Quiz 14: Capital Investment Decisions


The process of making the capital investment decisions is known as capital budgeting. In capital budgeting basically two types of projects will be considered which are given below: • Independent projects • Mutually exclusive projects Independent projects are those projects whose acceptance or rejection does affect the cash flows of other projects, whereas the mutually exclusive projects are those projects whose acceptance precludes the acceptance of all other competing projects.

a. NoFat manufactures one product, olestra, and sells it to large potato chip manufacturers as the key ingredient in NoFat snack foods, including ruffles, lays, Doritos and Tostitos brand products. For each of the past three years, sales of olestra have been far less than the expected annual volume of 125,000 pounds. One company, Patterson union (PU), a toxic waste cleanup company offered to buy 10,000 of olestra from NoFat during December for a price of $2.20 per pound. For the special offer NoFat would bear $1,000 cost of the inspection team. From the relevant information given in the case the relevant revenues from the special sales offer is computed as follows: Given: img img Hence, the relevant revenue from the special offer is $22,000. b. Relevant costs from the special offer are computed as follows: img Given: img img A relevant fixed cost is calculated as follows: img img If the special sale is accepted the plant inspection team cost is: img The relevant cost from the special sales offer is img Hence, the relevant cost associated with the special offer is $25,000. c. The relevant profit associated with the special sales offer is: img

C. Earn back their original capital outlay. Capital investments should earn back their original capital outlay. The capital investments are basically long term and huge investments. These should be invested in such a way that the initial outflow is earned back.