A Company Is Considering a New Project

question 68

Multiple Choice

A company is considering a new project.The CFO plans to calculate the 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 flows) ,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 additional investment in net operating working capital (NOWC)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.

---

Definitions:

Cost of Goods Sold

The total cost directly involved in manufacturing or acquiring the products sold by a company during a particular period.

Acid Test Ratio

A liquidity ratio; those assets that are most easily converted to cash are divided by current liabilities to indicate ability to pay off short-term debt. Also called quick ratio.

Quick Assets

Assets that can be quickly converted into cash without significantly affecting their value, such as stocks and receivables.

Current Liabilities

Current liabilities are a company's debts or obligations that are due to be paid within a year, including accounts payable, short-term loans, and accrued expenses.