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Problem 7-5 Keep-or-Buy Decision, Sunk Costs

Problem 7-5 Keep-or-Buy Decision, Sunk Costs
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MT425 / MT 425
Managerial Finance and Accounting
Kaplan University (KU Campus)

James Jiambalvo
Managerial Accounting, 4e
Hoboken, NJ: John Wiley & Sons.

Unit 6: Management Accounting in a Competitive Business Environment

Chapter 7 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.



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