Question

(CHAPTER 10)

TRUE OR FALSE? The following cash flows are irrelevant to proposed project valuation.

Interest payments on loans that would be taken to raise $$ for the initial investment

Money paid over the last few months to local consultants for making projections for future sales revenues of the proposed project

Expenditures made over the last weeks on upgrading existing production equipment that the managers are now considering using for the proposed project

Wages that would be paid every year to the employees who would be working on the proposed project

Answer 1

The following cash flows are irrelevant to proposed project valuation.	TRUE/FALSE	Explination
Interest payments on loans that would be taken to raise $$ for the initial investment	FALSE	Relevant Cost (Note: 1)
Money paid over the last few months to local consultants for making projections for future sales revenues of the proposed project	TRUE	Irrelevant Cost (Already Incurred Sunk Cost)
Expenditures made over the last weeks on upgrading existing production equipment that the managers are now considering using for the proposed project	TRUE	Irrelevant Cost (Already Incurred Sunk Cost)
Wages that would be paid every year to the employees who would be working on the proposed project	FALSE	Relevant Cost (Note: 1)

Note:

(1) Relevant costs are only the costs that will be affected by the specific management decision being considered.

A relevant cost is a cost that differs between alternatives being considered. In order for a cost to be a relevant cost it must be incurred in future which requires Cash flows and should be Incremental to Current Cash flows.

(2) Sunk costs are those which have already been incurred and which are unrecoverable, hence, they are irrelavent for decision making.Sunk costs are excluded from future business decisions because the cost will remain the same regardless of the outcome of a decision.