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

Info iconThis preview shows pages 1–11. Sign up to view the full content.

View Full Document Right Arrow Icon
Faculty of Business and Economics University of Hong Kong Dr. T. Lin Chapter 10: Making Capital Investment Decisions Chapter 2: Cash Flows
Background image of page 1

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

View Full DocumentRight Arrow Icon
Capital Budgeting 2 9 Investment Criteria 2, 10 Discounted Cash Flow 11 Sensitivity Analysis 14 Cost of Capital
Background image of page 2
Cash Flow vs. Accounting Income Discount actual cash flows Using accounting income, rather than cash flow, could lead to erroneous decisions. Example A project costs $2,000 and is expected to last 2 years, producing cash income of $1,500 and $500 respectively. The cost of the project can be depreciated at $1,000 per year. Given a 10% required return and zero tax rate, compare the NPV using cash flow to the NPV using accounting income.
Background image of page 3

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

View Full DocumentRight Arrow Icon
Year 1 Year 2 Cash Income $1500 $ 500 Depreciation -$1000 Accounting Income + 500 - 500 32 . 41 $ ) 10 . 1 ( 500 1.10 500 = NPV Apparent 2 Cash Flow vs. Accounting Income
Background image of page 4
Today Year 1 Year 2 Cash Income $1500 $ 500 Project Cost -2000 Free Cash Flow +1500 + 500 14 . 223 $ ) 10 . 1 ( 500 ) 10 . 1 ( 1500 -2000 = NPV Cash 2 1 Cash Flow vs. Accounting Income
Background image of page 5

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

View Full DocumentRight Arrow Icon
Cash Flow Special Cases 1. Cost-Cutting 2. Bidding 3. EAC 4. Replacement DCF Valuation Irrelevant CFs Relevant CFs Operating CFs 4 definitions Net Capital Spending Changes in NWC
Background image of page 6
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
Background image of page 7

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

View Full DocumentRight Arrow Icon
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
Background image of page 8
Things to Watch Out Forget the sunk cost. Remember the opportunity cost. Think of the side effects. Be ware of the net working capital. Consider financing costs separately. Figure out the tax implications
Background image of page 9

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

View Full DocumentRight Arrow Icon
Sunk Cost In 1971 Lockheed sought a federal guarantee for a bank loan to continue development of the Tristar airplane.
Background image of page 10
Image of page 11
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 05/11/2011 for the course BUSI 1003 taught by Professor Cyc during the Spring '11 term at HKU.

Page1 / 38

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

This preview shows document pages 1 - 11. Sign up to view the full document.

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