The correct method to handle overhead costs in capital budgeting is to:
A) allocate a portion to each project.
B) allocate them to projects with the highest NPVs.
C) ignore all except identifiable incremental amounts.
D)ignore them in all cases.

Question

Quizplus · Accepted Answer

Overhead costs are indirect costs that cannot be specifically allocated to a particular project or product. Therefore, it is best to ignore them in capital budgeting, except for identifiable incremental amounts that are directly related to the project. This ensures that the project's profitability is not overstated or understated due to the inclusion or exclusion of irrelevant overhead costs. Allocating a portion of overhead costs to each project (option A) or allocating them to projects with the highest NPVs (option B) may not accurately reflect the true profitability of each project. Ignoring overhead costs altogether (option D) would also be inappropriate as identifiable incremental amounts should still be considered.

The Correct Method to Handle Overhead Costs in Capital Budgeting