Question

12. You are provided a chart representing the cash flows expected from a coffee shop project in a fetail store. You remember from vour finance course that only incremental cash flows Should be included in the chart as relevant items for capital budgeting decision. When you examine the chart, you have noted the following points. a. Comment on each as relevant or not and, b. briefly explain why in one or two sentences. (10p) The coffee shop project chart includes expected revenue increase in retail store due to opening of the planned coffee shop. The retail store owner first wanted to initiate this project two years ago and spent 100.000 Lira for a market research and feasibility report. The invoice is already paid. The chart includes this item as Initial Cash Outflow. The project uses an empty corner in the retail store. The space is currently not rented to anyone, thus no income is generated. However, it is estimated that 2.000 Lira rental income could be generated if rented. The chart includes this figure as cash outflow. 50% of the project's initial outlay will be financed by bank loan. The chart includes the costs (interest) of this loan. The current overhead costs for the retail store (electricity, heating, security, etc.) is 5.000 Lira per month. The new project will not cause an increase in these costs. However, since 20% of the store space will be allocated for the coffee shop project, the accountant decides to allocate 1.000 TL (20%) of the said expenses to the new project, once it starts to operate. These expenses are included in the chart as cash outflow.

Answer 1

1. Information is Relevant. Includes Since the information pertains to gross revenue arising in future, it has impact on the future cash-flows.
2. No, information is irrelevant. It is of the costs already incurred. Hence, its sunk cost and has no impact over the future cash flows.
3. No, information is irrelevant. Since income is not generated or compensated by some other alternative, there is loss of opportunity costs. Hence, has no impact over cash flows in future.
4. Information is Relevant. Since Interest is primary factor in determining cash profits, the same is very relevant and has high impact on the cash flows in future.
5. No, Information is irrelevant. Since costs are fixed and constant regardless of whether coffee shop project is taken up or not, the outflow of cash happens. Hence, it does not impact the project cashflows, information is not relevant.