Question

a firm faces two alternatives. the first is to proceed with an investment today. the second is to conduct additional r&d that will take one year and cost $100,000. Since the costs are related to r&d, the firm can exclude them from their cash flow analysis in determining whether to proceed today or postpone the project for a year. True or False?

Answer 1

The correct asnwer is True.

The firm can exclude from the cash flow analysis becuase that cost would become the Sunk Cost for the cash flow to be determined in future. This is because that cost would already be incurred when we will have to make the decision in future.

Decision making is done on the basis of future cash flows and future costs which should be considered for our decision making. Also the firm should try to minimise its sunk cost so that all cost can be considered in decision making.