Question

A.Hickman Manufacturing purchased a piece of equipment costing $15,000 to produce light-up sneakers for adults. The product is not selling, and the firm is losing money on the adult light-up sneakers. If the company stops producing the adult light-up sneakers, the equipment can be sold for $5,000. In addition, the factory is currently at capacity, so if the company stops producing the adult light-up sneakers, it could produce more of its trail-running sneakers, which would result in $7,000 of additional income. Pretend you are the CEO of Hickman Manufacturing.

What type of cost is the $15,000 cost of the equipment?

i.Should this impact your decision to stop producing the adult light-up sneakers?

What type of cost is the $5,000 salvage value of the equipment?

i.Should this impact your decision to stop producing the adult light-up sneakers?

What type of cost is the $7,000 potential additional income from the trail-running sneakers?

i.Should this impact your decision to stop producing the adult light-up sneakers?

Now pretend that Hickman Manufacturing actually has excess capacity.

i.How would this impact your consideration of the $7,000 additional income from producing more trail-running sneakers?

ii.Would it change your decision regarding whether to stop producing the adult light-up sneakers?

________ Yes, , it would change my decision             ________ No, it would not change my decision

Now pretend that your accountant points out that the adult light-up sneakers actually have a positive segment margin, and that it is the subtraction of common fixed costs that result in a negative income number for the adult light-up sneakers. Considering this, should you keep or stop producing the adult light-up sneakers?

_______ Keep producing the adult light-up sneakers ________ Drop the adult light-up sneakers

Answer 1

1. No, cost of equipment of $ 15000 will not affect the decision. Because it is a sunk cost. And irrelevant for decision making. Sunk cost are those cost which are incurred on the past and have no relevance in future.

2. yes, Salvage value of $ 5000 is relevant for the decision , since this is the amount to be received in the future.

3. yes, $ 7000 is relevant for the decision , since this is the oppourtunity cost of producing the light up sneakers. oppournuity cost are the benefit foregone due to the selection of alternative benefit.

B. No, it would not affect my decision because continuation of light up sneakers will only result in loss and it not goof for business.

C. Yes, keep producing aduly light up sneakers because if the production shuts down it will utlimately result if increase on loss due to the absorption of fixed cost.