Question

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?

a. Shipping and installation costs associated with a machine that would be used to produce the new product.

b. The cost of a study relating to the market for the new product that was completed last year. The results of this research were positive, and they led to the tentative decision to go ahead with the new product. The cost of the research was incurred and expensed for tax purposes last year.

c. It is learned that land the company owns and would use for the new project, if it is accepted, could be sold to another firm.

d. Using some of the firm's high-quality factory floor space that is currently unused to produce the proposed new product. This space could be used for other products if it is not used for the project under consideration.

e. Revenues from an existing product would be lost as a result of customers switching to the new product.

Answer 1

Cost of market study conducted is sunk cost. This cost shall NOT be included in the capital budgeting analysis for a new product.

Answer is the choice (b).

Regarding other choices which are not correct:

a. Shipping and installation costs is part of initial investment. It should be included

c. Land the company owns and would use for the new project, if it is accepted, could be sold to another firm. Hence it is opportunity cost and should be included.

d. Using some of the firm's high-quality factory floor space that is currently unused to produce the proposed new product. This space could be used for other products if it is not used for the project under consideration. Hence it is opportunity cost and should be included

e. Revenues from an existing product would be lost as a result of customers switching to the new product. This also should be included as opportunity loss.