Shamroll inc. is a household products frim that is considering developing a new detergent. In evaluationg whether to go ahead with the new detergent project, which of the following statements is most correct?
A) The company will produce the detergent in a building that they already own. The cost of the building is therefore zero and should be exluded from the analysis
B) THe company will need to use some equipment that it could have leased to another company. This equipment lease could have generated $200,000 per year in afte-tax income. THe $2,000 should be excluded because the equipment can no longer be leased
C) The company will need to hire 10 new workers whose salaries and benefits will total $400,000 per year. Labor costs are nt part of capital budgeting and should be excluded.
D) The company will produce the detergent in a building that is renovated 2 years ago for $300,000. The $300,000 should be excluded from the analysis.
finance - Jonathan, Monday, April 6, 2015 at 5:34am
The best answer is D
A - sometimes, in questions like these, the examiner discusses the building/land cost. But they say they could sell it / lease it at X amount today. That sale would be an "opporunity cost" - and it would be counted.
B - Just the oppoisite of what I said about A. If the equipment could have generated $200k, than that is an opportunity cost and it is relevant.
C - These costs would form part of the fixed costs. That is necessary when calculating the sale price, and also eventually tax to be paid.
D - The building was renovated 2 years ago. Therefore it is NOT a cost that was caused by deciding to go ahead with the project. It is a sunk cost, and therefore not relevant to this project.
finance - Jonathan, Monday, April 6, 2015 at 5:36am
In other words Statements A-C are all false. D is true.