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.
E)The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis.

Question

Quizplus · Accepted Answer

Financing costs such as interest expense should be deducted when calculating the project's operating cash flows because they are cash outflows that affect the firm's ability to generate cash. However, when discounting cash flows at the weighted average cost of capital (WACC), financing costs are already accounted for, so deducting them from cash flows when estimating them would result in double counting.

Company Is Considering a Proposed New Plant That Would Increase