Which of the following is/are true about operating cash flows of a project?
I. The annual operating cash flow equals operating income minus net non-cash expenses.
II. Financing costs are excluded from the operating cash flows.
III. Project evaluation is based on net cash flows, not net income.
Click on the arrows to vote for the correct answer
A. B. C. D. E. F. G.D
The annual operating cash flow equals operating income plus net non-cash expenses. Financing costs are excluded since they are accounted for in the discounting process through the use of WACC.
The correct answer is E. I & III.
Explanation:
I. The statement "The annual operating cash flow equals operating income minus net non-cash expenses" is true. Operating cash flow represents the cash generated or consumed by a project's core operations. It is calculated by starting with the operating income (also known as earnings before interest and taxes, or EBIT) and then adjusting for non-cash expenses, such as depreciation and amortization. These non-cash expenses do not require an outflow of cash but are deducted from operating income when calculating net income. By excluding them from the operating cash flow, we focus on the actual cash inflows and outflows resulting from the project's operations.
II. The statement "Financing costs are excluded from the operating cash flows" is true. Financing costs, such as interest expense on debt or dividends on equity, are not considered in operating cash flows. Operating cash flows focus solely on the cash flows generated or consumed by the project's operations, excluding any cash flows related to financing activities. Financing costs are more appropriately accounted for in the calculation of net income or cash flows from financing activities.
III. The statement "Project evaluation is based on net cash flows, not net income" is true. Net cash flows, which consider both operating and financing cash flows, provide a more comprehensive view of the cash generated by the project. Net income, on the other hand, is an accounting measure that includes non-cash items and may not reflect the actual cash flows. When evaluating a project, it is important to consider the net cash flows, as they represent the cash available to the project's investors and can be used for reinvestment or distribution purposes.
In summary, the correct answer is E. I & III because both statements I and III are true. Operating cash flows are calculated by adjusting operating income for net non-cash expenses and exclude financing costs. Project evaluation is based on net cash flows rather than net income to capture the actual cash flows generated by the project.