You are helping to decide whether or not to start a new project. The project would be housed in a building that is currently 70% full. Your project would use the other 30% of the building. This year, the annual electricity cost for the building is $80,000. When your project occupies the building, the annual electricity cost would rise to $100,000. Barney, your company accountant, has told you that since you will be occupying 30% of the building, $30,000 of the electric bill would be allocated to your project. Which of the following is true?
A. You should allocate $30,000 to electricity expense when you determine the incremental cash flows for your new project.
B. You should not include electricity costs in your incremental cash flows.
C. When you determine incremental cash flows, you should use $20,000 as the electricity cost.
D. You should include the $25,000 your team spent on creating the pro forma for this project as an incremental cash flow.
E. You should allocate 30% of last year's electric bill to incremental cash flows for the new project.
Which of the following statements is CORRECT?
A. If an asset is sold for less than its book value at the end of a project's life, it will generate a loss for the firm, hence its terminal cash flow will be negative.
B. Only incremental cash flows are relevant in project analysis, the proper incremental cash flows are the reported accounting profits, and thus reported accounting income should be used as the basis for investor and managerial decisions.
C. It is unrealistic to believe that any increases in net operating working capital required at the start of an expansion project can be recovered at the project's completion. Operating working capital like inventory is almost always used up in operations. Thus, cash flows associated with operating working capital should be included only at the start of a project's life.
D. If equipment is expected to be sold for more than its book value at the end of a project's life, this will result in a profit. In this case, despite taxes on the profit, the end-of-project cash flow will be greater than if the asset had been sold at book value, other things held constant.
E. Changes in net operating working capital refer to changes in current assets and current liabilities, not to changes in long-term assets and liabilities, hence they should not be considered in a capital budgeting analysis.