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Based from the reference below discuss the sunk costs and opportunity cost in a firm.

Based from the reference below discuss the sunk costs and opportunity cost in a firm.

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Based from the reference below discuss the sunk costs and opportunity cost in a firm.
When esti flowsa roposed invest- ortunity SUNK COSTS AND OPPORTUNITY COSTS When estimating the incremental cash flows associated with a proposed invest- ment opportunity, the firm must take care to treat sunk costs and opportunity costs properly. These costs are easy to mishandle, classifying costs as incremen- tal when they are not or ignoring costs that should be counted as part of a proj- ect's incremental cash flows. Sunk costs are cash outlays that have already been Cash outlays that have already made (past outlays) and cannot be recovered, whether or not the firm follows through and makes an investment. Suppose that before building a new store, managers at Target first invest a lot of time and money to assess the market for or not the firm follows through the proposed store. This analysis might look at the population and average sunk costs been made (past outlays) and cannot be recovered, whether and makes an investment. income in the surrounding community, the local cost of labor, taxes, and many other factors. The process may cost tens of thousands of dollars. However, once it is completed, those costs are sunk and should not influence the company's decision to open a new store. Whether Target opens a new store or not, it cannot recover the costs of analyzing the investment opportunity in the local market. Sunk costs are irrelevant and should not be included in a project's incremental cash flows. opportunity costs Cash flows that could have Opportunity costs are cash flows that the firm could have realized from the best alternative use of assets already in place. When a firm undertakes a replace- ment project, it repurposes or replaces some portion of its existing assets to gen- erate a new cash flow stream and, in doing so, forgoes any of the future cash inflows that the existing assets would have provided had they not been replaced. Thus, the incremental operating cash flows for a replacement project will be the difference between the new operating cash flows and the forgone operating cash flows. Opportunity costs therefore represent cash flows that the firm will not realize as a result of using that asset in the proposed project. Thus, any opportu- nity costs are relevant and should be included as part of the cash flow projections when determining a project's net cash flows. been realized from the best alternative use of an owned asset.
Transcribed Image Text:When esti flowsa roposed invest- ortunity SUNK COSTS AND OPPORTUNITY COSTS When estimating the incremental cash flows associated with a proposed invest- ment opportunity, the firm must take care to treat sunk costs and opportunity costs properly. These costs are easy to mishandle, classifying costs as incremen- tal when they are not or ignoring costs that should be counted as part of a proj- ect's incremental cash flows. Sunk costs are cash outlays that have already been Cash outlays that have already made (past outlays) and cannot be recovered, whether or not the firm follows through and makes an investment. Suppose that before building a new store, managers at Target first invest a lot of time and money to assess the market for or not the firm follows through the proposed store. This analysis might look at the population and average sunk costs been made (past outlays) and cannot be recovered, whether and makes an investment. income in the surrounding community, the local cost of labor, taxes, and many other factors. The process may cost tens of thousands of dollars. However, once it is completed, those costs are sunk and should not influence the company's decision to open a new store. Whether Target opens a new store or not, it cannot recover the costs of analyzing the investment opportunity in the local market. Sunk costs are irrelevant and should not be included in a project's incremental cash flows. opportunity costs Cash flows that could have Opportunity costs are cash flows that the firm could have realized from the best alternative use of assets already in place. When a firm undertakes a replace- ment project, it repurposes or replaces some portion of its existing assets to gen- erate a new cash flow stream and, in doing so, forgoes any of the future cash inflows that the existing assets would have provided had they not been replaced. Thus, the incremental operating cash flows for a replacement project will be the difference between the new operating cash flows and the forgone operating cash flows. Opportunity costs therefore represent cash flows that the firm will not realize as a result of using that asset in the proposed project. Thus, any opportu- nity costs are relevant and should be included as part of the cash flow projections when determining a project's net cash flows. been realized from the best alternative use of an owned asset.
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