Which of the following is not an example of a real option in a capital budgeting decision?
Answer(s): D
Real options include such factors as the ability to abandon the project early. the opportunity for follow-up investments or ability' to create new products, the ability' to base additional cash outflows on a wait-and-learn opportunity', or the option to change capacity' during the project. Risk-adjusted discount rates are not real options but are a form of sensitivity' analysis.
The relevance of a particular cost to a decision is determined by
Relevance is the capacity of information to make a difference in a decision by helping users of that information to predict the outcomes of events or to confirm or correct prior expectations. Thus, relevant costs are those expected future costs that vary with the action taken. All other costs are constant and therefore have no effect on the decision.
Of the following decisions, capital budgeting techniques would least likely be used in evaluating the
Capital budgeting is the process of planning expenditures for investments on which the returns are expected to occur over a period of more than 1 year. Thus, capital budgeting concerns the acquisition or disposal of long-term assets and the financing ramifications of such decisions. The adoption of a new method of allocating non-traceable costs to product lines has no effect on a company's cash flows, does not concern the acquisition of long- term assets, and is not concerned with financing. Hence, capital budgeting is irrelevant to such a decision.
In equipment-replacement decisions1 which one of the following does not affect the decision-making process?
Answer(s): C
All relevant costs should be considered when evaluating an equipment-replacement decision. These include the cost of the new equipment1 the disposal price of the old equipment, and the operating costs of the old equipment versus the operating costs of the new equipment. The original cost or fair market value of the old equipment is a sunk cost and is irrelevant to future decisions.
The term that refers to costs incurred in the past that are not relevant to a future decision is
A sunk cost cannot be avoided because it represents an expenditure that has already been made or an irrevocable decision to incur the cost.
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