Sunk and opportunity costs for decision-making. Mrs Johnston has taken out a lease on a shop for a down payment of £5000. Additionally, the rent under the lease amounts to £5000 per annum. If the lease is cancelled, the initial payment of £5000 is forfeit. Mrs Johnston plans to use the shop for the sale of clothing, and has estimated operations for the next 12 months as follows:
(£) (£)
Sales 115 000
Less Value-added tax (VAT) 15 000
Sales less VAT 100 000
Cost of goods sold 50 000
Wages and wage related costs 12 000
Rent including down payment 10 000
Rates, heating, lighting and insurance 13 000
Audit, legal and general expenses 2 000
87 000
Net profit before tax 13 000
In the figures, no provision has been made for the cost of Mrs Johnston but it is estimated that one half of her time will be devoted to the business. She is undecided whether to continue with her plans, because she knows that she can sublet the shop to a friend for a monthly rent of £550 if she does not use the shop herself.
You are required to:
(a) (i) explain and identify the 'sunk' and 'opportunity' costs in the situation depicted above;
(ii) state what decision Mrs Johnston should make according to the information given, supporting your conclusion with a financial statement;