Which of the following rules is CORRECT for capital budgeting analysis?
A) The interest paid on funds borrowed to finance a project must be included in estimates of the project's cash flows.
B) Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions.
C) Sunk costs are not included in the annual cash flows, but they must be deducted from the PV of the project's other costs when reaching the accept/reject decision.
D) A proposed project's estimated net income as determined by the firm's accountants, using generally accepted accounting principles (GAAP), is discounted at the WACC, and if the PV of this income stream exceeds the project's cost, the project should be accepted.
E) If a product is competitive with some of the firm's other products, this fact should be incorporated into the estimate of the relevant cash flows. However, if the new product is complementary to some of the firm's other products, this fact need not be reflected in the analysis.

Question

Quizplus · Accepted Answer

Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions. This means that only the cash flows that are directly attributable to the project and would not exist if the project is not undertaken should be considered. Other options listed in the question either include irrelevant cash flows (such as interest paid on funds borrowed to finance the project) or non-cash expenses (such as net income determined by GAAP) that are not useful for making accept/reject decisions.

Which of the Following Rules Is CORRECT for Capital Budgeting