Ch 10 - 10. Making Capital Investment Decisions 1. Project...

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10. Making Capital Investment Decisions
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1. Project cash flows 1) Incremental cash flows associated with the project: cash flows consist of any or all changes in the firm’s future cash flows that are a direct consequence of taking the project. Stand-alone principle. - Sunk costs: a cost that has been already incurred and can not be removed regardless of whether or not a project would be launched. Thus it should not be considered in an investment decision. - Opportunity costs: not considered in an investment decision. - Side effects (erosion): cash flows of a new project that come at the expense of a firm’s existing projects. The cash flow from the new line should be adjusted downwards to reflect the any sales lost.
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- New working capital: It is usually financed by a loan (A/R). At the end of the life of the project, net working capital would be recovered by selling inventories, collecting A/R, etc - Financing costs: not considered in evaluating the proposed investment. - After-tax cash flow.
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2. Pro forma financial statement and project cash flow 1) Project cash flow (free cash flow) = Operating cash flow – project change in net working capital – project capital spending. (1) Operating cash flow = EBIT + Depreciation – Taxes (2) Change in net working capital = ending net working capital - beginning net working capital (3) Capital spending = ending net fixed asset – beginning net fixed asset + depreciation
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(4) Modified ACRS Depreciation (MACRS) Here, ACRS means accelerated cost recovery system. It is a depreciation method under U.S tax law allowing for the accelerated write-off of property.
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Ex) Shark Attractant Can Maker Sell 50,000 cans of shark attractant at $4 per
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Ch 10 - 10. Making Capital Investment Decisions 1. Project...

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