Chapter 8: Relevant cash flows for DCF

A research project which to date has cost the company $150,000 is currently under review. If the project were allowed to proceed, it will be completed in approximately one year, when the results would be sold to a government agency for $300,000. The additional expenses the managing director estimates will be necessary to complete the work are:

Materials: the materials required have just been purchased at a cost of $60,000. They are toxic and, if not used in this project, must be disposed of at a cost of $5,000.

Labour: skilled labour is hard to recruit. The workers concerned have been transferred to this project from a production department, and the production manager claims that if the men were returned to him they could generate sales of $150,000 in the next year. The prime cost of these sales would be $100,000 including $40,000 for the labour cost itself. The overhead absorbed into this production would amount to $20,000.

Research staff: it has already been decided that when work on this project ceases, the research department will be closed. Research wages for the year are $60,000, and redundancy and severance pay has been estimated at $15,000 now, or $35,000 in one year's time.

Equipment: the project utilises a special microscope which cost $18,000 three years ago. It has a residual value of $3,000 in another two years, and a current disposal value of $8,000. If used in the project it is estimated that the disposal value in a year's time will be $6,000.

Share of general building services: the project is charged with $35,000 p.a. to cover its share of general building expenses. Immediately the project is discontinued, the space occupied by the project could be sub-let for an annual rental of $7,000.

Advise the managing director whether the project should be allowed to proceed, explaining the treatment of each item. (Ignore the time value of money.)