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.

Question

BlackTom AI · Accepted Answer

Changes in working capital (including inventory) are included in capital budgeting because they represent real cash inflows or outflows tied to the project.

1) Relevant knowledge points and concepts
- Capital budgeting uses incremental cash flows, not accounting net income. 
- Net working capital (NWC) = current assets (inventory, receivables) − current liabilities (payables). Changes in NWC tie up or release cash and therefore must be included. 
- Noncash accounting items like depreciation are added back when computing operating cash flow, but changes in noncash balance sheet accounts (inventory, receivables, payables) are cash-related and are included.

2) Step-by-step reasoning
- Determine incremental operating cash flow (OCF) from operations.
- Account for initial investment cash outlay, which includes any increase in NWC at project start (a cash outflow).
- During the project, treat increases in inventory as cash outflows (reduces available cash) and decreases as inflows.
- At project termination, recover any NWC increases (cash inflow).

3) Example with intermediate steps
Assume: Sales = 300, Operating costs = 180, Depreciation = 20, Tax rate = 30%, initial inventory increase = 50.
- Earnings before depreciation and taxes = 300 − 180 = 120.
- EBT = 120 − 20 = 100.
- Taxes = 100 × 0.30 = 30.
- Net income = 100 − 30 = 70.
- OCF = Net income + Depreciation = 70 + 20 = 90.
Alternatively OCF formula: (Sales − Costs) × (1 − T) + Dep × T = 120 × 0.7 + 20 × 0.3 = 84 + 6 = 90.
Initial cash outflow includes inventory increase: Initial outlay = equipment cost + 50. At project end the 50 is recovered. Omitting the 50 would overstate the project's initial cash position and distort NPV.

4) Why the correct answer is correct
The statement given says inventory changes are not included. That is false: inventory changes are cash consequences and must be included in incremental cash-flow analysis for correct NPV/IRR evaluation.

5) Why the other option is incorrect
The only other choice would be “True.” That is incorrect because it ignores the cash impact of working capital changes; treating inventory changes as irrelevant would lead to incorrect investment decisions.

6) Conclusion
Therefore the correct response is False, which matches the provided answer.

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.判断题

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