BCOR 2200 Chapter 9 w cq

BCOR 2200 Chapter 9 w cq - Chapter 9 Making Capital...

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1 Chapter 9 Making Capital Investment Decisions
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2 We know from Chapter 8: Capital budgeting requires calculating the NPV: Discount future cash flows at the require rate of return But how do you determine the cash flows? And how do you know what discount rate to use? First we’ll look at cash flows Then we’ll look at the discount rate The General Idea: Only use CFs associated with the project being considered – New (aka Incremental) CFs. – Only these are the relevant CFs for the analysis CFs from existing (or previous) operations are not relevant
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3 Chapter Outline: 1. The Stand-Alone Principle Use only Incremental or Relevant CFs 2. So which CFs do you include? 3. Use of Pro-Forma Financial Statements 4. More About Net Working Capital (Inv, A/R, A/ P) Depreciation 5. Evaluating NPV estimates 6. Sensitivity and Scenario Analyses 7. Additional Considerations
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4 9.1 Project Cash Flows – A First Look Don’t calculate the whole firm’s CFs Calculate CFs With and Without the project Use the Stand-Alone Principle Calculate the Incremental CFs associated with the project Include any and all changes in the firm’s future CFs that are a direct consequence of taking on the project. These are the Relevant CFs use to calculate NPV
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5 9.2 Incremental CFs Only those CFs that result from doing the project Some Issues and Definitions associated with Identifying Incremental CFs: Sunk Costs A cost already paid or a liability already incurred Opportunity Costs Using and asset the firm already owns How is this different from a sunk cost? You could sell the asset Side Effects Cannibalization or generation of service revenues CFs Assoc. with Changes in Working Capital Inventory build-up, customer credit, supplier credit Financing Costs We’ll incorporate these later (see why in a minute)
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6 Sunk Costs A Sunk Cost is cost that has already been paid Or a liability already incurred Any decision about the project will not affect these costs Example: Money spent studying a project before the decision Architectural plans, legal fees concerning zoning… Do not include since this money is spent whether or not the project is accepted Example: Already paying a manager to manage one factory Do not allocate ½ the manager’s salary to the 2 nd factory The salary is a sunk cost since you are already paying it So do not included ½ the salary in the 2 nd factory CFs
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7 Two More Sunk Cost Examples: Example 1: One more $1 slot-machine-pull after loosing $100. Should you consider the past $100 when deciding to the next $1? The $100 loss is not relevant to the decision to bet the next $1 Example 2: We tried to market a red version of our project and that didn’t work Should we try to market a blue version? Should we include the cost of the failed red version when deciding
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This note was uploaded on 12/06/2010 for the course BCOR 2200 at Colorado.

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BCOR 2200 Chapter 9 w cq - Chapter 9 Making Capital...

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