Question

Suppose LG decided to invest 45 billion wonin developing and launching a new model of its smart bathroom scales, expecting that it will bring additional sales of 60 billion won. The company has already invested 38 billion wonwhen the marketing department suddenly finds out that the introduction of a similar smart scalesby Samsungwill reduce LG's expected additional sales to 30 billion won. The company's management is trying to decide whether to continue investing in the newproduct or close the project.Explain what decision LG should make and why.

Answer 1

At this juncture after the investment of 38 billion won,

The new investment = 45 – 38 = 7 billion won

New benefits (curtailed) = 30 billion won

Since the new but curtailed benefits of 30 billion won are more than the new additional investment of 7 billion won, it means that marginal benefit is higher than the marginal cost. So LG should make the investment to get the additional sales of 30 billion won. Besides, the already investment of 38 billion won is a sunk cost, not pursuing the additional investment of 7 billion won will cause the company to forego the revenue of 30 billion won.

Hence, going for the remaining investment will help reduce the losses.