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Unformatted text preview: Cash Flow and Capital Budgeting 113 Chapter 8: Cash Flow and Capital Budgeting Answers to questions 8-1. Accounting numbers may not accurately reflect when revenues are received or when payments are made. Net present value focuses on when money is actually received or paid and then dis- counts these cash flows at an appropriate rate to find whether a project adds value to a company. This emphasis recognizes that whatever accounting earnings a company has, it must generate suf- ficient cash to pay its bills or it will not stay in business very long. 8-2. No, even if the project is not adopted, the cost would still be incurred making it a sunk cost. 8-3. No, this is an example of an opportunity cost. 8-4. Depreciation reduces taxable income. The lower the taxable income, the lower the taxes paid, which are a real cash outflow. Thus, depreciation creates a cash inflow through the lowering of a real cash outflow. 8-5. When constructing forecasts in nominal terms, each value that would be impacted by inflation should be increased by the rate of inflation each year. To construct projections in real terms, all values that would be inflated had they been in nominal terms should be in time zero dollars to re- flect real values. 8-6. No, a negative change in net working capital is actually beneficial. It is a cash inflow in the sense that it indicates proportionately more funding for current assets is coming from current liabilities. 8-7. Interest expense should be ignored and should not be treated as a cash outflow. The discount rate already captures the costs associated with financing a project, and deducting these costs from the projects cash flows would be double counting. 8-8. a. Depreciation positively impacts cash flow. Depreciation reduces taxable income. The lower the taxable income, the lower the taxes paid, which are a real cash outflow. Cash flow from operations is net income with depreciation added back in. Higher depreciation means higher cash flow. b. From a net present value perspective, the faster depreciation is taken the better. More de- preciation in the early years of a project means higher cash flows and higher net present value for a project. c. & d. Many companies use accelerated deprecation for cash flow/net present value purposes and straight line depreciation for reporting purposes. This ensures that the depreciation method used does not impact reported earnings per share; however, it does allow the company to take maximum tax advantage of depreciation and reduce its tax bill. 8-9. An increase in accounts payable is a cash inflow in the sense that the firm is asking its creditors to finance more of its purchases. The creditor is providing non-interest bearing financing for the firms working capital needs. The company is able to purchase more current assets since it has less of a need to pay its creditors....
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