1. Which of the following should be treated as incremental cash flows when decid
ID: 2784174 • Letter: 1
Question
1. Which of the following should be treated as incremental cash flows when deciding whether to invest in a new manufacturing plant? The site is already owned by the company but existing buildings would need to be demolished.
a. The market value of the site and existing buildings
b. Demolitions costs and site clearance
c. The cost of a new access road put in last year
d. Lost earnings on other products due to executive time spent on the new facility
e. A proportion of the cost of leasing the presidents jet airplane
f. Future depreciation of the new plant
g. The reduction in the firms tax bill resulting from tax depreciation of the new plant
h. The initial investment in inventories of raw materials
i. Money already spent on the engineering design of the new plant
Explanation / Answer
Incremental cash flow are the net cash generated by a firm as a result of taking a project.
It is calculated by comparing cash flows if a project is undertaken or not
The foolowing options are considered as incremental cash flows
b, d, g, h
Option a - Market value of site and buidling is not considered as it is already owned by firm so there is nor incremental cash flow
Option C - cost of a new access road put in last year is a sunk cost
Option e - A proportion of the cost of leasing the presidents jet airplane this is not necessary for project
Option f - Future depreciation of the new plant is a non cash flow expense however it will be considered as it reduces tax amount which is given in option g
Option i - Money already spent on the engineering design of the new plant - it is a sunk cost
All other costs are incremental cash flows as these will be occured only if project is undertaken.
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