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Hello sir
I have got this question from Kaplan text relating to relevant cost
A company is evaluating a proposed expenditure on an item of
equipment that would cost $160,000.
A technical feasibility study has been carried out by consultants, at a cost
of $15,000, into benefits from investing in the equipment.
It has been estimated that the equipment would have a life of four years,
and annual profits would be $8,000, after deducting annual depreciation
of $40,000 and an annual charge of $25,000 for a share of the existing
fixed cost of the company.
What are the relevant cash flows for this?I don’t understand why depreciation cost & fixed cost are added back when these are non cash &. committed costs?
Thank you in advance
is depreciation added up because cash flows takes depreciation amounts into consideration ?
But what about fixed cost?Depreciation is not a cash flow and is therefore added back – the profit will be higher is the depreciation expense is removed. We are only interested in cash flows.
Simply sharing fixed costs does not mean that the total fixed costs will change. We are only interested if the total fixed costs to the company change.
Have you watched my free lectures on relevant cash flows for investment appraisal, because I explain both items (with examples) in my lectures. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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