Chapter 10 - Chapter 10 Making Capital Investment Decisions...

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Chapter 10 Making Capital Investment Decisions
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Key Concepts and Skills Understand how to determine the relevant cash flows for various types of proposed investments Understand the various methods for computing operating cash flow Understand how to set a bid price for a project Understand how to evaluate the equivalent annual cost of a project 10-2
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Chapter Outline Project Cash Flows: A First Look Incremental Cash Flows Pro Forma Financial Statements and Project Cash Flows More about Project Cash Flow Alternative Definitions of Operating Cash Flow Some Special Cases of Discounted Cash Flow Analysis 10-3
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Relevant Cash Flows The cash flows that should be included in a capital budgeting analysis are those that will only occur (or not 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 10-4
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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 should include the part that occurs because of the project 10-5
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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 Taxes 10-6
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Pro Forma Statements and Cash Flow Capital budgeting relies heavily on pro forma accounting statements, particularly income statements Computing cash flows – refresher Operating Cash Flow (OCF) = EBIT + depreciation – taxes OCF = Net income + depreciation (when there is no interest expense) Cash Flow From Assets (CFFA) = OCF – net capital spending (NCS) – changes in NWC 10-7
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Table 10.1 Pro Forma Income Statement Sales (50,000 units at $4.00/unit) $200,000 Variable Costs ($2.50/unit) 125,000 Gross profit $ 75,000 Fixed costs 12,000 Depreciation ($90,000 / 3) 30,000 EBIT $ 33,000 Taxes (34%) 11,220 Net Income $ 21,780 10-8
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This note was uploaded on 04/30/2010 for the course FRL 300 taught by Professor Lentz during the Spring '08 term at Cal Poly Pomona.

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Chapter 10 - Chapter 10 Making Capital Investment Decisions...

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