Opportunity Cost of Purchase Discounts and Lost Sales
Spring Company manufactures hard drives for computer manufacturers. At the beginning of this year Spring
began shipping a much-improved hard drive, Model W899. The W899 was an immediate success and
accounted for $5 million in revenues for Spring this year.
While the W899 was in the development stage, Spring 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 Spring with ample profits.
Shortly before setting the price of the W899, Spring discovered that a competitor had a product very similar to
the W899 and was no more than 60 days behind Spring'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, Spring lowered the price of the W899 to $100. It maintained the
price although, to Spring's surprise, the competitor announced a price of $130 for its product.
After reviewing the current year's sales of the W899, Spring'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 next year's sales of the W899 would be either 85,000 units at $100 each or 60,000 units at $130
each. Spring has decided to raise the price of the disk drive to $130 effective immediately.
Having supported the higher price from the beginning, Sharon Haley, Spring's marketing director, believes that
the opportunity cost of selling the W899 for $100 should be reflected in the company's internal records and
reports. In support of her recommendation, Haley explained that the company has booked these types of costs
on other occasions when purchase discounts not taken for early payment have been recorded.
and explain why opportunity costs are not usually recorded.
b. What is the current year's opportunity cost?
c. Explain the impact of Spring Company's selection of the $130 selling price for the W899 on next year's
operating income. Support your answer with appropriate calculations.