Smith Petroleum has spent $204,000 to refine 62,000 gallons of petroleum distillate, which can be sold for $6.40 a gallon. Alternatively, Smith can process the distillate further and produce 56,000 gallons of cleaner fluid. The additional processing will cost $1.75 per gallon of distillate. The cleaner fluid can be sold for $9.00 a gallon. To sell the cleaner fluid, Smith must pay a sales commission of $0.13 a gallon and a transportation charge of $0.18 a gallon.
Requirements
1. Diagram Smith’s decision alternatives, using Exhibit 20-26 as a guide.
2. Identify the sunk cost. Is the sunk cost relevant to Smith’s decision?
3. Should Smith sell the petroleum distillate or process it into cleaner fluid? Show the expected net revenue difference between the two alternatives.