Explain why

1. Which of the following is NOT a relevant cash flow and thus should NOT be reflected in the analysis of a capital budgeting project?

a. Changes in net operating working capital.

b. Shipping and installation costs for machinery acquired.

c. Cannibalization effects.

d. Opportunity costs.

e. Sunk costs that have been expensed for tax purposes.

A company is considering a new project. The CFO plans to calculate the project's NPV by estimating the relevant cash flows for each year of the project's life (i.e., the initial investment cost, the annual operating cash flows, and the terminal cash flows), then discounting those cash flows at the company's overall WACC. Which one of the following factors should the CFO be sure to INCLUDE in the cash flows when estimating the relevant cash flows?

a. All sunk costs that have been incurred relating to the project.

b. All interest expenses on debt used to help finance the project. c. The additional investment in net operating working capital required to operate the project, even if that investment will be recovered at the end of the project's life.

d. Sunk costs that have been incurred relating to the project, but only if those costs were incurred prior to the current year.

e. Effects of the project on other divisions of the firm, but only if those effects lower the project's own direct cash flows.

Which of the following factors should be included in the cash flows used to estimate a project's NPV?

a. All costs associated with the project that have been incurred prior to the time the analysis is being conducted.

b. Interest on funds borrowed to help finance the project.

c. The end-of-project recovery of any additional net operating working capital required to operate the project.

d. Cannibalization effects, but only if those effects increase the project's projected cash flows.

e. Expenditures to date on research and development related to the project, provided those costs have already been expensed for tax purposes.

Rowell Company spent $3 million two years ago to build a plant for a new product. It then decided not to go forward with the project, so the building is available for sale or for a new product. Rowell owns the building free and clearthere is no mortgage on it. Which of the following statements is CORRECT?

a. Since the building has been paid for, it can be used by another project with no additional cost. Therefore, it should not be reflected in the cash flows of the capital budgeting analysis for any new project.

b. If the building could be sold, then the after-tax proceeds that would be generated by any such sale should be charged as a cost to any new project that would use it.

c. This is an example of an externality, because the very existence of the building affects the cash flows for any new project that Rowell might consider.

d. Since the building was built in the past, its cost is a sunk cost and thus need not be considered when new projects are being evaluated, even if it would be used by those new projects.

e. If there is a mortgage loan on the building, then the interest on that loan would have to be charged to any new project that used the building.

A company is considering a proposed new plant that would increase productive capacity. Which of the following statements is CORRECT?

a. In calculating the project's operating cash flows, the firm should not deduct financing costs such as interest expense, because financing costs are accounted for by discounting at the WACC. If interest were deducted when estimating cash flows, this would, in effect, "double count" it.

b. Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating the operating cash flows.

c. When estimating the project's operating cash flows, it is important to include both opportunity costs and sunk costs, but the firm should ignore the cash flow effects of externalities since they are accounted for in the discounting process.

d. Capital budgeting decisions should be based on before-tax cash flows because WACC is calculated on a before-tax basis.

e. The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis. To do otherwise would bias the NPV upward.