ACCA Financial Management (F9) Certification Practice Exam

Which of the following is NOT an example of a relevant cash flow?

1. Future production costs that vary with output

2. Initial investment in machinery

3. Sunk costs related to previous investments

4. Increased revenue from project completion

The correct answer is: Sunk costs related to previous investments

A relevant cash flow is one that will be affected by the decision at hand and thus will influence future cash flows. These cash flows are essential for project evaluation, especially in capital budgeting, where understanding the impact of decisions on potential revenue and costs is crucial. Sunk costs, such as costs that have already been incurred and cannot be recovered, do not affect future cash flows and are therefore not relevant to current decision-making. They should not influence the evaluation of investment projects because they will remain constant regardless of the outcome of the decision taken. Recognizing that past expenditures should not factor into future decisions helps ensure that capital budgeting is based on prospective financial outcomes rather than on irreversible past commitments. In contrast, future production costs that vary with output, the initial investment in machinery, and increased revenue from project completion are all cash flows that will change based on the decision to undertake a project. These costs and revenues will directly impact the financial viability of the decision being evaluated, making them relevant cash flows. Thus, the distinction lies in whether a cash flow impacts future cash positions and should be considered in the current decision-making process.