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ACCA Strategic Professional · Advanced Financial Management · Discounted cash flow techniques

Kestrel plc is appraising a project. It has already spent $120,000 on a feasibility study, and a further $30,000 of head-office overhead will be allocated to the project but would be incurred whether or not the project goes ahead. The project needs new machinery costing $400,000. Which amount is the relevant initial outlay for the appraisal?

The relevant initial outlay is $400,000. The feasibility study is a sunk cost and the head-office overhead would be incurred regardless, so neither is an incremental future cash flow. Only the machinery purchase changes because of the decision and belongs in the appraisal.

  1. A$400,000Correct
  2. B$430,000
  3. C$520,000
  4. D$550,000

Explanation

The feasibility study is a sunk cost and the allocated overhead is not incremental, so both are ignored. Only the $400,000 machinery cost is a relevant future incremental cash flow. Including the overhead ($430,000) or the study ($520,000 or $550,000) wrongly counts non-relevant costs.

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