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The company that you manage has invested $5 million in developing a new product, but the...

The company that you manage has invested $5 million in developing a new product, but the development is not quite finished. At a recent meeting, your salespeople report that the introduction of competing products has reduced the expected sales of your new product to $4.5 million. If it would cost $3 million to finish development and make the product, you (should, should not??) go ahead and do so. The most you should pay to complete development is (????)million.

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Answer #1

We should go ahead and finish the product. The fact that previous investment is now a sunk cost and cannot be included in the total cost of the product. As of now, the cost is $3 million and the expected sales revenue is $4.5 million so there is a profit of $1.5 million. Ignoring the sunk cost would anable the company to earn profits and therefore continuing production with be an economically rational and wise choice.

The most you should pay to complete development is 4.5 million because it is what we are expecting to receive as revenue.

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