1) Terminology description and full explanations of the following 3 concepts - Sunk Cost - Incremental...

1) Terminology description and full explanations of the following 3 concepts

- Sunk Cost

- Incremental Cashflow

- Profitability Index

Expert Solution

1) SUNK COST:

A sunk cost is a cost that an entity has incurred and which it can no longer be recovered. While making decision for investing in an ongoing project sunk cost should not be considered, since such cost cannot be recovered.

Eg are research and development cost, training cost etc.

2) INCREMENTAL CASHFLOW

It means it is the additional operating Cashflow that an organisation recieves from taking on a new project. A positive incremental Cashflow is a good indication that the company's cash flow will increase with the acceptance of the project. A positive incremental Cashflow also indicates that the company should invest in the project.

3) PROFITABILITY INDEX

This concept is also known as PROFIT INVESTMENT RATIO and VALUE INVESTMENT RATIO. Profitability index is the ratio of payoff to investment of a proposed project. It is useful for ranking the project because it allows you to quantify the amount of value created per unit of investment.

It is calculated using following formula :

PI= PV OF FUTURE CASH FLOWS/ INITIAL INVESTMENT

jeff jeffy answered 1 year ago

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