PROBLEM 7-5. Keep-or-Buy Decision, Sunk Costs [LO 1, 2, 4] Susan Crossing purcha

Question

PROBLEM 7-5. Keep-or-Buy Decision, Sunk Costs [LO 1, 2, 4] Susan Crossing purchased a used Ford Focus for $8,000.Since purchasing the car, she has spent the following amounts on parts and labor:
New stereo system $1,500
New paint job 2,500
New tires 900
New muffler 250
Total $5,150

Unfortunately, the car needs a few major repairs now; among other things, the brake rotors and
pads must be replaced, and the radiator has sprung a leak. (A new radiator is needed.) The repairs
are estimated to cost $2,500. Susan has looked around at other used cars and has found a used Honda Civic for $8,500 that is in very good condition and is approximately the same age as the Ford Focus. Susan can sell the Ford Focus “as is” for $6,500.
a. In trying to decide whether to repair the Ford Focus or buy the Honda Civic, Susan is upset
because she has already spent $13,150 on the Focus. The car seems like it costs too much to sell
at such a large loss. How would you react to her dilemma?
b. Assuming that Susan would be equally happy with either the Ford Focus or the Honda Civic,
should she buy the Civic or repair the Focus? Explain your answer.
c. Are there any qualitative factors that might enter into this decision? Explain.

Explanation / Answer

a. On the face of it , though it seems like Susan is making loss,this should not affect her decsions because the costs are sunk in nature. They are retrospective. b. Susan has two options : Repair the Ford Focus which would involve a cash Outflow of $2500. or, Sell the Ford Focus as is and buy Honda Civic. This would involve a cash outflow of $2000. Obviously , the second option works out cheaper. She would do better by buying Honda Civic. c. Obviously there would be more qualitative factors to consider: 1. Would she able to get Honda Civic in future at such a price. 2. Even if she got , would she be able to sell Ford Focus in future.

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