Question

Which of the following statements about capital budgeting cash flow estimation is most correct?

A	Interest expense on any loans used to acquire the equipment must be included in the project’s cash flows.

B	Money spent last year on a consulting report must be included in the project’s cash flows.

C	Opportunity costs associated with land usage must be included in the project’s cash flows.

D	Any impact on the cash flows of existing (current) projects must be included in the project’s cash flows.

E	Both c. and d. are correct.

Answer 1

Option E is correct.

We do include any opportunity cost in our assessment of capital investment analysis. Also, impat of the new project cash flows on existing cash flows is considered whether it is of cannibalizing form or synergistic form.

Option B is a sunk cost. This implies, that whether the project is taken up or not, that expense has been made last year and hence should not be used as a component of financial analysis for future cash outflows and inflows. So statement is incorrect.

Option A is incorrect. While assesing any cash flows interest expense is not used. we calculate the after tax cash flows for all investors in order to calculate the value that the project adds to the firm.