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CMA Final · Strategic Financial Management · Investment Decisions, Project Planning and Control

Which of the following is the correct treatment of costs in the cash flow estimation of a capital project?

Interest on project financing should be excluded from the cash flows because the cost of capital used for discounting already reflects it. Sunk costs and unchanged allocated overheads are not incremental, and depreciation is non-cash, so those treatments are wrong.

  1. AInclude the Rs 2,00,000 feasibility study fee already paid last year
  2. BInclude allocated head-office overhead that will not change if the project is accepted
  3. CExclude interest on borrowings used to finance the project from the cash flows, since the discount rate reflects financing costCorrect
  4. DInclude depreciation as a cash outflow

Explanation

Financing costs are captured in the discount rate, so including interest would double count. The sunk feasibility fee and unchanged allocated overhead are not incremental. Depreciation is non-cash and only matters through its tax shield.

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