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CMA Final · Strategic Financial Management · Investment Decisions, Project Planning and Control

Narmada Foods plans a new plant. Cost of machinery is Rs 20,00,000 and installation is Rs 2,00,000. Working capital of Rs 3,00,000 is needed at start and will be fully recovered at the end of year 4. An old warehouse, owned by the firm and idle, could otherwise be sold for Rs 5,00,000 and will be used for the project. Rs 1,00,000 already spent on a feasibility study is non-recoverable. What is the relevant initial cash outflow (time 0)?

The relevant initial outflow is Rs 30,00,000. It includes machinery, installation, working capital and the Rs 5,00,000 opportunity cost of using the idle warehouse, while the Rs 1,00,000 feasibility study is a sunk cost and must be ignored.

  1. ARs 30,00,000Correct
  2. BRs 31,00,000
  3. CRs 25,00,000
  4. DRs 28,00,000

Explanation

Relevant outflow = machinery 20,00,000 + installation 2,00,000 + working capital 3,00,000 + opportunity cost of warehouse 5,00,000 = 30,00,000. The feasibility study is a sunk cost and is excluded; including it gives 31,00,000. Omitting the warehouse opportunity cost gives 25,00,000.

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