Which of the following rules are essential to successful cash flow estimates, and ultimately, to successful capital budgeting?
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A. B. C. D. E.B
Incremental cash flows are the net cash flows attributable to an investment project and are the only cash flows relevant in capital budgeting.
Successful cash flow estimates and capital budgeting require careful consideration of relevant factors. Let's analyze each statement to determine its accuracy:
A. All of the statements are correct. This statement suggests that all the statements mentioned in the answer choices are essential to successful cash flow estimates and capital budgeting. To evaluate the accuracy of this statement, we need to assess the validity of each individual statement.
B. Only incremental cash flows are relevant to the accept/reject decision. This statement is generally correct. When evaluating a capital budgeting decision, the focus should be on incremental cash flows, which are the additional cash flows generated or saved as a result of accepting a particular project. Incremental cash flows consider the difference between the cash flows with and without the project. By focusing on incremental cash flows, decision-makers can assess the specific impact of the project on the company's cash flows.
C. The return on invested capital is the only relevant cash flow. This statement is incorrect. The return on invested capital (ROIC) is a financial metric that measures the profitability of an investment relative to the amount of capital invested. However, ROIC alone does not capture the full picture of cash flows associated with a project. Successful capital budgeting requires considering various cash flow components, such as initial investment, operating cash flows, salvage value, and any additional working capital requirements. These factors contribute to the overall cash flows associated with the project.
D. None of the statements are correct. This statement is incorrect. We have already determined that statement B is correct, indicating that incremental cash flows are relevant to the accept/reject decision.
E. Total cash flows are relevant to capital budgeting analysis and the accept/reject decision. This statement is incorrect. While total cash flows are important to understand the project's overall cash inflows and outflows, it is the incremental cash flows that are particularly relevant to the capital budgeting decision. Total cash flows alone may not accurately reflect the project's impact on the company's financials, as they do not account for the baseline cash flows without the project.
In summary, statement A is incorrect because statement C is incorrect. The correct answer is B: Only incremental cash flows are relevant to the accept/reject decision. This understanding is crucial for accurate cash flow estimation and successful capital budgeting.