2. Which one of the following would not result in incremental cash flows and thu

Question

2. Which one of the following would not result in incremental cash flows and thus should not be included in the capital budgeting analysis for a new product? Explain why it does not result in incremental cash flows. A) A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes. B) A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm’s current products. C) A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. D) A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. E) A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm’s other products.
2. Which one of the following would not result in incremental cash flows and thus should not be included in the capital budgeting analysis for a new product? Explain why it does not result in incremental cash flows. A) A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes. B) A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm’s current products. C) A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. D) A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. E) A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm’s other products.
2. Which one of the following would not result in incremental cash flows and thus should not be included in the capital budgeting analysis for a new product? Explain why it does not result in incremental cash flows. A) A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes. B) A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm’s current products. C) A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. D) A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. E) A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm’s other products.

Explanation / Answer

D) A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected.

This would not result in any cash flow and should not be included in the Capital Budgeting Analysis for a new product.

Reasons: The reason for the abouve being irrelevant is that it is Sunk Cost i.e. cost which has already been incurred and plays no role in the current decision making.

As deciding on a whether to produce the new product or not we analyse the future cash inflows or outflows not the costs which are already incurred.

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