You are a fleet manager for a metro-area company. You’ve recently discovered tha
ID: 1111583 • Letter: Y
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. 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.
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. 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.
Explanation / Answer
Note that repairs done in the past were conducted to maintain the productivity of the vehicle and not to increase its current value. Repairs done on a machine never increase the current value or book value. Moreover, to sell the vehicle now will require the analysis of cost and benefits and if the net present value is positive and greater than the new vehicle, it should be repaired and not replaced. It is however, true that past repairs cannot be used to compute the present value of the machine and so it becomes a sunk cost.
Hence option A is correct.
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