Question

A company is considering a proposed expansion to its facilities. Which of the following statements is most correct?

1.          In calculating the project's operating cash flows, the firm should not subtract out financing costs such as interest expense, since these costs are already included in the WACC, which is used to discount the project’s net cash flows.
2.          Since depreciation is a non-cash expense, the firm does not need to know the depreciation rate when calculating the operating cash flows.
3.          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 flows from externalities since they are accounted for elsewhere.
4.          Statements a and c are correct.
5.          None of the statements above is correct.

Answer 1

Depreciation is a non-cash expense but eligible for tax deduction. Since, it is a non-cash expense, no real cash outflow will rise. Tax saving on depreciation expense has to be considered as it reduces tax cash outflows.

Hence, correct option is B.

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