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Hello John
The question reads as follow:
An opportunity has arisen to open a new factory at a cost of $8 mil. It would generate the following annually: revenue 12m, variable costs 6m, incremental fixed costs 3.5, and a central recharge of 0.5 mil. What would be the payback period?My question:
In the answer, the 0.5 mil was not included, can you please tell me why? I am not familiar with that term and by extension its meaning. Since it wasn’t included I’m thinking its a one off cost but don’t know exactly what it refers to.We are only interest in incremental (extra) cash flows to the company as a whole.
A central recharge is where the company incurs costs (such as the costs of running the administration) and charges a bit of that cost to each of the various projects they have. For profit purposes that is fine, however we would always assume that the total cost (e.g. the total cost of running administration) would stay the same whether or not this particular project is undertaken.
Therefore doing the project means no extra cost to the company as a whole, and it is therefore not relevant for the decision.
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