Asked by Tegan Hendrix on May 09, 2024
Verified
Which of the following statements best describes a situation involving sunk costs?
A) An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted.
B) Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method.
C) A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed those funds for tax purposes, and now is deciding whether to go forward with the project.
D) If sunk costs are considered and reflected in a project's cash flows, then the project's calculated NPV will be higher than it otherwise would be.
Sunk Costs
Costs that have already been incurred and cannot be recovered, and thus should not factor into the decision-making process for future investments.
Internal Rate of Return (IRR)
A metric used in capital budgeting to estimate the profitability of potential investments, calculated as the discount rate that makes the net present value of all cash flows equal to zero.
Net Present Value (NPV)
A method used in capital budgeting to assess the profitability of an investment or project by calculating the difference between the present value of cash inflows and outflows.
- Acknowledge the impact of sunk costs and understand the justification for omitting them from investment analysis.
Verified Answer
YC
Yvonnesha CooleyMay 10, 2024
Final Answer :
C
Explanation :
Sunk costs refer to money that has already been spent and cannot be recovered. In choice C, the money spent by the banking corporation on investigating a site for a new office, which was then expensed for tax purposes, represents a sunk cost because it cannot be recovered regardless of whether the project goes forward.
Learning Objectives
- Acknowledge the impact of sunk costs and understand the justification for omitting them from investment analysis.