1) Your company currently sells oversized golf clubs. The Board of Directors wan
ID: 2791125 • Letter: 1
Question
1) Your company currently sells oversized golf clubs. The Board of Directors wants you to look at replacing them with a line of super-sized clubs. Briefly explain whether the following are relevant cash flows to this analysis and if so, how those cash flows can affect any decision. Discuss each item individually.
a. $300,000 drop in sales from terminating the oversized line of clubs
b. $750,000 in land you own that may be used for the project
c. $200,000 spent on Research and Development last year on oversized clubs
d. $350,000 you will pay to Fred Singles to promote your new clubs
e. $125,000 you will receive by selling the existing production equipment which must be replaced
Explanation / Answer
a) Drop in sales from terminating the oversized line of clubs is a relevant cash flow because it is an opportunity cost, i.e., these sales will be lost if we sell new super-sized clubs. In other words, this cash flow is directly affected by the decision. This is a negative cash flow and will in turn reduce our operating cash flows from the new sales.
b) $750,000 in land you own that may be used for the project is not relevant to the project as this is sunk cost which has already happened and will not be affected if we accept the project or not.
c) $200,000 spend on Research and Development last year on oversized clubs is also not relevant as it is sunk cost which has already been spent and it will not affect the project whether we accept it or not.
d) $350,000 you will pay to Fred singles to promote new clubs is a relevant cash flow to the project because this will be spent only if accept the project. This amount is also a negative cash flow and will be reduced from the operating cash flows of the project.
e) $125,000 you will receive by selling the existing production equipment which must be replaced is a relevant cash flow because this will be required only if the project is accepted and so directly affected by the project. This amount will be reduced from the initial investment that will required in any new equipment to produce new super-sized clubs.
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