You are a fleet manager for a metro-area company. You’ve recently discovered tha

Question

You are a fleet manager for a metro-area company. You’ve recently discovered that ten of your company’s vehicles require repairs which will cost an estimated $2,000 each. In considering whether to repair or replace your vehicles, your college roommate suddenly calls one day. After relaying your predicament, your roommate tells you that you need to consider all of the past repairs that those vehicles have cost the company, and pushes you to lean in favor of repair rather than replace. How would you assess your roommate’s advice?

Select one:

a. Whenever the value of the repair exceeds the replacement cost, it is preferable to disinvest from the asset entirely. The appropriate choice is to neither repair nor replace, but to sell the vehicles as-is.

b. Past repairs represent an investment in an asset; your roommate is correct that recouping the value of the investment necessitates keeping the vehicles and repairing them, rather than replacing them.

c. Past repairs increase the current value of the vehicle, and so the cost of those past repairs should be considered a benefit that may partially or completely offset the cost of the repairs that are now required.

d. The existence of past repairs is a sunk cost that does not affect the current cost-benefit decision, and so the cost of past repairs is irrelevant to your present decision whether to repair or replace.

Explanation / Answer

Whenever the value of the repair exceeds the replacement cost, it is preferable to disinvest from the asset entirely. The appropriate choice is to neither repair nor replace, but to sell the vehicles as-is.

Let me validate the above answer.

As per the 50/50 rule, one would consider to better forego the asset if you can get a higher value in the market. If a buyer is ready to buy the product, he will not be concerned about the past repairs you have done to the product. The past repairs which you have done would only add to the salvage cost which is a meagre amount that would be deducted from the cost of the product at the time of sale. He is concerned only about the quality of the product. Hence it is suggested neither to repair the machine nor to replace but to forego it at a reasonable price.

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