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Incremental Cash Flows and Misleading Statements

1. Which of the following should be treated as incremental cash flows when deciding whether to invest in a new manufacturing plant? The site is already owned by the company, but existing buildings would need to be demolished. Explain please

a. The market value of the site and existing buildings
b. Demolition costs and site clearance
c. The cost of a new access road put in last year
d. Lost earnings on other products due to executive time spent on the new facility
e. A proportion of the cost of leasing the president's jet airplane
f. Future depreciation of the new plant
g. The reduction in the corporation's tax bill resulting from tax depreciation of the new plant
h. The initial investment in inventories of raw materials
I. Money already spent on engineering design of the new plant

2. Each of the following statements is dangerous or misleading. Explain why.

a. A long-term United States government bond is always absolutely safe.
b. All investors should prefer stocks to bonds because stocks offer higher long-run rates of return.
c. The best practical forecast of future rates of return on the stock market is a 5- or 10-year average of historical returns.

Need references if possible.

Solution Preview

1.

Explanation:

Incremental cash flows can be defined as the investment of money into a division that is losing money, but the investment will provide a lot of opportunities for the organization.

Answer:

A. The market value of the site and existing buildings
B. Demolition costs and site clearance
D. Lost earnings on other products due to executive time spent on the ...

Solution Summary

This solution identifies the correct situations that should be treated as incremental cash flows and also explains why the three statements are dangerous or misleading.

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