Chapter10 - Making Capital Investment Decisions Chapter Ten...

Info iconThis preview shows pages 1–9. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Making Capital Investment Decisions Chapter Ten Relevant Cash Flows The cash flows that should be included in a capital budgeting analysis are those that will only occur if the project is accepted These cash flows are called incremental cash flows The stand-alone principle allows us to analyze each project in isolation from the firm simply by focusing on incremental cash flows Asking the Right Question You should always ask yourself Will this cash flow occur ONLY if we accept the project? If the answer is yes, it should be included in the analysis because it is incremental If the answer is no, it should not be included in the analysis because it will occur anyway If the answer is part of it, then we Common Types of Cash Flows Sunk costs costs that have accrued in the past Opportunity costs costs of lost options Side effects Positive side effects benefits to other projects Negative side effects costs to other projects Changes in net working capital Financing costs Pro Forma Statements and Cash Flow Capital budgeting relies on pro forma accounting statements Cash Flow From Assets ( CFFA): the total net cash flow per period associated with a project. Cash Flow From Assets has three components: Operating Cash Flow ( OCF ): regularly generated cash flows from the ongoing activities of the project. Income statements. Changes in Net Working Capital ( NWC ): cash flows associated with cash on hand to smooth the current accounts. Balance sheet. Net Capital Spending ( NCS ): cash flows associated with the fixed assets of the project. Balance sheet. At Each Point in Time: ! CFFA = OCF NWC NCS ! 3 Methods for Computing OCF Bottom-Up Approach Works only when there is no interest expense OCF = NI + depreciation Top-Down Approach OCF = Sales Costs Taxes Tax Shield Approach OCF = (Sales Costs)(1 T) + Depreciation*T Pro Forma Balance Sheet Year 1 2 3 NWC $40K $40K $40K $40K Net Fixed Assets $60K $40K $20K 0 Total $100K $80K $60K $40K Pro Forma Income Statement Sales (100,000 units at $2.00/unit) $200,000 Variable Costs ($.75/unit) 75,000 Gross profit $125,000 Fixed costs 10,000 Depreciation 20,000 EBIT $ 95,000 Taxes (34%) 32,300 Net Income $ 62,700 Projected Cash Flows...
View Full Document

Page1 / 32

Chapter10 - Making Capital Investment Decisions Chapter Ten...

This preview shows document pages 1 - 9. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online