11-5 Sunk costs and opportunity costs:
Covol Industries is developing the relevant cash flows associated with the proposed replacement of an existing machine tool with a new, technologically advanced one. Given the following costs related to the proposed project, explain whether each would be treated as a sunk cost or an opportunity cost in developing the relevant cash flows associated with the proposed replacement decision.
a. Covol would be able to use the same tooling, which had a book value of $40,000, on the new machine tool as it had used on the old one.
b. Covol would be able to use its existing computer system to develop programs for operating the new machine tool. The old machine tool did not require these programs. Although the firm’s computer has excess capacity available, the capacity could be leased to another firm for an annual fee of $17,000.
c. Covol would have to obtain additional floor space to accommodate the larger new machine tool. The space that would be used is currently being leased to another company for $10,000 per year.
d. Covol would use a small storage facility to store the increased output of the new machine tool. The storage facility was built by Covol 3 years earlier at a cost of $120,000. Because of its unique configuration and location, it is currently of no use to either Covol or any other firm.
e. Covol would retain an existing overhead crane, which it had planned to sell for its $180,000 market value. Although the crane was not needed with the old machine tool, it would be used to position raw materials on the new machine tool.
This question was answered on: May 23, 2022
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