Please answer completely and correctly all questions when firms make pital budge
ID: 2786516 • Letter: P
Question
Please answer completely and correctly all questions
when firms make pital budgeting decisions, they should concern themselves with incremental cash flows, not net income, when evaluating projects. To determine the incremental cash flows associated with a capital project, an analyst should include all of the following except: O The project's depreciation expense O The project's marginal taxes O The project's terminal value O The project's financing costs Indirect cash fNows often affect a firm's capital budgeting decisiors. However, some of these indirect cash flows are relevant to capital budgeting decisions (because they represent marginal cash flows that depend on the project's acceptance), but others should be ignored are costs the firm paid in the past and are unrecoverable. Accepting or rejecting a project will not change them, so they should not be included in capital budgeting analysis. Consider the case of Bumbly Products Inc. The company is evaluating a capital budgeting project and has come across a few issues that require special attention. Classify each item as a sunk cost, cannibalization, opportunity cost, or a change in net working capital (NWC). Then, in the last column, indicate whether the item should be included in the project's analysis or not. Change Include in Cost Cannibalization in NWC the Analysis? The new project isexpected to reduce sales revenue for one of the company's other product lines The project will use some equipment that the firm owns but isn t using currently. However, a used-equipment dealer has offered to buy the equipment Bumbly spent nearly $1.1 millon in market research to develop new product ideas. Many of the new sales from this project will be made on credit, causing accounts receivable to increase. The factory that the project will use could be used for another project that is expected to have a slightly positive net present value (NPV). O Suppose Bumbly will be issuing debt to support this project and other capital budgeting projects this year. The firm's interest expense ncrease by $700,000. Should the change in interest expense be included in the analysis? O YesExplanation / Answer
a.
Project financing cost does not included in determining incremental cash flow of the project.
Option (D) is correct answer.
b.
Sunk cost is type of cost that firm paid in past and are unrecoverable. acccepting or rejecting the project does not change them. so, this cost is not included in capital budgeting.
c.
1.
The new project is expected to reduce sales revenue for one of the company’s other product line is example of cannibalization.
2.
The project will use some equipment that the firm owns but isn’t using currently. However, a used equipment dealer has offered to buy the equipment. This event should be included in the analysis.
3.
Bombly spent nearly $1.10 million in market research to develop new project is an example of sunk cost.
4.
Many of new sale from this project will be made pm credit, causing account receivables to increase is an example of change in net working capital.
5.
The factory that the project will use could be used for another project that is expected to have a slightly positive Net present value is example of opportunity cost.