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Precision Worldwide, Inc.
The management team of Precision Worldwide, Inc. (PWI) is currently facing commonly business dilemmas regarding to strategic decisions due to threat of a new substitute product introduced by the competition (Henri Poulec). The new product (plastic ring) not only has a longer life than the one manufactured by PWI (steel ring). Apparently, it also has a much lower manufacturing cost. In order to solve the problem, PWI should look ahead (as an investment decision) and do not be highly influenced by past operating decisions that were already incurred (fixed or sunk cost fallacy). The intuition or rationale to follow is to identify which are the relevant costs to the decision. In order to address the problem, the following analysis should help PWI to make the decision:
* In the worst case scenario, the special steel inventory with a book value of $390,000 and cost of $110,900 (representing enough material to produce 34,500 rings) should be assumed as a sunk cost. This asset was already purchased and, if there is no market for it (no more steel rings can be sold), the opportunity cost of the inventory is zero. It is probably true that this is not the case of PWI, since they could still have a market and opportunities for the steel rings. Consequently, the cost of this material would not be zero (assuming that the marginal cost of manufacturing the steel rings would be lower or equal to the market price). Otherwise, it is better not to produce the steel rings and dispose the material since inventory costs are incurred if the asset is hold in the warehouse (transportation, space that could be used for other materials, etc.). Finally, there is also the opportunity to evaluate which other replacement parts can be manufactured using the special steel.
* The necessary tools and equipment (total amount of $7,500) is relevant to the decision and should be considered.
* Although the case does not provide enough information about...
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