, PREVIEW OF QUESTION 1
QUESTION 1
1.1
R190 000 is a sunk cost.
Sunk costs are costs that cannot be avoided, even if the project is not undertaken. Sunk costs do
not affect the accept/reject decision, they should not be included in the analysis.
Financing costs are ignored because both the cost of debt and the cost of other capital are
captured in the discount rate. Interest expenses on the bank loan are finance costs which are
reflected in the projects' required return.
1.2
Initial Investment
R
Installed cost (3000 000)
After tax proceed (sale of old machine) 216 000
Change in networking capital (72 000)
Initial Investment (2 856 000)
Proceeds from the old machine
Book value R0 (Purchased four years ago hence fully depreciated)
Capital gain R300 000 – R0 = R300 000
Capital gains tax R300 000 x 0.28= R84 000
Proceeds from sale R300 000 – R84 000 = R216 000
QUESTION 1
1.1
R190 000 is a sunk cost.
Sunk costs are costs that cannot be avoided, even if the project is not undertaken. Sunk costs do
not affect the accept/reject decision, they should not be included in the analysis.
Financing costs are ignored because both the cost of debt and the cost of other capital are
captured in the discount rate. Interest expenses on the bank loan are finance costs which are
reflected in the projects' required return.
1.2
Initial Investment
R
Installed cost (3000 000)
After tax proceed (sale of old machine) 216 000
Change in networking capital (72 000)
Initial Investment (2 856 000)
Proceeds from the old machine
Book value R0 (Purchased four years ago hence fully depreciated)
Capital gain R300 000 – R0 = R300 000
Capital gains tax R300 000 x 0.28= R84 000
Proceeds from sale R300 000 – R84 000 = R216 000
