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Sunk costs and opportunity costs - Masters Golf Products, Inc. spent 4 years and $1,160,000 to...

Sunk costs and opportunity costs - Masters Golf Products, Inc. spent 4 years and $1,160,000 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 $1,850,000 in new equipment. The new clubs are expected to generate an increase in operating cash inflows of $746,000 per year for the next 14 years. The company has determined that the exiting line could be sold to a competitor for $248,000.

a. how should the $1,160,000 in development costs be classified?

b. how should the $248,000 sale price for the existing line be classified?

c. what are all the relevant cash flows for years 0 through 14 (note: that all of the numbers are net of taxes)?

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Answer #1

a. Devlopment cost of $116000 is to be classified as sunk cost and it is irrelevant for decision making

b. $248,000 sale price for the existing line be classified as opportunity cost as it is cost of moving to a better opportunity

c. relevant cash flows for years 0 through 14. The initial investment is $ 1850000- $248000= $ 1602000

0.-$1602000

1.$ 746000

2.$ 746000

3 $ 746000

4.$ 746000

5.$ 746000

6.$ 746000

7.$ 746000

8.$ 746000

9.$ 746000

10.$ 746000

11$ 746000

12.$ 746000

13.$ 746000

14.$ 746000

SO net cash inflows= $ 8842000

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