A Company Is Considering a Proposed New Plant That Would

question 50

Multiple Choice

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, it would in effect be "double-counted."
• B) Since depreciation is a noncash expense, the firm does not need to deal with depreciation when calculating the operating cash flows.
• C) When estimating the project's operating cash flows, it is important to include any opportunity costs and sunk costs, but the firm should ignore 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.

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Definitions:

Annual Payment

A recurring payment made once a year for a variety of purposes, including loan repayments, leases, and annuities.

Perpetuity

A type of annuity that pays a fixed amount of money to an individual indefinitely, without a termination date.

Annual Percentage Rate

The annual rate charged for borrowing or earned through an investment, including any fees or additional costs associated with the transaction.

Effective Annual Rate

The annual rate of interest that accounts for compounding over the year, providing a true reflection of the financial product's yield.