Final answer:
The statement that capital budgeting focuses on cash flows and not directly on the income statement is true. Capital budgeting involves evaluating the potential cash flow impacts of investment decisions, considering future profits, interest rates, and ways to finance such investments. Hence, option (a) is true.
Step-by-step explanation:
The statement that 'investments are evaluated in terms of cash flows, hence capital budgeting does not necessarily demonstrate the effect that an investment will have on a firm's income statement' is true. Capital budgeting focuses on the cash inflows and outflows associated with investment projects, rather than the accounting profits that are shown on an income statement.
When a firm engages in capital budgeting, it is primarily interested in understanding the cash flow implications of a project over its life span. This includes analyzing expectations of future profits, the interest rates impacting the cost of investment, and the methods by which a firm can raise financial capital for investment, such as from investors, profits, loans, or by selling stock.