Sales $950,000
Variable Costs $450,000
Fixed Costs $310,000
A proposed addition to Farrell's factory is estimated by the sales manager to increase sales by a maximum of $750,000. The company's accountants have determined that the proposed addition will add $320,000 to fixed costs each year.
a) Explain why the existing $310,000 of fixed costs is a sunk cost while the $320,000 of fixed costs associated with the proposed addition is an out of pocket cost.
b) Calculate by how much the proposed addition will either increase or reduce operating income.