FM
Grid C: Investment Appraisal
Section 1: Relevant Cash Flows for Investment Projects
Table of Contents Reference: Chapter 9, Sections 9.2.1 to 9.2.7
Definition: Relevant costs and benefits are future, incremental cash flows that
happen only because you made a specific decision.
Principles of relevant cost
i)They are future cashflows
ii)They are incremental
iii)They are future costs
•
Future: Ignore "Sunk Costs" (money already spent, like a past feasibility
study).
•
Incremental: Only include the extra money moving in or out.
•
Cash Flows: Ignore non-cash items like Depreciation.
•
Opportunity Costs: Include the value of the next best thing you are giving
up to do this project.
•
Working Capital: The extra cash needed for daily operations (like
inventory). It is usually invested at the start (Year 0) and recovered at the
end of the project.
CALCULATION AREA: Deprival Value If using an existing asset, the relevant cost is
its Deprival Value:
•
Formula: The Lower of (Replacement Cost) and (Recoverable Amount).
•
Recoverable Amount: The Higher of (Net Realisable Value/Sale Price) and
(Value in Use/Economic Value).
•
Regularly used-Replacement cost
When material is not in regularly use –(higher of alternative use and scrap
value)
ELIAS 10: Imagine you want to start a lemonade stand. The Relevant Cost is the
sugar you buy today. The Sunk Cost is the pitcher you bought last year (you
already have it). Opportunity Cost is the ₦500 you would have made if you spent
the afternoon washing cars instead of selling lemonade.