Question

Which of the following is NOT a relevant cash flow and thus should not be reflected in the analysis of a capital budgeting project?
A. Changes in net working capital.B. Shipping and installation costs.
C. Cannibalization effects.
D. Opportunity costs.
E. Sunk costs that have been expensed for tax purposes.

Answer 1

Answer:

E. Sunk Costs that have been expensed for tax purposes

Explanation:

A relevant casf flow is a future cashflow that arises as direct consequence of a decison. A cost or revenue is cosidered to be relevant cash flow to a decision if it satisfies all of the following three (3) conditions:

1. Future: A decision is a choice step of action to be taken in the future. Therefore no cost or revenue should be recognised until the action  is taken. Costs that have been incurred in the past prior to the decision should not be considered and are therefore not relevant. They are called sunk cost. Sunk costs are not relevant costs.
2. Cash-based: items of expenditures  that do not result in the movement of cash should not be considered. e,g depreciation, amortization, provisions, e.t.c
3. Must arise as a direct consequence of a decision. Also, only costs and benefits associated to decision should be included and consider as relevant. i.e incremental costs and benefits

Opportunity cost: the is the value of the next best benefit sacrificed in favour of a decision. Where taking a decision would lead to a loss of benefits The lost  benefits are therefore costs to be charged to the decision.

Cannibalization Effects. This occurs where the introduction of a new product by a firm causes a loss of sales and profits from the the existing product line. The loss of sales is an opportunity cost to be charged to the new product.