Which of the following are relevant cash flows and what type of cost would you c

Question

Which of the following are relevant cash flows and what type of cost would you categorize them as given all the cost terms covered in this chapter?

The CEO will spend 20% of his time on the new project so we will allocate 20% of his salary as a project cost.

The project’s forecast sales are based on a $500,000 test market

The project will require the addition of one administrative assistant

The project will utilize a facility we already own that can be rented out for $4,000 per month.

What are the potential differences in cash flow for a machine that is highly automated versus a machine that requires more employee supervision and ongoing input to run it? How will these different aspects of the new machine affect the final decision whether to replace the current machine?

Explanation / Answer

Particulars Relevant or Irrelevant Comments The CEO will spend 20% of his time on the new project so we will allocate 20% of his salary as a project cost. Irrelevant Since it will be incurred whether project is undertaken or not. The project’s forecast sales are based on a $500,000 test MARKET Sunk Cost(Irrelevant) Since it has already bee incurred and will not be affected whether project is undertaken or not. The project will require the addition of one administrative assistant Relevant Since admin Assistant will be specifically hired for this project. The project will utilize a facility we already own that can be rented out for $4,000 per month. Oppurtunity cost(Relevant) Since rent will be lost if project is undertaken. Thus it needs to be considered while analysing project costs. In case of highly automated machine there are more factory overhead which includes higher depreciation, fuel, poweretc In case of less automated machine there are more Labour charges and supervision cost for monitoring labour The difference in cash flows need to be discounted over the life of the machine by using appropriate discountr rate and then the machine with higher NPV is selected.

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