in page 476 at the part of in practice, answer the question below that

08:11 Principles of Man...ew in Finance).pdf . . . inflows that the existing assets would have provided had they not been replaced. Thus, the incremental operating cash flows for a replacement project will be the difference between the new operating cash flows and the forgone operating cash flows. Opportunity costs therefore represent cash flows that the firm will not realize as a result of using that asset in the proposed project. Thus, any opportun nity costs are relevant and should be included as part of the cash flow projections when determining a project's net cash flows. 476 PART FIVE Long-Term Investment Decisions FOCUS ON ETHICS in practice Fumbling Sunk Costs A core concept in economics is mar- draft. The deal also gave the Redskins Recent research suggests NFL ginal analysis-decisions should an option to keep RGIll around a fifth teams routinely fail to ignore sunk depend on incremental costs and ben- year for a hefty sum; here sunk costs costs. One study looked at factors efits. Costs already incurred that can- entered the equation. influencing the number of games not be recovered-sunk costs-are In the first year of the contract, started by defensive players. The irrelevant. Surprisingly, businesses the investment paid off handsomely- empirical model included performance often wrongly consider sunk costs, a Griffin was named Offensive Rookie of measures like solo tackles for lineback- practice sometimes called the Con- the Year, and the Redskins won their ers as well as contract size to test for corde Fallacy after the most notorious division for the first time in 13 years. the Concorde Fallacy. Other things case. Long after the Supersonic Trans- But late that season, RGIll suffered being equal, performance rather than port Aircraft proved a commercial the first of many injuries that kept him compensation should determine which disaster, the British and French govern- from regaining rookie form. Just players should start more games- ments continued funding it because no before the 2015 season (the fourth contracts are sunk because a player is senior official wanted to concede the and final year of the initial contract) paid the same dollars whether he project had been folly. When consider- the Redskins took advantage of their begins the game on the field or the ing project renewal, managers have an right to sign Griffin for 2016, promis- bench. Contracts turned out to have a ethical duty to focus on net present ing a cool $16.2 million. At the time, large impact-a 15% increase in a value and avoid letting emotional fac- the move was called "the biggest defensive player's compensation tors or concerns about their own repu- blunder in NFL history" because of boosted the number of starts as much tations distort investment decisions. the injury risk. The Redskins tried to as nine extra solo tackles would. In Professional sports offer the best- hedge by not guaranteeing the other words, more expensive players known example of the Concorde salary-meaning the full amount would were more likely to start even if they did Fallacy-a team signs a marquee be owed only if RGIll stayed healthy not perform better than players on the player to an expensive long-term con- the entire 2016 season. But under the bench. From an economic perspective, tract, then sticks with him no matter terms of the initial contract, the team choosing starters based on sunk costs what. Consider the case of Robert Grif- was on the hook if a 2015 injury pre- deserves a flag for illegal procedure. fin III (RGIII), the 2011 Heisman Trophy- vented him from playing in 2016. Sure winning quarterback drafted second enough, in the 2015 preseason, Griffin Recommitting to a losing project by the National Football League (NFL) suffered a concussion-forcing the or emotional or reputational rea- Washington Redskins. Griffin cost the Redskins to bench him to prevent fur- sons can destroy shareholder Redskins plenty-a four-year guaran- ther injury that could carry over and wealth. What safeguards could a teed contract worth $21.1 million as cost $16.2 million. The team owned up firm use to remove such bias from well as numerous draft picks traded to to the mistake by releasing a now- recommitment decisions? obtain the second overall pick in the healthy RGIll after the 2015 season. Sources: Isidore, Chris. "Redskins' RG3 Contract May Be Biggest Blunder in NFL History," CNN Money, September 1, 2015. Keefer, Quinn A. W. "Performance Feedback Does Not Eliminate Sunk Cost Fallacy." Journal of Labor Research 36 (2015): 409-426. EXAMPLE 11.1 Jankow Equipment is considering enhancing its drill press X12, which it pur- chased 3 years earlier for $237,000, by retrofitting it with the computerized MyLab Finance Solution control system from an obsolete piece of equipment it owns. The obsolete Video equipment could be sold today for $42,000, but without its computerized con- trol system, it would be worth nothing. Jankow is in the process of estimating the labor and materials costs of retrofitting the system to drill press X12 and the benefits expected from the retrofit. The $237,000 cost of drill press X12 is a sunk cost because it represents an earlier cash outlay. It would not be included as a cash outflow when determining the cash flows relevant to the retrofit CHAPTER 11 Capital Budgeting Cash Flows 477 decision. However, if Jankow uses the computerized control system of the obsolete machine, then Jankow will have an opportunity cost of $42,000, which is the cash the company could have received by selling the obsolete equipment in its current condition. By retrofitting the drill press, Jankow gives up the opportunity to sell the old equipment for $42,000. This opportunity