7. Barbara and Fred have decided to put in an automatic sprinkler system at thei

Question

7. Barbara and Fred have decided to put in an automatic sprinkler system at their cabin. They have requested bids and the lowest price they received is S3,800 from Water Systems Inc. (WSI). They decide to do the job themselves. They begin the installation. After few days of work they had spent S700, but Fred hurt his knee and Barbara is sick of the project. On the same day, they again contact WSI, who tells than that with some of the materials they have ins talled they could reduce the price from S3,800 to S3,250. A different contractor, Sprinkler Systems (SS) recommends a design that costs S3,500 and tell Fred and Barbara that this is less than the total they would have spent with WSI (a) How much will Fred and Barbara have spent when the project is over if they accept the new offer from WSI (assuming the costs happen at the same period)? (b) Should Barbara and Fred go with WSI or SS? Why?

Explanation / Answer

Part a) Barbara and Fred have already spent $700 which is now kind of sunk cost because it is not recoverable. With water system Inc, they are going to spend $3,250 in addition to the $700 they have already spent. Therefore Fred and Barbara would have spent $3,950 when the project is over if the accept the offer from water system Inc.

Part b) the sunk cost does not matter in economic decision making. It implies that the new sprinkler system that is going to cost $3,500 is currently expensive then $3,250 proposed by water system inc. Therefore Barbara and friends should go with water system Inc because its current cost is lower.

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