The 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 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. This is because the working capital investment is a cash outflow at the beginning of the project and a cash inflow at the end of the project, and therefore affects the project's overall cash flows. Sunk costs that have been incurred prior to the current year should not be included, as they are already incurred and are irrelevant to future cash flows. Interest expenses on debt used to finance the project should be included in the cost of capital used to discount cash flows, but not in the actual cash flows themselves. Effects of the project on other divisions of the firm should also not be included, unless they directly affect the project's own cash flows.

The CFO of Cicero Industries Plans to Calculate a New