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H received an order for product Y. It need additional machine capacity. It purchased a machine that could be used three years ago for $25,000. It could be sold for $8,000. The replacement cost of the equivalent machine is $10,000. If H keeps the machine for use else where, it will generate net income of $11,000. What is the relevant cost of the contract?
1. The answer is $10,000
2. How(the logic) the answer?If they take the machine for the new order, they have the choice of either replacing the machine and so paying $10,000, or not replacing the machine and so losing income of $11,000.
They will choose to replace because 10,000 is less than the 11,000 they would otherwise lose.The original cost of 25000 is a sunk cost and therefore irrelevant. The sales value of 8,000 is irrelevant because they would never consider selling it when it is currently earning them 11,000.
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