Chapter 6, Problem 1PS

Cash flows* Which of the following should be treated as incremental cash flows when deciding whether to invest in a new manufacturing plant? The site is already owned by the company, but existing buildings would need to be demolished.

1. a. The market value of the site and existing buildings.
2. b. Demolition costs and site clearance.
3. c. The cost of a new access road put in last year.
4. d. Lost earnings on other products due to executive time spent on the new facility.
5. e. A proportion of the cost of leasing the president’s jet airplane.
6. f. Future depreciation of the new plant.
7. g. The reduction in the corporation’s tax bill resulting from tax depreciation of the new plant.
8. h. The initial investment in inventories of raw materials.
9. i. Money already spent on engineering design of the new plant.

Summary Introduction

To determine: The items that must be treated as incremental cash flows at the time of taking decision on whether to invest in a new manufacturing plant.

Incremental cash flow is the extra operating cash flow that a firm receives from taking on a new project.

Sunk cost is a cost which is already incurred or met by the firm and it cannot able to recover.

Non-cash expenses are the expenses for which there is no exact cash outflow is happening but it is recorded in the books of accounts.

Explanation of Solution

Determine the items which can be treated as incremental cash flow:

Item name	Category
a	Incremental cash flow
b	Incremental cash flow
c	Sunk cost
d	Incremental cash flow
e	Overhead cost
f	Non-cash expense
g	Incremental cash flow
h	Incremental cash flow
i	Sunk cost