Chapter 10, Problem 1MCQ

To determine

Relevant and Sunk Costs:

Relevant costs are those costs in any managerial decision-making process that will influence the flow of capital in the future. Hence, such costs decide whether the decision is taken forward or rejected.

On the other hand, sunk costs can be referred to as the outflows of cash which have already occurred, and no further decision can be taken to recover them. Such types of costs are required to be ignored while making decisions.

To identify: The correct statement from the given statements.

Answer to Problem 1MCQ

Solution:

Option a.

The company must correct the defect and sell them at the regular price is the correct statement.

Explanation of Solution

Option a.

The company has produced defective products, so the cost of production is a sunk cost and thus, no longer relevant. It is to be seen that maximum incremental revenue can be generated by the detective goods.

If the company corrects the anomaly and resells the product at its original price, the incremental revenue generated is calculated as shown below.

$\begin{array}{c}\text{Incremental}\text{Revenue}=\left[\begin{array}{l}\left(\text{Rate}\text{at}\text{which}\text{sold}-\text{Recycler's}\text{rate}\right)\times \\ \text{Number}\text{of}\text{defective}\text{products}\end{array}\right]\\ =\left(19-8\right)\times 3,000\\ =11\times 3,000\\ =\$33,000\end{array}$

Hence, option a is correct.

Option b.

If the company decides to sell it to the recycler, the incremental revenue is as follows.

$\begin{array}{c}\text{Incremental}\text{Revenue}=\left[\begin{array}{l}\text{Recycler's}\text{rate}\times \text{Number}\text{of}\\ \text{defective}\text{products}\end{array}\right]\\ =8\times 3,000\\ =\$24,000\end{array}$

In this case, the incremental revenue is less than $33,000. Hence, option b is not correct.

Option c.

If the company decides to sell 2,000 units, incremental revenue is as follows.

$\begin{array}{c}\text{Incremental}\text{Revenue}=\left\{\begin{array}{l}\left(\text{Rate at which sold}-\text{Recycler's}\text{rate}\right)\times 1,000\\ +\text{Recycler's}\text{rate}\times 2,000\end{array}\right\}\\ =\left(19-8\right)\times 1,000+8\times 2,000\\ =\$27,000\end{array}$

The incremental revenue in this case is also less than $33,000. Hence, option b is not correct.

Option d.

If the firm decides to sell 1,000 units, the incremental revenue is as follows.

$\begin{array}{c}\text{Incremental}\text{Revenue}=\left\{\begin{array}{l}\left(\text{Rate at which sold}-\text{Recycler's}\text{rate}\right)\times 1,000\\ +\text{Recycler's}\text{rate}\times 1,000\end{array}\right\}\\ =\left(19-8\right)\times 1,000+8\times 1,000\\ =\$19,000\end{array}$

In this case, the incremental revenue is less than $33,000. Hence, option d is not correct.

Option e.

If the firm decides to throw the players away, no incremental revenue would be generated. Hence, option (e) is also not correct.

Conclusion

Hence, to maximize the incremental revenue, the firm must correct the anomaly and sell it in the market at the same price. Hence, the correct option is a.