CFA Practice Question

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CFA Practice Question

Which of the following is not a relevant cash flow for evaluating a new project?

A. An increase in accounts payable from initial orders placed with suppliers
B. An increase in cash balances to cover start-up costs
C. Interest expense on funds borrowed to finance the project
D. Increased wear and tear on previously purchased assembly equipment
Correct Answer: C

Financing costs such as interest payments are not explicitly included since they are implicitly included in the firm's cost of capital.

User Contributed Comments 9

User Comment
kalps Hold on depreciation is not a cash flow and is ignored so sureley answer is c and d
stefdunk answer D, wear and tear, is an externality and should be considered.
haarlemmer I believe your answers are not that right. The interest expense is not considered as when the NPV method is used, the leverage effect has been included from WACC. Thus interest expense is not a concern.
tengo wear and tear is not a cash flow. But the additional maintenance and repair required in the future would be a cash flow when expended and would be revelant at that time
moneyguy @Tengo... Yes, and during the auditing phase of analysis, the firm should look carefully at these additional costs that have incurred.
johntan1979 Agree with tengo. Increased wear and tear of fixed assets means replacement costs will be incurred soon.
tichas Depreciation is not a cash flow, it has nothing to do with future costs or incremental costs. However if by using the machine to produce the NEW PRODUCT , additional wear and tear is incurred as a result then the additional depreciation becomes relevant
ascruggs92 To those harping on depreciation: D. says nothing about depreciation. Depreciation is calculated based on a formula for tax reasons (tax depreciation is relevant here, not book, bc tax depreciation effects cash flow), therefore a change in wear and tear wouldn't change depreciation. Increased wear and tear means increased cost of maintenance, which means increased cash outflows.

Also, depreciation reduces cash taxes, so you are still wrong to say that depreciation does not effect cash flow.
UcheSam What make option "D" to be relevant is the "Increased" wear and tear. Had it not been the new project, the wear and tear would have remained the same. Hence, its incremental and relevant.
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