Which of the following rules is CORRECT for capital budgeting analysis?
A) The interest paid on funds borrowed to finance a project must be included in estimates of the project's cash flows.
B) Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions.
C) Sunk costs are not included in the annual cash flows, but they must be deducted from the PV of the project's other costs when reaching the accept/reject decision.
D) A proposed project's estimated net income as determined by the firm's accountants, using generally accepted accounting principles (GAAP), is discounted at the WACC, and if the PV of this income stream exceeds the project's cost, the project should be accepted.

Question

Quizplus · Accepted Answer

Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions. This means that any cash flows that would occur regardless of whether the project is accepted (such as sunk costs or interest paid on funds borrowed) should not be included in the analysis. Additionally, accounting net income is not relevant for capital budgeting as it includes non-cash expenses such as depreciation. Therefore, choice B is the correct rule for capital budgeting analysis.

Which of the Following Rules Is CORRECT for Capital Budgeting