Which of the following is/are true?
I. A project's sunk costs are irrelevant to the decision of accepting or rejecting it.
II. A project's incremental cash flows are not affected by interest expenses.
III. Project rankings using incremental net income and incremental net cash flows can be different.
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A. B. C. D. E. F. G.Explanation
Incremental cash flows of a project are the cash flows that occur if and only if the project is undertaken. Since the effects of debt financing are taken into account through the discount rate used to discount the project cash flows, interest payments are ignored while estimating the project's cash flows. Therefore, a project's incremental cash flows are not affected by interest expense. Sunk costs represent expenses that have already been incurred or committed to. Therefore, they should not be allowed to affect future decisions. Finally, since income includes non-cash items, the discounting of income numbers can distort the project rankings based on cash flows. In capital budgeting, annual cash flows, not accounting income, are used to evaluate a project.