tof finance charges in is the correct Which of the following project evaluation?
ID: 2815632 • Letter: T
Question
tof finance charges in is the correct Which of the following project evaluation? D ef iennechare shouald be includeod in a projet's net cash fnows and in the inance charges should be included in a project's net cash flows and the discount rate C: Finance charges should be excladed from a project's net cash flows and the discoust rate. D. Statements B and C. correct treatment of inflation in he)? 23: Which of the following statements presents the projoct evaluation (cost of capital is the required rate of return is t A. Estimating cash flows based on constant prices and discounting them by the B. Estmating cash flows without adjustment for anticipated price changes and discounting them by the real cost of capital. nominal cost of capital C: Estimating cash flows based on anticipated price changes and discounting them by the real cost of capital D: All of the above. 24: Which of the following methods should be applied when comparing independent projects with different lives? A: The constant chain of replacement method only B: Either the constant chain of replacement method or the cquivalent annual value method only C: The constant chain of replacement method using the real cost of capital only D: The net present value method is adequate. 25: If it is feasible to undertake a project irrespective of the decision concerning the acceptance of another, the two projects are said to be: B: dependent. C: mutually exclusive. D: None of the above. 26: Sunk costs can be defined as: A: incremental costs. B: opportunity costs C: cost that has already been incurred but is relevant to future decision making. D: cost that has already been incurred and is irrelevant to future decision making.Explanation / Answer
22 C
The costs of financing the project (such as interest payments on debt and dividend payments) are embodied in the project cost of capital (r). To avoid double counting, financing costs should not be included as part of the project’s incremental cash outflows.
The correct treatment is to include financing cost in cost of capital and exclude in in project cash flows.
23 B
Inflation must be treated in a consistent manner in any NPV model. There is a choice between two approaches. Either:
24 B
When comparing two projects with unequal lives, NPV and IRR menthods will give us differing results due to unequal lives of the two projects.
So we should opt for either replacement chain method in which we analyse the two projects over the common life - usually adjusting the life span of one project to the longest lifespan prject and then calculate the NPV of discounted cashflows and select the project with higher NPV. With the cash flows adjusted with the replacement-chain method, both the NPV and the IRR arrive at the same conclusion.
Or we can use the equivalent annual value method in which we calculate the expected payment over the project's life, where the future value of the project would equal zero for each of the projects. And select the project with higher value of equivalent annual value.
25 A
An Independent Project is a project whose cash flows are not affected by the accept/reject decision for other projects. Thus, all Independent Projects which meet the Capital Budgeting critierion can be accepted. Mutually Exclusive Projects are a set of projects from which at most one will be accepted.
26 D
Once the company's money is spent, that money is considered a sunk cost. Regardless of what money is spent on, sunk costs are dollars already spent and permanently lost. Sunk costs cannot be refunded or recovered. Since sunk costs are costs the firm has already incurred, they shouldn't be included in future cash flows. Since decision-making only affects the future course of business, sunk costs should be irrelevant in the decision-making process.
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