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5. 387376

A company is considering a proposed new plant that would increase productive capacity. Which of the following statements is CORRECT?

Answer
1. In calculating the project's operating cash flows, the firm should not deduct financing costs such as interest expense, because financing costs are accounted for by discounting at the WACC. If interest were deducted when estimating cash flows, this would, in effect, 'double count' it.

2. Since depreciation is a non-cash expense, the firm does not need to deal with depreciation when calculating the operating cash flows.

3. When estimating the project's operating cash flows, it is important to include both opportunity costs and sunk costs, but the firm should ignore the cash flow effects of externalities since they are accounted for in the discounting process.

4. Capital budgeting decisions should be based on before-tax cash flows.

5. The WACC used to discount cash flows in a capital budgeting analysis should be calculated on a before-tax basis.