Explain why sunk costs should not be included in a capital budgeting analysis but opportunity costs...

Explain why sunk costs should not be included in a capital budgeting analysis but opportunity costs and externalities should be included (1 point). Give an example of each (1 point).

Expert Solution

Sunk costs are the amount of fund which has been already invested and it will have no effect on future cash flows. As capital budgeting analysis is dependent on future cash flows, sunk costs are not included. For eg, rent is a sunk cost. If a project uses a building and pays rent for it, it will not affect future cash flows as it has to be paid irrespective of the circumstances.

Opportunity costs should be included as it gives the return of the next best alternative; a capital budgeting analysis is done to know whether the project is beneficial for the firm and by how much. In order to know how much it is beneficial from other projects, a benchmark is needed and opportunity costs serve as the purpose of the benchmark. For eg, a project gives return of 10 % and if the money is deposited in bank, it gives 6 % as return. Hence, it aids in knowing that the project is more beneficial by 4 % in comparison to depositing money in the bank.

Externalities are included in capital budgeting analysis as it shows whether the project will have effect on another project or not, and how is the effect, whether positive or negative. For eg, a plant is being established to increase the sales of an existing product. Hence, it is essential to know whether the establishment of this plant will increase the sales or not and by how much.

jeff jeffy answered 2 years ago

Sunk or Opportunity costs. Explain the difference between a sunk cost and an opportunity cost and...

Sunk or Opportunity costs. Explain the difference between a sunk cost and an opportunity cost and give an example of each. please explain in depth.

Why are relevant costs important in decision making? Explain sunk costs, incremental costs, opportunity costs, make...

Why are relevant costs important in decision making? Explain sunk costs, incremental costs, opportunity costs, make or buy decisions and strategic costing giving examples of each.

Why is it that sunk costs are never relevant to a decision whereas opportunity costs are...

Why is it that sunk costs are never relevant to a decision whereas opportunity costs are always relevant? Why do you think Goldratt’s Theory of Constraints received so much press by the business community?

Explain sunk costs and opportunity costs. Provide a business example for each of these terms.

discuss sunk and opportunity costs, why must managers consider these things

Differentiate between opportunity costs and sunk costs. Are they used differently in decision-making? Explain.

Why don't we include sunk costs in decision making? Define relevant costs and opportunity costs and...

Why don't we include sunk costs in decision making? Define relevant costs and opportunity costs and explain how they're different from sunk costs.

describe differential cost, avoidable costs, sunk costs, and opportunity costs

Discuss in depth how opportunity cost, cannibalization, positive externalities, and sunk costs are instrumental in capital...

Discuss in depth how opportunity cost, cannibalization, positive externalities, and sunk costs are instrumental in capital budgeting decision making.

define capital budgeting and explain why it is important to business and if the financial analysis...

define capital budgeting and explain why it is important to business and if the financial analysis should play a dominant role in capital budgeting decisions

Question