Question 1
Which of the following is NOT a cash flow and thus should NOT be reflected in the analysis of a capital budgeting project?
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increases in net operating working capital
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sunk costs that have been expensed for tax purposes
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cannibalization effects
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opportunity costs
Question 2
Which of the following statements best describes a situation involving sunk costs?
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A good example of a sunk cost is money that an investment corporation spent last year to investigate the site for a new office, then expensed those funds for tax purposes, and now is deciding whether to go forward with the project.
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A good example of a sunk cost is a situation where a company opens a new shopping centre, and that new shopping centre leads to a decline in sales of the company’s other shopping centres.
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An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted.
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If sunk costs are ignored and not reflected in a project’s cash flows, then the project’s calculated NPV will be lower than it otherwise would be.
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