A company is considering a proposed new plant that would increase productive capacity. Which of the following statements is CORRECT?

Question

BlackTom AI · Accepted Answer

Operating cash flows for project evaluation exclude interest expense because financing effects are captured in the discount rate (WACC) rather than in the cash flows themselves.

1) Relevant concepts:
- Incremental (project) cash flows: include only cash flows that change because of the project (operating revenues, operating costs, taxes, depreciation shield, capital expenditures, changes in working capital, and opportunity costs).
- Free Cash Flow to the Firm (FCFF): FCFF = EBIT(1 − T) + Depreciation − CapEx − ΔNWC. FCFF is discounted at the WACC.
- Free Cash Flow to Equity (FCFE): FCFE = Net income + Depreciation − CapEx − ΔNWC + Net borrowing; FCFE is discounted at the cost of equity (Re).
- Financing costs (interest) are not subtracted when using FCFF because WACC already reflects the required return for debt and equity.

2) Step-by-step reasoning:
- If a firm estimates operating (incremental) cash flows, it should compute FCFF (starting from EBIT), not subtract interest. That yields the cash available to all providers of capital.
- WACC = (E/V)Re + (D/V)Rd(1 − T) reflects the blended cost of capital. Discounting FCFF by WACC allocates the project’s value appropriately to debt and equity holders.
- If interest were deducted from cash flows and you still discounted by WACC, the cost of debt would be accounted for twice: once as a subtraction in cash flows and again through the Rd(1 − T) component of WACC.

3) Numerical illustration (simple): Suppose project yields EBIT = 100, T = 30%, so FCFF = 100(1 − 0.3) = 70. If WACC = 10%, PV = 70/0.10 = 700. If you wrongly subtract interest = 20 to get 50 and still discount at 10%, PV = 50/0.10 = 500 — the project value is understated because debt cost was double-counted.

4) Why this answer is correct: It follows standard capital budgeting practice—use pre-financing operating cash flows and discount at WACC (or use equity cash flows and discount at Re). Interest is a financing cash flow, not an operating one.

5) Why other potential statements are incorrect: Including interest in operating cash flows double-counts financing costs; sunk costs should be excluded; opportunity costs should be included.

Conclusion: The correct answer is that financing costs (interest) should not be deducted when calculating operating project cash flows because they are captured by discounting at the WACC. This matches the provided answer.

A company is considering a proposed new plant that would increase productive capacity. Which of the following statements is CORRECT?单项选择题

类似问题

What is meant by mutually exclusive projects?

Which of the following statements is FALSE?

Capital investment decisions often involve all of the following except ________.

Which of the following factors should be included in the cash flows used to estimate a project’s NPV?

Since the focus of capital budgeting is on cash flows rather than on net income, changes in noncash balance sheet accounts such as inventory are not included in a capital budgeting analysis.

更多留学生实用工具

智能学习助手

风格化写作助手

论文查重助手

文献引用助手

课堂转译助手

课堂笔记助手

Quiz搜索助手

学校历年真题

智能刷题助手

智能匹配练习

希望你的学习变得更简单