To increase productive capacity, a company is considering a proposed new plant.Which of the following statements is CORRECT?
A) Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating the operating cash flows.
B) 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.
C) Capital budgeting decisions should be based on before-tax cash flows.
D) The cost of capital used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis.
E) 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 cost of capital.If interest were deducted when estimating cash flows, this would, in effect, "double count" it.

Question

Quizplus · Accepted Answer

Financing costs like interest expense are not deducted when calculating a project's operating cash flows because these costs are accounted for in the discounting process using the cost of capital. Deducting interest expense when estimating cash flows and then discounting those cash flows at the cost of capital would indeed result in double counting the financing costs.

To Increase Productive Capacity, a Company Is Considering a Proposed