the car. He goes on to spend $9,000 restoring the car. At this point, he can sell the car for $10,000. As an alternative, he can spend an additional $3,000 replacing the engine. With a new engine, the car would sell for $13,000. Rick should:
a) Complete the repairs and sell the car for $13,000,
b) Sell the car now for $10,000,
c) Never try such an expensive project again,
d) Be indifferent between: selling the car now and replacing the engine and then selling it.
Expert Solution
Rick should b) Sell the car now for $10,000,
Selling the car now will be at a loss of -$2,000 - The $3,000 original cost plus the $9,000 he invested minus the $10,000 selling price.
If he replaces the engine, he will have $15,000 invested and he can sell the car for $13,000, which is also a loss of -$2,000. But there will also be an additional loss of the time he would invest in replacing the engine, which would put him further behind. Thus the marginal cost of doing any further work on the car is more than the marginal benefit, or in this case means a smaller marginal loss.
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