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?

Question

Quizplus · Accepted Answer

The CFO should be sure to 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 investment in working capital represents a cash outflow that is required to operate the project, and is therefore relevant to the NPV calculation. Sunk costs that have been incurred relating to the project are not relevant to the NPV calculation, as they are already incurred and cannot be recovered. Likewise, the effects of the project on other divisions of the firm are not relevant, as only the direct cash flows of the project should be considered. Interest expenses on debt used to help finance the project are relevant to the calculation of the project's cash flows, but they should not be included in the cash flows themselves, as they are already accounted for in the company's overall WACC.

The CFO of Cicero Industries Plans to Calculate a New