Sunk and opportunity Cash flows
Don and Betsy Draper have been living at their present home for the past 6 years. During that time, they have replaced the water heater for $375, replaced the dishwasher for $599, and have had to make miscellaneous repair and maintenance expenditures of approximately $1,500. They have decided to move out and rent the house for $975 per month. Newspaper advertising will cost $75. Don and Betsy intend to paint the interior of the home and power-wash the exterior. They estimate that will run about $900. The house should be ready to rent after that. In reviewing the financial situation, Don views all of the expenditures as being relevant, and so he plans to net out the estimated expenditures discussed above from the rental income.
- Do Don and Betsy understand the difference between sunk costs and opportunity costs? Explain the two concepts to them.
- Which of the expenditures should be classified as sunk costs and which should be viewed as opportunity cash flows?