Westside Plumbing and Heating Company is offered a contract for $100,000 to prov

Question

Westside Plumbing and Heating Company is offered a contract for $100,000 to provide plumbing for a new building. The labor and equipment costs are calculated to be $60,000 for fulfilling the contract. Westside has materials in its inventory to complete the job. The raw materials initially cost the firm $50,000; however the material prices have declined in the interim and now cost only $37,500. Thus if the firm chose not to accept the contract and sells the materials, they would incur a loss of $12,500. Material prices are not expected to go up in the future. Should Westside accept the contract

Explanation / Answer

Raw materials is a sunk cost. Sunk costs should always be ignored when determining the acceptance or rejection of a proposed contract. Because whether or not you accept the contract, you'll have the same loss. Costs of completing the contract $60,000 Labor + equipment $37,500 Materials $97,500 Total Contract Fee is $100,000 Thus a $2,500 profit. Westside Plumbing would still have the $50,000 of materials in its inventory that it could sell for a loss later, but those materials should never come into the equation.

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