Question

Sunk costs and opportunity costs Masters Golf Products, Inc. spent four years and $ 1,200,000 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 $1,780.000 in new equipment. The to generate an increase in operating cash inflows of $744,000 per year for the next 10 years. The company has determined that the existing line could be sold to a competitor for

new clubs are expected
a. How should the $51 200,000 in development costs be classified?
$252,000
b. How should the $252,000 sale price for the axisting Ina be classified?
c. What are all the incremental cash flows for years 0 thru 107 (Note Assume that all of these numbers are net of taxes)

Answer 1

Sunk costs are past expenses that should not affect future decision-making; the $1,200,000 development cost is a sunk cost. The $252,000 from selling the existing line is an opportunity cost if not realized. Incremental cash flows involve an initial investment and expected annual inflows, adjusted for opportunity costs.

Step-by-step explanation:

The sunk costs of $1,200,000 in development spent by Masters Golf Products, Inc. should be considered a past expense that is not relevant to the future business decision making. It's a cost that has already been incurred, and it cannot be recovered. The cash inflows and outflows that the company experiences from this point forward are the relevant costs for decision-making.

The $252,000 sale price for the existing line could be considered an opportunity cost if the company decides not to sell; this is the revenue they would forego if they keep the old line instead of selling it to a competitor.

To calculate the incremental cash flows for years 0 through 10, we must consider the initial investment of $1,780,000 at year 0, the potential sale of the existing line for $252,000, and the additional annual operating cash inflows of $744,000 from year 1 to year 10.