Question

4. (Identifying incremental cash flows) Last week, your firm bought a fleet of trucks for $200,000 to begin a delivery service business. Today, someone came up with the idea to use the trucks to sell ice cream to suburban children door to door. Converting the trucks would cost $75,000. You have been asked to work on this capital budgeting project.

a. What is the role of the $200,000 in your analysis?

b. What is the role of the $75,000 in your analysis?

c. What other information would you need to know about the trucks before making this decision?

Answer 1

Answer to question no. 4

(a) Firm has already bought a fleet of truck for $200000 to begin a delivery service business. Now someone came with an idea for use of trucks to sell ice cream.
Hence $200000 is Sunk Cost in my new capital budgeting decision analysis because it has already been expended.

(b) Conversion of truck for use in selling ice cream would cost $75000 which is an investment for the new project. We had not expended this amount yet an we are now just analysing the new business of selling ice cream. Hence this will be used in our analysis as an initial investment or outflow.

(c) Other information that we will need to know about the trucks before making this decision are as follows:-
Additional Repair & Maintenance expense
Petrol expenses
Milage of truck/fuel consumption per km
Opportunity cost of using the truck etc.

And apart from above we will also see that what is the NPV of the project, cost of capital, Tax rates, depreciation benefits, salvage value of truck, Revenue, our contribution, any extra overhead etc.