A company is considering a proposed new plant that would increase productive capacity.Which of the following statements is CORRECT?
A) 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 WACC.If interest were deducted when estimating cash flows,this would,in effect,"double count" it.
B) Since depreciation is a non-cash expense,it has no impact on a project's calculated NPV..
C) 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.
D) Capital budgeting decisions should be based on before-tax cash flows because WACC is calculated on a before-tax basis.
E) The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis.To do otherwise would bias the NPV upward.

Question

Quizplus · Accepted Answer

Depreciation affects cash flows through its tax shield effect, making statement B incorrect. Opportunity costs should be included, but sunk costs should not, making statement C incorrect. Capital budgeting decisions should be based on after-tax cash flows, and the WACC is calculated on an after-tax basis, making statements D and E incorrect. Statement A is correct because interest expense is accounted for in the WACC, and deducting it again when estimating cash flows would indeed double count it.

A Company Is Considering a Proposed New Plant That Would