Question

4. Relevant cash flows

Which of the following are cash flows that Davis Company forgoes as a result of accepting the project under consideration? (In general, these are the cash flows of the next-best alternative to the project.)

- Opportunity costs

- An externality

- Sunk costs

Which of the following factors should Davis Company include in its capital budgeting analysis? Check all that apply.

-Davis’s forecasted cash flows are expressed on an after-tax, as opposed to pre-tax, basis.

-Davis buys most of its raw materials on credit, causing accounts payable to increase by $30,000.

-Davis’s annual common stock dividends total $435,000.

-Davis’s preferred stock pays $150,000 in dividends each year.

Answer 1

The answer is

- Opportunity costs

The value of next best alternative is known as opportunity costs

Sunk costs are the costs already incurred and hence, are irrelevant

Factors to be included are:

-Davis’s forecasted cash flows are expressed on an after-tax, as opposed to pre-tax, basis.

-Davis buys most of its raw materials on credit, causing accounts payable to increase by $30,000.

After tax cash flows are relevant. Accounts payable is relevant as change in working capital is relevant for capital budgeting

Dividends paid are not relevant