313.9
9. You've recently completed a $300,000 marketing survey that indicates that there is solid potential for your internet business plan. You are thinking of starting a new internet working group within your company. You will transfer employees earning a total of $400,000 per year to the new group. You plan to fill the positions they leave vacant with new hires at approximately 80% of the cost of the older employees. New employees will require training that costs about $10,000. Ten percent of the costs of the present administration and operation of your headquarters is $40,000 and the salaries of this group represent 10% of your overall salary expenses. The new group will need $50,000 in new equipment, which will be depreciated over four years. Which of these costs are relevant to the decision of whether to go forward and why? (8)
The marketing survey is sunk and irrelevant. The cost of replacing the employees you are transferring is relevant (you wouldn’t have to replace them if you don’t start the new group). The training costs of the new employees is also a cost you wouldn’t bear without the new project. The administrative and operating costs is a red herring. These are your current costs and you bear them now without the new internet working group, so they are not incremental to the project. The new equipment expense is relevant and the tax shield created by the depreciation is relevant (it affects cash flows), but not the depreciation itself (it is not an actual cash flow).