Sir, thanks for the great lecture but I am confused in one bit. We haven’t discounted the revenue which we will be earning after a year. how have we come to this conclusion that we should continue with this project ?

The cost so far for the project was £150,000 and the cost of continuing is £174,000. So the total cost of the project would be £324000 and we are only going to gain £300000…surely it is a loss overall? Im confused

The 150,000 already spent is a sunk cost – it has been spent whether or not we decide to continue. So it is therefore irrelevant – we have lost the 150,000 whatever happens. We therefore just need to compare how much extra would need to be spent if we continue with the revenue we get from continuing.

Thanks John for the explanation aspect of each class of expense. Indeed this area of DCF is closely related to relevant costing as in paper F5/FM. The key to questions of this nature is to identify what is relevant to the decision in question taking into account any opportunity cost/revenue.

I know we have to ignore the $150,000 already spent. But if we add that $150,000 and the additional $174,000 we would incur if we continue for 1 more year, it totals to $324,000 which is $24,000 more than the $300,000 we would earn. On that basis, shouldn’t we be discontinuing the project since it’s not going to be making a profit?

Profits are not relevant – we are looking at the discounted cash flow method of appraisal.

The 150,000 has already been spent. If we nothing then the 150,000 is lost. If we continue then all that matters is whether the extra inflows are more than the extra outflows – if they are, then the loss is reduced and that is worthwhile.

Because the overhead is not for the particular project. It is the overhead for the company as a whole and will incur even if the project is continued or not.

I am confused about this as well. The question says that if we don’t use the materials in the project (so if we don’t do the project) then the disposal cost is £5000. But we are calculating the cost to the company if the project is continued…therefore, aren’t we saving the £5000 disposal cost if the project is continued? Thank you

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Pratibhapahwa4313 says

Sir, thanks for the great lecture but I am confused in one bit. We haven’t discounted the revenue which we will be earning after a year. how have we come to this conclusion that we should continue with this project ?

John Moffat says

The very last line of this question specifically says to ignore the time value of money!

tejal14 says

The cost so far for the project was £150,000 and the cost of continuing is £174,000. So the total cost of the project would be £324000 and we are only going to gain £300000…surely it is a loss overall? Im confused

John Moffat says

The 150,000 already spent is a sunk cost – it has been spent whether or not we decide to continue. So it is therefore irrelevant – we have lost the 150,000 whatever happens. We therefore just need to compare how much extra would need to be spent if we continue with the revenue we get from continuing.

tejal14 says

Thank you for your reply sir. I think I get it from theory point of view…your lecturers are always so helpful thank you

John Moffat says

Thank you for your comment 🙂

faith20ul19 says

Thanks John for the explanation aspect of each class of expense. Indeed this area of DCF is closely related to relevant costing as in paper F5/FM. The key to questions of this nature is to identify what is relevant to the decision in question taking into account any opportunity cost/revenue.

willywonka says

I know we have to ignore the $150,000 already spent. But if we add that $150,000 and the additional $174,000 we would incur if we continue for 1 more year, it totals to $324,000 which is $24,000 more than the $300,000 we would earn. On that basis, shouldn’t we be discontinuing the project since it’s not going to be making a profit?

John Moffat says

Profits are not relevant – we are looking at the discounted cash flow method of appraisal.

The 150,000 has already been spent. If we nothing then the 150,000 is lost. If we continue then all that matters is whether the extra inflows are more than the extra outflows – if they are, then the loss is reduced and that is worthwhile.

willywonka says

That makes sense. Thank you!

John Moffat says

criss07: you are welcome 🙂

emilia27 says

Thank you sir. I love watching your lectures. They are always very well explained 🙂

crystabel says

Please why is wages and severance cost not in negative. Afterall it is a cost.

borkarrahul95 says

We are calculating the total additional cost to the company if the project in continued. So, we add all the costs.

alinaqvi111 says

Hey! Couldn’t understand why the overhead absorption costs where ignored?

borkarrahul95 says

Because the overhead is not for the particular project. It is the overhead for the company as a whole and will incur even if the project is continued or not.

h9ammad40 says

Why you take 5000 as negative ?

John Moffat says

Because it is a cost. The question says that it costs 5,000 to dispose of the materials because they are toxic (poisonous).

criss07 says

I am confused about this as well. The question says that if we don’t use the materials in the project (so if we don’t do the project) then the disposal cost is £5000. But we are calculating the cost to the company if the project is continued…therefore, aren’t we saving the £5000 disposal cost if the project is continued? Thank you

criss07 says

I reviewed the video and now I understand. Thank you