Question

1. CyTykes Toy has spent $1.5 mil developing a remote control helicopter. The firm is now trying to decide whether to continue with production. What type of cost is this, and should it be considered?

2. CyTykes Toy forecasts that sales of a remote control helicopter would be $600,000/yr. However, the firm expects that offering a remote control helicopter will reduce sales of the firm's remote control cars by $150,000/yr. What is the loss in remote control car sales called? Should it be considered in the helicopter project?

3. Ralph the real estate developer has purchased two adjoining properties. He has planned a new development project for each property separately.

•At Property A, his project will have an initial cost of $25 mil, with CFs of $4 million each year for 10 years

–Ralph estimates the cost of capital at 7.5%, for an NPV of $2.46 mil

•At Property B, his project will have an initial cost of $1 mil, with CFs of $75,000 each year for 30 years

–Ralph estimates the cost of capital at 3%, for an NPV of $470,033

•What is the NPV of both projects together?

Answer 1

1.This cost is SUNK COST and it SHOULD NOT be considered.

Sunk cost is the cost which has already been incurred and cannot be changed by the future course of action. This cost is not relevant for decision making.

2.The loss in remote control car sales called OPPORTUNITY COST.IT SHOULD BE considered.

Opportunity Cost is the benefit lost or foregone. It is relevant for decision making.

3.NPVof both projects together = NPV of Project A + NPV of Project B

= 2,460,000+470,033

= $2,930,033