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6 Capital Budgeting

6 Capital Budgeting - Click to edit Master subtitle style...

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Click to edit Master subtitle style Copyright © 2009 Pearson Prentice Hall. All Forecasting Cashflows in Capital Budgeting 11
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Copyright © 2009 Pearson Prentice Hall. All Incremental Cashflows The objective of a manager is to maximize NPV of cash flows and is derived from the firm’s objective to maximize firm value. l Earnings flows do not translate into spendable resources though they will resemble cash flows in the long run. l Furthermore, in determining whether to accept a project or not, we need to look at the extent to which it adds to the 22
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Copyright © 2009 Pearson Prentice Hall. All Incremental Earnings Forecast for HomeNet 33 Consider the development of a wireless networking appliance, called HomeNet by Linksys. The firm forecasts annual sales of 100,000 units for 4 years at a price of $260, with production cost of $110 per unit. Other details are as given below (note assumed treatment of depreciation):
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Copyright © 2009 Pearson Prentice Hall. All Project Details Unlevered Net Income is income from the project if it were financed entirely with equity (sometimes referred to as Net Operating Income). Hence, interest expense is not taken into account in cash flows. On the other hand, tax advantages of debt (interest deductibility) are also not considered. Financing costs are instead generally considered in the cost of capital discount rate. l SG&A expenses are estimated to be about $2.8m per year; however, these expenses are fixed and do not vary with the level of 44
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Copyright © 2009 Pearson Prentice Hall. All Adjustments for Externalities Recall that we need incremental cash flows; hence, we need to adjust our figures for externalities. l Externalities are indirect effects of the project that may increase or decrease the profits of other business activities of the firm. Here are some examples. l If the introduction of the new product would lead to increased sales in other areas of the firm, that would be a positive externality. In HomeNet’s case, we have the following 55
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Copyright © 2009 Pearson Prentice Hall. All Opportunity Costs 66 The lab will be housed in an existing facility, which would have been rented out for $200,000/yr.
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