Capital budgeting analysis not only requires the evaluation of cash flows but also requires the understanding of the origin of those cash flows. Based on your understanding of cash flows in a firm, answer the following questions:

Which of the following is a reason cash flows may differ from accounting income?

Depreciation is a tax-deductible expense but is not a cash outlay.

The total number of units sold will be different for accounting income and cash flows.

Which of the following best describes incremental cash flows?

Incremental cash flows are not relevant because they will occur whether or not the project is accepted.

They are the difference between the cash flows the firm will have if it accepts the project versus the cash flows it will have if it rejects the project.

Understanding the nature of projects

Capital budgeting analysis often involves decisions related to expansion projects and/or replacement projects. Based on your understanding of expansion and replacement projects, answer the following:

A rental car company bought a new fleet of midsize cars and sold off its old midsize cars because they had too many miles on them. Which type of project would this be considered?

A replacement project

An expansion project

What are sunk costs?

Sunk costs are in the capital budgeting analysis.

The role of externalities

A cell phone company recently gave customers the ability to buy applications that they can download to their cell phones. Allowing customers to use these applications increased cell phone sales. This is an example of externality.