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3 June, 15:28

Management of Plascencia Corporation is considering whether to purchase a new model 370 machine costing $465,000 or a new model 220 machine costing $411,000 to replace a machine that was purchased 7 years ago for $431,000. The old machine was used to make product I43L until it broke down last week. Unfortunately, the old machine cannot be repaired. Management has decided to buy the new model 220 machine. It has less capacity than the new model 370 machine, but its capacity is sufficient to continue making product I43L. Management also considered, but rejected, the alternative of simply dropping product I43L. If that were done, instead of investing $411,000 in the new machine, the money could be invested in a project that would return a total of $439,000. In making the decision to buy the model 220 machine rather than the model 370 machine, the sunk cost was

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  1. 3 June, 17:11
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    Sunk cost = WDV of old machinery costing $431,000 - Any amount recovered.

    Explanation:

    Sunk cost is the cost that has actually been incurred and can not be avoided in any manner, currently while making both the decisions whether to buy model 220 machine or 370 machine we incurred the cost of dropping the old machinery of value of $431,000.

    Therefore the book value of old machinery costing $431,000 is the sunk cost incurred in making the decision of buying new model.

    In case any amount is recovered from sale of such amount then such amount recovered shall be deducted from the Written down value (WDV) of the old machinery and that will be our sunk cost.

    Sunk cost = WDV of old machinery costing $431,000 - Any amount recovered.
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