Final answer:
Operating cash flow should exclude interest expense because it is a financing activity, not an operating activity. Fixed and variable costs, as well as taxes, are included as they are directly tied to the company's operations and affect cash flows from business activities. The correct answer is option a. interest expense.
Step-by-step explanation:
The operating cash flow for a project should exclude interest expense. Operating cash flow is concerned with the cash inflows and outflows that result from a company's normal business operations. In this context, operating cash flow should reflect the earnings before interest and taxes (EBIT), and after adjusting for taxes and changes in working capital. It is important to remove interest expense from operating cash flow since interest is a financing activity, not an operating activity.
Fixed costs, such as rent, are expenditures that do not change regardless of the level of production and are not sunk costs, as they are recurring and relevant for the future operations of a business. Fixed costs must be accounted for when evaluating a project's operating cash flow. Variable costs, incurred in the act of producing, while adjustable in the short term based on production levels, are also included since they are part of the cost of goods sold and necessary to operate. Taxes are an expense directly tied to operating profitability and must be considered as an adjustment to derive net operating cash flow because they affect the actual cash outflows associated with a firm's operations.
Ignoring interest expense allows a more accurate assessment of the profitability and viability of the project itself, without the distorting effects of how the project is financed.