Kelly Flooring spent 6 years and $800,000 to develop its new style of hardwood f
ID: 2768713 • Letter: K
Question
Kelly Flooring spent 6 years and $800,000 to develop its new style of hardwood floors to replace a line that is becoming obsolete. To roll out its new look hardwood floors to potential builders, the company will have to invest $550,000 in new tools and equipments. The new looking hardwood floor styles are expected to generate an increase in operating cash inflows of $300,000 per year for the next 6 years. They have planned to sell their existing style to a competitor for $160,000.
A. How should the $800,000 in development costs be classified?
B. How should the $160,000 sale price for the existing style be classified?
Explanation / Answer
A. How should the $800,000 in development costs be classified?
It is sunk cost. Whether or not you accept project it will remain same so it is irrelavant. The development cost of $800,000 should not be considered for decision making to go further with new style of hardwood floors because money that was spent cannot be retrieved regardless of whether project is accepted or rejected , this is why it is sunk cost.
B. How should the $160,000 sale price for the existing style be classified?
The sale price $160,000 for the existing style that could be sold is an opportunity cost. Kelly Flooring have the opportunity to sell their existing style to a competitor and receive income of $160,000. If they decide to do anything with existing style they must compare benefit of such decsion versus the sale price of $160,000. Not Proceeding with new style implies opportunity cost of $160,000 because Kelly Flooring will not sell the old style and not able to receive $160,000.
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