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Sheet1 Page 1 CAPITAL BUDGETING C NET PRESENT VALUE hLast Lecture concluded that the method to use for accepting or rejecting projects is the NET PRESENT VALUEmethod hRequires determining the Cash Flows of the Project hRequires determining the correct discount rate to get the PRESENT VALUEof the Project r CASH FLOW OF THE PROJECT hWe are only interested in Cash Flows that will only occur if the Project happens, i.e., the INCREMENTALCash Flows of the Project. h We will start determining the rules to understand which Operations are INCREMENTALto the Project hThen we will learn how to determine the Cash Flows from those Operations. F INCREMENTAL CASH FLOWS h Sunk Costs: costs that already occurred. NOT INCREMENTAL. h Ex: Marketing Studies already made to predict the impact of the new product to be launched. h Opportunity Costs: the Value of the best alternative use to give to the Assets to be used in the Project. INCREMENTAL. h Ex: The value of a property you would sell only if you d INCREMENTAL CASH FLOWS h Side Effects: The effect the Project will have on the other Projects the Firm already has running. Can be positiveeffects (SYNERGY) or negative(EROSIONor CANIBALISM).
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Sheet1 Page 2 INCREMENTAL h Ex: The impact on the sales of the current lines of production from the addition of a new product p INCREMENTAL CASH FLOWS h Allocated Costs: The proportion of the cost of a COMMON resource to many Projects that is allocated to the new Project. NOT INCREMENTALif the total value of the cost across all Projects does no change with the addition of the new Project. hEx: The electric bill of the plant is split equally among all the products. If adding a new product does not increase the electric bill, the changes in the allocated proportions are NOT INCREMENTALto any of the products. p CASH FLOW OF THE PROJECT hOPERATING CASH FLOW hCAPITAL SPENDING hADDITION TO NET WORKING CAPITAL h OPERATING CASH FLOW hWill represent the difference between the
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