Iridium Corp. has spent $3.5 billion over the past decade developing a satellite

Question

Iridium Corp. has spent $3.5 billion over the past decade developing a satellite, based telecommunication system. It is currently trying to decide whether to spend an additional $350 million on the project. The firm expects that this outlay will finish the project and will generate cash flow of $15 million per year over the next 5 years. The competitor has offered $450 million for the satellites already in orbit. Classify the firm’s outlays as sunk costs or opportunity costs, and specify the relevant cash flows.

Explanation / Answer

Answer:

The $3.5 billion developing a satellite based telecommunication system is a sunk cost because it represents an earlier cash outlay.  It would not be included as a cash outflow when determining the cash flows relevant to the decision to spend the additional funds.  Although, Iridium Corp owns the satellites that are already in orbit, the proposed offer of $450 million from a competitor represents an opportunity cost of $450 million.  This opportunity cost would be included as a cash outflow associated with spending the additional funds on the project.

  Spending the additional $350 million on the project that would generate a cash flow of $15 million per year over the next 5 years represents an incremental cash flow because it is an expected result from a proposed capital expenditure if the project is undertaken.

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