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 flow), 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 investment in 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 investment in working capital required to operate the project, even if that investment will be recovered at the end of the project's life, as it is a relevant cash flow that affects the project's overall profitability. Sunk costs that have been incurred prior to the current year may be considered for other purposes, but they should not be included in cash flow projections when estimating NPV. Interest expenses on debt used to help finance the project are also relevant, but these are included as a separate line item in the cash flow projections. The effects of the project on other divisions of the firm may be important to consider, but only if those effects directly impact the project's cash flows.

Company Is Considering a New Project