EXERCISE 2–8 Opportunity Costs and Sunk Costs [LO7]

Johnson Company manufactures sporting goods. One of its products is generating very low operating income, and management is trying to decide whether it should keep or drop that product. Five years ago, the company paid $1,500,000 for the building in which the product is manufactured and $500,000 for the land. The net book value (original cost less accumu- lated depreciation) for the building is $1,375,000. Management paid the annual property taxes and insurance on the building two weeks ago ($30,000 total). The manufacturing equipment used to make the product was also purchased five years ago at a cost of $300,000 and has a net book value of $150,000. Management was recently approached by an individ- ual who offered to pay $1,000,000 for the land, building and equipment. Two weeks later, a second individual contacted management and offered to rent the manufacturing facilities for $20,000 per month.

 

Required:

Which of the above costs are opportunity costs with respect to deciding whether or not to continue to manufacture the product, and which are sunk costs? Explain your answers.