A Chief Financial Officer (CFO) invested in Division A last year and is considering whether to invest in Division B this year. Division B requires the utilization of some spare capacity of a machine in Division A but produces completely different products.[Fill in the blank]

Question

BlackTom AI · Accepted Answer

Incremental cash flows and opportunity costs determine which costs belong to a new project. Past expenditures (the machine’s original purchase) are sunk and irrelevant, but any future cash flows caused by Division B’s use of Division A’s machine are relevant.

1) Relevant knowledge points and concepts
- Sunk cost: historical cost already incurred (irrelevant for the current decision).  
- Incremental (marginal) cash flows: only additional future cash inflows/outflows caused by accepting the project.  
- Opportunity cost: the value of the best alternative use of resources.  
- Accelerated depreciation/replacement: increased use can shorten useful life, causing earlier replacement and a future cash outflow; that future replacement cost is incremental and must be included.

2) Step-by-step reasoning
- The machine was bought last year: that purchase is a sunk cost and should not affect the evaluation.  
- Division B will use spare capacity but will cause additional wear, so the machine’s remaining life shortens → replacement happens sooner than otherwise.  
- The earlier replacement is a new, incremental cash outflow caused by Division B and thus must be included when computing Division B’s project cash flows (or allocated appropriately).

3) Example (intermediate arithmetic)
- Suppose replacement cost = $50,000; without B replacement in 10 years, with B in 8 years. Discount rate r. Incremental PV of replacement = 50,000/(1+r)^8 − 50,000/(1+r)^10 which is positive, so the project bears an extra PV cost.

4) Why the correct answer is correct
- Option b explicitly recognizes that faster depreciation → earlier replacement → an incremental cash outflow attributable to Division B, which is the correct treatment under capital budgeting.

5) Why other options are incorrect
- a: wrong because there is a correct option.  
- c: incorrect insofar as it suggests never mixing flows; interactions (like accelerated wear) create relevant incremental cash flows that must be included.  
- d: incorrect because using the firm WACC for all projects is not always appropriate; project/division-specific risk or opportunity cost should guide discounting, and moreover Division A’s past decision is irrelevant now.

Conclusion: therefore option b is correct, matching the provided answer.

A Chief Financial Officer (CFO) invested in Division A last year and is considering whether to invest in Division B this year. Division B requires the utilization of some spare capacity of a machine in Division A but produces completely different products.[Fill in the blank]Single choice

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