BEC Ch 3 - BEC Notes Chapter 3 http/

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BEC - Notes Chapter 3 Factors affecting financial modelling and decision making Relevant data - data, such as future revenues or costs, that change as a result of selecting different alternatives Can either be fixed or variable, but usually variable Direct costs - costs that can be identified with or traced to a given cost object Prime costs Discrentionary costs - costs arising from a periodic or annual budgeting decision (i.e. landscaping) Incremental/differential costs - additional costs incurred to produce an additional unit over current output Avoidable - costs or revenues resulting from choosing one course of action instead of another Not Relevant data Unavoidable - costs or revenues that will be the same regardless of the chosen course of action Absorption costs - represent the allocated portion of fixed mfg OH, and therefore are not relevant Objective probability - based on past outcomes (like returns on the stock market Subjective probability - based on an individuals belief about the likelihood of an event occurring (a lawsuit) Expected value - is the weighted avg of the probable outcomes Expected value = (probability of each outcome * its payoff) then sum the results Financial modelling for capital decisions Cash flow direct effect - a company pays out or receives cash Cash flow indirect effect - transactions either indirectly associated (sale of old assets) with a capital project or that represent non-cash activity (depreciation) that produce cash benefit (reduces taxable income) Invoice price + cost of shipping + cost of installation +/- Working capital [such as increase in payroll, supplies expenses or inventory requirements] - Cash proceeds on sale of old asset net of tax = net cash outflow for new PPE Tax depreciation on new PPE * Marginal tax rate = Depreciation tax shield After-tax cash flow on operations + Depreciation tax shield = Total after tax cash flow on operations * present value of annuity - initial cash outflow = Net Present Value (NPV) Discounted cash flow (DCF) methods are considered the best methods to use for long-run decision because it accounts for time value of money. However, it only uses a single growth rate, which is unrealistic as interest rates change over time. Payback period - is simple to understand and focuses on the time period for return of investment (liquidity). However, it ignores the time value of money. It shows the return of investment not the return on investment (ignores cash flows occurring after initial investment is recovered) 1
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BEC - Notes Chapter 3 Net initial investment [cash outflow + change in WC - sale proceeds on old PPE] ÷ increase in annual net after-tax cash flow [After-tax cash flow on operations + Depreciation tax shield] = payback period The larger the denominator the shorter the payback period Discounted payback method - computes payback period using expected cash flows that are discounted by the
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BEC Ch 3 - BEC Notes Chapter 3 http/

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