CFO of Cicero Industries plans to calculate a new 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 interest expenses on debt used to help finance the project.
B) 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.
C) Sunk costs that have been incurred relating to the project, but only if those costs were incurred prior to the current year.
D) Effects of the project on other divisions of the firm, but only if those effects lower the project's own direct cash flows.
E) All sunk costs that have been incurred relating to the project.

Question

Quizplus · Accepted Answer

Working capital is required to operate the project and it should be included in the relevant cash flows. All interest expenses on debt used to finance the project should be subtracted from the cash flows to determine the net cash flows. Sunk costs are irrelevant to the decision-making process and should not be considered in the cash flows. The effects of the project on other divisions of the firm should be considered only if they result in additional cash inflows or outflows for the project. All sunk costs that have been incurred relating to the project should be ignored because sunk costs cannot be recovered and should not be factored into the decision-making process.

CFO of Cicero Industries Plans to Calculate a New Project's