Sunk costs and opportunity costs Masters Golf Products, Inc., spent 2 years and

Question

Sunk costs and opportunity costs Masters Golf Products, Inc., spent 2 years and $1,100,000 to develop its new line of club heads to replace a line that is becoming obsolete. To begin manufacturing them, the company will have to invest $1,790,000 in new equipment. The new clubs are expected to generate an increase in operating cash inflows of $756,000 per year for the next 14 years. The company has determined that the existing line could be sold to a competitor for $257,000 a. How should the $1,100,000 in development costs be classified? b. How should the $257,000 sale price for the existing line be classified? c. What are all the relevant cash flows for years 0 thru 14? (Note: Assume that all of these numbers are net of taxes.)

Explanation / Answer

Ans a.The $1,000,000 in development should be classified as sunk costs. It has already been spent and cannot be recovered.

b. The $257,000 sale price for the existing line should be classified as as opportunity costs.

c. The initial investment is 1,533,000 (1,790,000-257000) Net operating cash flow 0 $ (1,533,000.00) 1 $     756,000.00 2 $     756,000.00 3 $     756,000.00 4 $     756,000.00 5 $     756,000.00 6 $     756,000.00 7 $     756,000.00 8 $     756,000.00 9 $     756,000.00 10 $     756,000.00 11 $     756,000.00 12 $     756,000.00 13 $     756,000.00 14 $     756,000.00 Total $ 9,051,000.00

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