BCOR 2200 Chapter 9 w cq

BCOR 2200 Chapter 9 w cq - 1 Chapter 9 Making Capital...

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Unformatted text preview: 1 Chapter 9 Making Capital Investment Decisions 2 We know from Chapter 8: Capital budgeting requires calculating the NPV: So Discount the future cash flows at the require rate of return But how do you determine the cash flows? And how do you know what discount rate to use? First well look at cash flows Then well look at the discount rate The General Idea: Only use CFs associated with the project being considered New (or incremental) CFs. Only these are the relevant CFs for the analysis CFs from existing (or previous) operations are not relevant 3 Chapter Outline: 1. The Stand-Alone Principle Use only Incremental or Relevant CFs 2. So which CFs do you include? 3. Use of Pro-Forma Financial Statements 4. More About NWC and Depreciation 5. Evaluating NPV estimates 6. Scenario Analysis 7. Additional Considerations 4 9.1 Project Cash Flows A First Look Dont calculate the whole firms CFs Calculate CFs With and Without the project Use the Stand-Alone Principle Calculate the Incremental CFs associated with the project Include any and all changes in the firms future CFs that are a direct consequence of taking on the project. These are the Relevant CFs use to calculate NPV 5 9.2 Incremental CFs Only those CFs that result from the project Some Issues and Definitions associated with Identifying Incremental CFs: Sunk Costs A cost already paid or a liability already incurred Opportunity Costs Using and asset the firm already owns How is this different from a sunk cost? You could sell the asset Side Effects Cannibalization or generation of service revenues CFs Assoc. with Changes in Working Capital Inventory build-up, customer credit, supplier credit Financing Costs Well ignore these and well see why in a minute 6 Sunk Costs: A cost already paid or a liability already incurred The decision about the project will not affect these costs. Example: Money spent studying a project before the decision is made. Architectural plans, legal fees concerning zoning Do not included since the money is spent whether the project is accepted or not Example: Already paying a manager to manage one factory Allocate the managers salary to the 2 nd factory The salary is a sunk cost Do not included in the 2 nd factory CFs 7 Two More Sunk Cost Examples: Example: One more $1 slot machine pull after loosing $100. Should you consider the past $100 when deciding to the next $1? The loss is not relevant in the decision to bet the next $1 Example: We tried to market a red version of our project and that didnt work Should we try to market a blue version?...
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This note was uploaded on 10/08/2009 for the course BCOR 2200 taught by Professor Tomnelson during the Spring '08 term at Colorado.

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BCOR 2200 Chapter 9 w cq - 1 Chapter 9 Making Capital...

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