Question

Our Lakewood facility would benefit from an additional unit (NPV=$10,000). We could buy the new unit for $6,000 or relocate a unit from another facility for $5,000. You decide to relocate a unit. While it is in transit an accident results in the destruction of the unit. There was no insurance on the unit or the transit. The accountant tells you that if you now buy the additional unity, then $11,000 will all be allocated to the project causing it to show a loss. What do you do?

Answer 1

The unit which was meant to relocate was destructed due to accident which is worth of $5,000.

Since, this event has happened it would become sunk cost for the decision making.

If we buy the new unit for $6,000, we would get a gain of $4,000.

But initial loss of existing unit in relocating, we would have a net loss of $4,000 - $5,000 = -$1,000

.

But if the project is not taken up, we can't recover even $4,000 loss out of $5,000.

It is suggested to take up the project inorder to reduce the effect of loss from $5,000 to $1,000.