CS Executive · Corporate Accounting and Financial Management · Capital Budgeting
Bharat Auto Ltd. is evaluating a new plant. Data: purchase cost of machinery Rs 40 lakh; installation Rs 5 lakh; working capital to be injected Rs 8 lakh and recovered at the end of the project; Rs 2 lakh already spent last year on a feasibility study; existing idle land (no alternative use, market value nil) to be used. What is the initial cash outflow relevant for capital budgeting?
The relevant initial outflow is Rs 53 lakh, being machinery Rs 40 lakh, installation Rs 5 lakh and working capital Rs 8 lakh. The Rs 2 lakh feasibility study is a sunk cost and the idle land has no opportunity cost, so both are excluded.
- ARs 55 lakh
- BRs 53 lakhCorrect
- CRs 45 lakh
- DRs 47 lakh
Explanation
Relevant outflow = 40 + 5 + 8 = Rs 53 lakh. The Rs 2 lakh feasibility cost is a sunk cost and is ignored. The idle land has no opportunity cost since its market value is nil. Rs 55 lakh wrongly includes the sunk cost; Rs 45 lakh omits working capital.
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