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

Sahyadri Auto Ltd is evaluating a new plant. Which of the following items should be EXCLUDED from the incremental cash flows when computing the project's NPV?

The Rs 8 lakh market research fee already paid should be excluded because it is a sunk cost that cannot be recovered or changed by the decision. Working capital, cannibalised contribution and salvage value are all incremental future cash flows and belong in the project's NPV.

  1. ARs 8 lakh market research fee already paid last year, which cannot be recovered whether or not the plant is builtCorrect
  2. BAdditional working capital of Rs 5 lakh needed at the start of the project
  3. CLoss of Rs 3 lakh annual contribution from an existing product that the new plant will cannibalise
  4. DRs 10 lakh salvage value expected from the plant at the end of its life

Explanation

Only incremental, future cash flows matter. The market research fee is a sunk cost, unaffected by the decision, so it is excluded. Working capital, cannibalisation loss (an opportunity cost) and salvage value all change with the decision and must be included.

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