Question

Michael Smith has undertaken an environmental assessment to determine if he should go ahead with the building of a new mine. Explain whether the cost of the assessment would be included in a capital budgeting analysis. Explain your answer.

Answer 1

The cost of the assessment should be included in a capital budgeting analysis as cash flows are based on the opportunity cost. Environmental assessment is undertaken to predict the impact of the proposed project on it's environment. It needs an intensive study and huge cost involvement during the assessment. The assessment will help us in predicting the cash generation in future and will help in discounting the cash flow with the opportunity cost. Capital budgeting decision are based on incremental cash flow and in this case after assessing the environment only the cash flow can be predicted.