Question: The PQR Coal Company has several conventional and strip mining

The PQR Coal Company has several conventional and strip mining operations. Recently, new legis-lation has made strip mining, which produces coal of high sulfur content, unprofitable, so those opera-tions will be discontinued. Unfortunately, PQR purchased $ 1 million of earth- moving equipment for the strip mines two years ago and this equipment is not particularly well- suited to conventional mining.
Ms. Big, the president, suggests that since the equipment can be sold for $ 500,000, it should be scrapped. In her words, “ I learned a long time ago that when you make mistakes it’s best to admit them and take your lumps. By ignoring sunk costs you aren’t tempted to throw good money after bad. The original value of the equipment is gone.”
A new employee, Mr. Embeay, has suggested that the equipment should be adapted to the conventional operations. He argues, “ We are about to spend $ 800,000 on some new conventional equipment. However, for a smaller expenditure of $ 250,000 we can adapt the old equipment to per-form the same task. Of course, it will cost about $ 20,000 per year more to operate over the assumed 10- year lives of each alternative. But at an interest rate of 10 percent, the inclusion of the present value of $ 20,000 per year for 10 years and the initial $ 250,000 is still less than $ 800,000 for new equipment. While it’s true that we should ignore sunk costs, at least this way we can cut our losses somewhat.”
Who’s correct? Why? What should PQR do? Why?

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  • CreatedDecember 15, 2014
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