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.

Question

Quizplus · Accepted Answer

The CFO should include 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. This is because the investment in working capital is a cash outflow that is necessary to operate the project, and it should be taken into account when calculating the project's cash flows. The other options are incorrect because: A) sunk costs are irrelevant and should not be included in the cash flows, B) interest expenses should already be included in the WACC used to discount the cash flows and should not be double-counted, D) sunk costs are irrelevant and should not be included in the cash flows, and E) effects on other divisions are not relevant to the project's own cash flows and should not be included in the cash flow estimation.

A Company Is Considering a New Project