McKnight Petroleum has spent $207,000 to refine 64,000 gallons of petroleum distillate, which can be sold for $6.20 per gallon. Alternatively, McKnight can process the distillate further and produce 53,000 gallons of cleaner fluid. The additional processing will cost $1.85 per gallon of distillate. The cleaner fluid can be sold for $9.20 per gallon. To sell the cleaner fluid, McKnight must pay a sales commission of $0.13 per gallon and a transportation charge of $0.16 per gallon.
Requirements
1. Diagram McKnight’s decision alternatives, using Exhibit 25-18 as a guide.
2. Identify the sunk cost. Is the sunk cost relevant to McKnight’s decision?
3. Should McKnight sell the petroleum distillate or process it into cleaner fluid? Show the expected net revenue difference between the two alternatives.