Sven owns ABBA Bar (a bar dedicated to the Disco band ABBAS). Sven pays his land
ID: 1153805 • Letter: S
Question
Sven owns ABBA Bar (a bar dedicated to the Disco band ABBAS). Sven pays his landlord a monthly
rent of $3,000. If Sven breaks the lease before the end of the calendar year, he must pay $2,000 for
each of the remaining months in that year. Sven just purchased $40,000 of ABBA-themed bar fixtures;
the fixtures have absolutely no value in any alternative use (a sacrilegious thing to say). Each weekend
Sven contracts with a security company that provides four security guards for a total of $1,200
a. Is the $1,200 payment to the security firm a variable cost, sunk cost, or avoidable fixed cost?
Explain your answer
b. Suppose that at the end of August Sven permanently shuts down his bar. What are Sven's sunk costs?
Explanation / Answer
a.
The amount $1,200 is an avoidable fixed cost.
Explanation: This is not a variable cost, since it doesn’t depend on the number of audience. This is not a sunk cost, since the cost is recurring in nature. Therefore, this is a fixed cost since the payment is fixed for each period; this is also avoidable, because there will be no such cost if the unit is discontinued.
b.
The non-recoverable amounts due to shut-down should be considered as sunk cost. This is also the cost which doesn’t depend on future decision making, suppose continuing or discontinuing a unit.
Answer: The suck cost is the fixture of $40,000.
This is the suck cost, since it has no recoverable value.
The other two amounts are not suck costs:
$2,000: This is the amount which depends on decision making; such as if the unit is continued the lease rent is $3,000 but if the unit is discontinued such rent would be $2,000. Since it depends on organizational decision, it is not a sunk cost.
$1,200: As described above this is an avoidable fixed cost but not sunk cost.
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