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

Answer: Analysis of relevant cash flows:

1. 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. Reason - As CEO is a regular employee his salary is paid to him any way, even if he does not allocate his time towards the proect.

2. The project’s forecast sales are based on a $500,000 test market - Irrelevant. Reason -Cost were incurred in past which is no further relavant in decision making. These are sunk cost.

3. The project will require the addition of one administrative assistant - Relevant. Reason - It is the incremental cost that the project would incurr if the project is under taken.

4 The project will utilize a facility we already own that can be rented out for $4,000 per month. - Relavant cost. Reason - It is the opportunity forgone, so it's relevant. It is classified as an opportunity cost..

b)The potential differences:

1. Manual machine would require a cashflow outflow towards:

a) Salary benefit of the operator/supervisor of the machine.

b) Higher cost of maintenance, Power usage, higher defects

c) Automated machine may result in higher level of output than the manual machine.

c) The company would perform an analysis incremental analysis of benefits and cost to arrive at the final decesion of replacing the machine.

But it sould be also be taken in to account that, a manual machine with more employees supervison gives the company the flexibility of adujust according to market conditions.

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