Question

You have been made treasurer for a day at AIMCO, Inc. AEVICO develops technology for video conferencing. A manager of the satellite division has asked you to authorize a capital expenditure in the amount of $10,000. The manager states that this expenditure is necessary to continue a long-running project designed to use satellites to allow video conferencing anywhere on the planet. The manager admits that the satellite concept has been surpassed by recent technological advances in telephony, but he feels that AEVICO should continue the project because $2.5 million has already been spent over the past 15 years on this project. .Although the project has little chance to be viable, the manager be Keves it would be a shame to waste the money and time already spent. Use marginal cost-benefit analysis to make your decision regarding whether you should authorize the $10,000 expenditure to continue the project.
Which of the following statements correctly describes your decision? (Select the best answer below.)
a) You should not authorize the $10,000 expenditure to continue the project because it is surpassed by new telephony technology. Though the marginal cost-benefit analysis treats the $2.5 million as a cost that is irrelevant to the current decision making, continuing the project would be foolish even if the $10,000 expenditure generates a positive net present value.
b) You should not authorize the $10,000 expenditure to continue the project even if the project will generate a positive net present value. The marginal cost-benefit analysis treats the $2.5 million as a cost that is extremely unlikely to be recovered and the $10,000 expenditure will also become a cost unlikely to be recovered.
c) You should authorize the $10,000 expenditure to continue the project because the marginal cost-benefit analysis treats the $2.5 million as part of the project's initial capital outlay that can be recovered only if the project is implemented

Answer 1

Answer: D. You should authorize the $10,000 expenditure to continue the project if the project will generate a positive net present value. The marginal cost-benefit analysis treats the $2.5 million as a cost that is irrelevant to the current decision making.

Explanation:

The options you presented were not all the options listed. The option I have listed as the answer is the correct option.

Under the Marginal Cost - Benefit analysis, only the Additional costs and inflows are considered. The original cost is considered a Sunk Cost and therefore irrelevant.

When making a decision therefore, the company or person should ask if the new investment will bring about a positive NPV. If it is not anticipated to, then there is no need to invest more into it.