Having carried out a full capital appraisal for a construction project, H Company has approved the project with initial outflows of $6,000,000 and a…

The decision to continue or abandon a project must be based on relevant, future-oriented cash flows, ignoring any sunk costs. The $1,500,000 (25% of $6m) already spent is a sunk cost.

The re-evaluated Net Present Value (NPV) is the primary decision tool. The original PV of inflows was $7,200,000 ($6m outflow + $1.2m NPV). The remaining relevant outflows are the uncommitted $4,500,000 plus the new $1,300,000, totaling $5,800,000. The new NPV from this point forward is $1,400,000 ($7.2m - $5.8m). This positive NPV is a defining factor supporting continuation.

Additionally, the decision is a choice between continuing and abandoning. The costs associated with abandonment, such as site restoration, are relevant cash flows that must be considered, making the abandonment option less financially attractive.

B. The re-evaluated NPV is positive ($1,400,000), not negative, as the $1,500,000 sunk cost is correctly excluded from the forward-looking analysis.

C. While shareholder confidence is a valid consideration, the primary defining factor in capital budgeting decisions, according to established theory, is the quantitative financial appraisal (NPV).

E. The potential for other unexpected costs represents project risk, which should be assessed, but it is not a defined factor in the current NPV calculation itself.

1. Brealey, R. A., Myers, S. C., & Allen, F. (2020). Principles of Corporate Finance (13th ed.). McGraw-Hill Education. In Chapter 6, Section 6-2, the text emphasizes the principle of incremental analysis: "The key is to trace all incremental cash flows from the project... Forget sunk costs." This supports ignoring the $1.5m already spent.

2. Drury, C. (2018). Management and Cost Accounting (10th ed.). Cengage Learning. Chapter 10, "Measuring relevant costs and revenues for decision-making," explains that for project abandonment decisions, the analysis should compare the net future cash flows from continuing with the net cash flows from abandonment (including any abandonment costs).

3. MIT OpenCourseWare. (2008). 15.401 Finance Theory I, Fall 2008. Massachusetts Institute of Technology. Lecture Notes, "Lecture 3: The Net Present Value Rule: The First Principle of Investment Decision Making," pp. 10-11. The notes explicitly state the "Sunk Cost Fallacy" and instruct that "Sunk costs are not incremental cash flows" and should be ignored in NPV analysis.