Question

For the NPV of a 3-year project, are the following included in incremental cash flows and if so where?:

(a) a 3-year lease agreement, paid before the project starts

(b) a bank loan needed to pay for half of the equipment for the project.

(c) interest payments of the above bank loan

Answer 1

(a) A 3-year lease agreement, paid before the project starts- Not included in incremental cash flows. It is paid before project starts and hence sunk cost and not relevant for evaluation of project

(b) a bank loan needed to pay for half of the equipment for the project.- not part of incremental cash flows since it is financing activity and not relating to operating activity to calculate incremental cash flow

(c) Interest payments of the above bank loan – Interest element is not part of incremental cash flow evaluation