Question

which of the following examples likely characterizes relevant incremental cash flow for capital budgeting?

A) market value of premises (buildings) which are going to be used as part of a new project

B) the depreciation of a newly acquired capital assets for the new project

c) interest expense on new loans used to finance the new project

D) all of the above

Answer 1

Incremental cash flow is the net cash flow from all cash inflows and outflows over a specific time and between two or more project or business options. It is the cash flow realized after a new project or business is accepted or a capital decision is taken, i.e., the resultant increase in cash flow from operations due to the acceptance of new business option or a project. If the project or business options results in positive incremental cash flow, then the company should invest in that project as it would increase the company’s existing cash flow.

The following examples likely characterizes relevant incremental cash flow for capital budgeting is Option D ( all the above).

Explanation:-

A) Market value of premises(building) which are going to be used as part of a new project is an relevant incremental cost since there is an opportunity to sell the building(premises) if the new project is undertaken. Hence, its a relevant incremental cost for Capital Budgeting.

B) The depreciation of a newly acquired capital assets for the new project is an relevant Incremental Cost since depreciation expense should be treated as an incremental cash flow as depreciation is taken while calculating annual cash flows. Depreciation expense must be taken into account when calculating the cash flows related to a given project.

C) Interest expense on new loans used to finance the new project is an relevant Incremental Cost since interest expenses will be used to compute annual cash flows of the new project while analysing the capital budgeting decision.