Question

Which of the following statements regarding cash flow is correct?

Multiple Choice

• In evaluating capital budgeting decisions, cash flows should be valued on a pre-tax basis for consistency's sake.

• Incremental cash flows should include opportunity costs but ignore sunk costs.

• Cash flow should be recognized only when it has accrued according to GAAP practices.

• Cash flow measures changes in the firm's cash account.

• After-tax cash flow is usually identical to accounting profits when accrual accounting is used for financial statement purposes.

Answer 1

Correct option is Incremental cash flow should include opportunity cost but ignore sunk cost.

Explanation:-Sunk cost is the cost which has already incurred and does not change whether the project is taken up or not and hence there is no change in cash flow due to the sunk cost and therefore it is not included in Incremental cash flow.

Opportunity cost is the cost of foregoing or losing one alternative while choosing other alternative for example loss of rent on building because of using the building for the project ,Now ,in this case ,cash flow has affected and therefore included in Incremental cash flow

Other options are not correct because cash flows are evaluated on post tax basis not pre tax basis .

Cash flow is not recognised when it is accrued but actually inflow or outflow occurs .

After tax cash flow is not identical to accounting profits because non cash expenses are deducted while calculating accounting profits but this is not the case in calculating cash flow.