Which of the following statements is correct?
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A. B. C. D. E.B
A gain on the sale occurs when equipment is sold for more than its book value. This increases profit and cash flow.
The correct statement among the given options is:
D. An asset that is sold for less than book value at the end of a project's life will generate a loss for the firm and will cause an actual cash outflow attributable to the project.
Explanation:
A. This statement is incorrect. Increases in net working capital that are required at the start of an expansion project are typically recovered at the project's completion. Therefore, these cash flows are included both at the start and the end of a project.
B. This statement is incorrect. When equipment is sold for more than its book value at the end of a project's life, it results in a gain for the firm. This gain will increase income and, despite increasing taxes, will generate a greater cash flow than if the same asset is sold at book value.
C. This statement is incorrect. Option D is correct, so not all the statements are false.
D. This statement is correct. When an asset is sold for less than its book value at the end of a project's life, it will generate a loss for the firm. This loss will cause an actual cash outflow attributable to the project, as the firm will receive less cash than the asset's book value.
E. This statement is incorrect. Only incremental cash flows are relevant in project analysis, which means only the cash flows that are directly attributable to the project are considered. Accounting profits, on the other hand, include various non-cash items such as depreciation and amortization. Therefore, accounting profits do not form the true basis for investor and managerial decisions when evaluating a project.
To summarize, statement D is correct because selling an asset for less than its book value at the end of a project's life generates a loss for the firm and causes an actual cash outflow attributable to the project.