Alderon Enterprises is evaluating a special order it has received for a ceramic fixture to be used in aircraft engines. Alderon has recently been operating at less than full capacity, so the firm’s management will accept the order if the price offered exceeds the costs that will be incurred in producing it. You have been asked for advice on how to determine the cost involved in considering this special order.
The special order also would require 1,500 kilograms of tatooine, a material not normally required in any of Alderon’s regular products. The company does happen to have 2,000 kilograms of tatooine on hand, since it formerly manufactured a ceramic product that used the material. Alderon recently received an offer of $14,000 from Solo Industries for its entire supply of tatooine. However, Solo Industries is not interested in buying any quantity less than Alderon’s entire 2,000-kilogram stock. Alderon’s management is unenthusiastic about Solo’s offer, since Alderon paid $20,000 for the tatooine. Moreover, if the tatooine were purchased at today’s market price, it would cost $11.00 per kilogram. Due to the volatility of the tatooine, Alderon will need to get rid of its entire supply one way or another. If the material is not used in production or sold, Alderon will have to pay $1,000 for each 500 kilograms that is transported away and disposed of in a hazardous waste disposal site.
Using the cost terminology introduced in this chapter, comment on each of the cost figures mentioned in the preceding discussion.
1. How much is the sunk cost and why it is considered a sunk cost? Justify your answer.
2. How much is the opportunity cost lost if this special order is accepted and why it is considered opportunity cost? Justify your answer.
3. How much is the out-of-pocket cost and why it is considered out-of-pocket cost? Justify your answer.
4. What is the real cost of tatooine to be used in the special order? Justify your answer.