FINC Chapter 12 Homework Essay

Sunk Costs: - Big sunk costs. It is difficult to exit from the industry. Surviving and beating competition is the only way to do business.

2. The current NPV is negative. One way to save money would be to reduce consulting costs. Please set the average consulting cost per month in cell b33 to $5000. At what discount rate is the NPV for the project 0?_____0.026____

In the long run an organizations fixed costs must be covered in order for the company to continue to operate and continue to make profits. If these fixed costs fail to be covered, an organization will ultimately run out of money (and most likely go out of business). In utilities some costs are often ‘sunk’ costs. Sunk costs are defined as a cost that has already been incurred and thus cannot be recovered. A sunk cost differs from other, future costs that a business may face, such as inventory costs or R&D expenses, because it has already happened. Sunk costs are independent of any event that may occur in the future (Investopedia) and must not be confused with other costs. The latter (sunk costs) are not considered in price and output calculations; so it is important to determine the nature of a cost to ensure it is accounted for the relevant fixed costs in pricing decisions.

In this meeting we learned that around 80% of the auxiliary orders was being returned by patients for refunds. The main causes was that the product was uncomfortable, tore easily (unreliable), and that patients would rather get it locally for much cheaper. With this upper management asked for us not to offer the products to patients into further notice. We also discussed that the only sunk cost in this situation is the hiring and training of new sale agents which we couldn't consider in order to discontinue the project. We all understood that this cost wouldn't be recovered as well. According to Accounting Tool" A sunk cost is a cost that an entity has incurred, and which it can no longer recover by any means. Sunk costs should not be considered when making the decision to continue investing in an ongoing project, since these costs cannot be recovered. Instead, only relevant costs should be considered. However, many managers continue investing in projects because of the sheer size of the amounts already invested in the past. They do not want to "lose the investment" by curtailing a project that is proving to not be profitable, so they continue pouring more cash into it. Rationally, they should consider earlier investments to be sunk costs, and therefore exclude them from consideration when deciding whether to continue with further investments. " We convinced

g) Out-of-pocket cost requires future outlay of cash and results from management’s decisions; is relevant.

1. Incremental cash flows are ultimately the relevant cash flows to be used in project analysis. It is the difference between the cash flows the firm will have if it implements the project, and the cash flows the firm will have if it rejects the project. Although they are a cash expense, interest expenses are not included in project cash flows. We discount a projects cash flows by using its weighted average cost of capital (WACC), which already includes the cost of debt. Therefore, we do not include interest expenses in cash flows because it would essentially be counting them twice.

Please EXPLAIN the concept of sunk cost effect and give a personal example from your experiences.

where CFt is the cash flow at time t, k is the appropriate discount rate. Our project can be acceptable if the NPV is greater than or equal to zero and unacceptable otherwise. An NPV profile that shows the NPV for various discount rates will show how sensitive the project's NPV is to the discount rate assumption. Taking into account our Project's key financial data, we can compute the NPV as follows:

c) The annual cash flow for the project to provide an NPV of $ 75000 when cash flow are discounted @ 20% is $ 415260.

Another cost concept that can be applied involve sunk costs, costs that have already been incurred and subsequent decisions cannot change them (Emery, Finnerty, & Stowe, 2007). A sunk cost for Guillermo would be the materials used in his special stain that he had already purchased before he chose the broker option where his special stain was no longer needed.

D. With the given cost of capital at 5% the project has a negative NPV of 205,123. Therefore, we should reject the project since the NPV is less than zero or negative.

C) NPV $75,000 when cash flows discounted at 20%: Year 0 Year 1 Year 2 -1,052,334 371,739 371,739 City spends 52,334

because an investment in working capital is usually returned in full at the end of the project’s life, it is ignored in computing the amount of the investment required for the project.

Define NCF as the minimum constant annual net cashflow that justifies the purchase of the given equipment. The value of NCF can be obtained from the equation

Sunk costs are irrelevant for decision-making, as they do not vary with the changes contemplated for future by the management. It is the incremental costs, which are important for decision-making.