To explain: The reason for not considering the sunk cost in capital budgeting analysis and for considering the
Introduction:
Sunk Cost:
The cost that is not based on the acceptance or rejection of a decision is called sunk cost. It is an already incurred cost before taking decision about the project and can’t be adjusted or recovered.
Opportunity Cost:
The loss of estimated income due to the rejection of a project is known as opportunity cost. It is considered as an important factor for capital budgeting decisions.
Externalities:
The cost to eliminate the effect of an alternative on other parties that are not involved in the decision making is called externalities cost. It is considered along with other factors, to accept or reject an alternative.
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Chapter 12 Solutions
Fundamentals of Financial Management, Concise Edition (with Thomson ONE - Business School Edition, 1 term (6 months) Printed Access Card) (MindTap Course List)
- What is capital budgeting? Compare the advantages and disadvantages of various capital budgeting techniques. Do you think NPV is the best decision criterion and it can overcome the problems inherent in other methods? Justify your answer.arrow_forwardWhat is capital budgeting? Explain various steps in its preparation and throw light on its limitations.arrow_forwardAre capital budgeting decisions termed either replacement decisions or expansion decisions? How can I distinguish between these two decision types and illustrate with an example?arrow_forward
- Discuss how sunk costs, opportunity costs, side effects, financing costs, and taxes should be treated in capital budgeting analysis and why.arrow_forwardWhat exactly is the analytic hierarchy process (AHP) and how can it be used in the context of capital budgeting choices are two important questions.arrow_forwardIs capital budgeting decisions can be reversedarrow_forward
- Under what circumstances the cross over rate will be an important point in capital budgeting. Can it create a problem in project selection? Explain.arrow_forwardDistinguish between goal weights and historical weights in terms of how they are used to compute the weighted average cost of capital (WACC) and how they differ from one another. What is the recommended weighting system, and why is it favored?arrow_forwardUse an example to explain to show why capital budgeting relies on cash flows rather than net income?arrow_forward
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