Opportunity Cost of Purchase Discounts and Lost Sales

Essay

Opportunity Cost of Purchase Discounts and Lost Sales
Winter Company is a medium-size manufacturer of disk drives that are sold to computer manufacturers. At the beginning of 2010, Winter began shipping a much-improved disk drive, Model W899. The W899 was an immediate success and accounted for $5 million in revenues for Winter in 2010.
While the W899 was in the development stage, Winter planned to price it at $130. In preliminary discussions with customers about the W899 design, no resistance was detected to suggestions that the price might be $130. The $130 price was considerably higher than the estimated variable cost of $70 per unit to produce the W899, and it would provide Winter with ample profits.
Shortly before setting the price of the W899, Winter discovered that a competitor was reading a product very similar to the W899 and was no more than 60 days behind Winter's own schedule. No information could be obtained on the competitor's planned price, although it had a reputation for aggressive pricing. Worried about the competitor, and unsure of the market size, Winter lowered the price of the W899 to $100. It maintained the price although, to Winter's surprise, the competitor announced a price of $130 for its product.
After reviewing the 2010 sales of the W899, Winter's management concluded that unit sales would have been the same if the product had been marketed at the original price of $130 each. Management has predicted that 2011 sales of the W899 would be either 85,000 units at $100 each or 60,000 units at $130 each. Winter has decided to raise the price of the disk drive to $130 effective immediately.
Having supported the higher price from the beginning, Sharon Daley, Winter's marketing director, believes that the opportunity cost of selling the W899 for $100 during 2010 should be reflected in the company's internal records and reports. In support of her recommendation, Daley explained that the company has booked these types of costs on other occasions when purchase discounts not taken for early payment have been recorded.
Required:
a. Define opportunity cost and explain why opportunity costs are not usually recorded.
b. Winter Company's management is considering Sharon Daley's recommendation to book the opportunity costs and have them reflected in its internal records and reports. If one were to record a nonzero opportunity cost, calculate the dollar amount of the opportunity cost that would be recorded by Winter Company for 2010 and explain how this cost might be reflected on its internal reports.
c. Explain the impact of Winter Company's selection of the $130 selling price for the W899 on 2011 operating income. Support your answer with appropriate calculations.
Source: CMA adapted