If at all possible I need this question answered by Friday night.

Masters Golf Products, Inc., spent three years and $1,000,000 to
develop its new line of club heads to replace a line that is becoming
obsolete. In order to begin manufacturing them, the company will have
to invest$1,800,000 in new equipment. The new clubs are expected to
generate an increase in operating cash inflows of $750,000 per year
for the next 10 years. The company has determined that the existing
line could be sold to a competitor for $250,000.

a. How should the $1,000,000 in devlopment costs be classified?
b. How should the $250,000, sale price for existing line be classified?
c. Depict all of the known relevant cash flows on a time line.

Hi help123!!


a. How should the $1,000,000 in development costs be classified?

It is a sunk cost. Remember that sunk costs remain the same whether or
not you accept the project.
The development costs should not be considered part of the decision to
go ahead with the new production because when that money was spent it
cannot be retrieved regardless of whether the project is accepted or
rejected, this is why it is a sunk cost.


b. How should the $250,000, sale price for existing line be classified?

The sale price of an existing line that could be sold is an
opportunity cost. Masters Golf Products have the opportunity to sell
the old line and receive an income of $250,000. If they decide to do
any other thing with the old line they must compare the benefit of
such decision versus the $250,00 of sale price.
Not proceeding with the new line implies an apportunity cost of
$250,000, because Masters Golf Products will not sale the old line and
will not receive the $250,000.


c. Depict all of the known relevant cash flows on a time line.

Tips:
A relevant cost is a future cost arising as a consequence of a
decision. A cost which has been incurred in the past is therefore
totally irrelevant to any decision that is being made now. Such past
costs are called 'sunk costs'.
Only those future costs that are in the form of cash should be
included. Therefore, costs which do not reflect cash spending should
be ignored for the purpose of decision-making. For example
depreciation charges should be ignored, but when the tax rates are
given depreciation gains importance as there is tax savings on it.
An opportunity cost is the value of a benefit foregone as a result of
choosing a particular course of action. Such a cost will always be a
relevant cost.
Certain other costs will be irrelevant to decision-making, such as
'committed costs'. A committed cost is a future cash outflow that will
be incurred anyway, regardless of what decision will be taken (for
example salaries of existing staff).
The above paragraphs are summed up from "Capital investment appraisal"
by Ann Irons:
http://www.accaglobal.com/publications/studentaccountant/1105038


Incremental cash flows are cash flows that results directly from the
decision to accept the project. They represent the changes in the
firms total cash flows that occurs as a direct result of accepting the
project. So only the incremental cash flows are relevant to the accept
or reject decisions.
In most cases the incremental cash flows can be classified into three
different categories:
1. Total Initial Investment: Cash flows that occur only at the start
of the project?s life, year 0.
2. Operating Cash Flows: Cash flows that continuously occur throughout
the project's life, years 1 to n.
3. Terminal Cash Flow: Cash flow that occurs only at the end, or the
termination, of the project, year n.


Relevant cash flows at the start of the project (Year 0):
Total Initial Investment = Sale of old line - Initial Investment =
                         = $250,000 - $1,800,000 =
                         = - $1,550,000


Operating Cash Flows (Years 1 to 10):
Increase in operating cash inflows = $750,000 

Terminal Cash Flows (End of year 10):
Not determined, so we can assume that the project has a life longer
than 10 years. For the purposes of this problem the terminal cash flow
is zero.

Relevant cash flows on a time line (in thousands):

YEARS:
 0    1     2     3     4     5     6     7     8     9    10
 |    |     |     |     |     |     |     |     |     |     |
-I----I-----I-----I-----I-----I-----I-----I-----I-----I-----I----->
 |    |     |     |     |     |     |     |     |     |     |
 |  $750  $750  $750  $750  $750  $750  $750  $750  $750  $750
 |
($1,550)

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I hope that this helps you. If you find something unclear feel free to
request for a clarification. I will be glad to give you further
assistance on this if you need it.

Regards.
livioflores-ga

Excellent Again!!!