ch%2010%20(Making%20Investment%20Decisions)[1]

ch%2010%20(Making%20Investment%20Decisions)[1] - 10 Making...

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10 Making Capital Investment Decisions Slide 10 - 1 ± Understand how to determine the relevant cash flows for different types of proposed investments ± Be able to compute depreciation expense for tax purposes ± Understand alternative methods for computing operating cash flow Key Concepts and Skills
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Slide 10 - 2 Project Cash Flows ± 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: Evaluation of a project may be based on the project’s incremental cash flows. So we analyze each project in isolation from the firm simply by focusing on the resulting incremental cash flows. Slide 10 - 3 ± The Question You Should Always Ask “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 Project Cash Flows
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Slide 10 - 4 ± Common Types of Cash Flows Opportunity Costs: costs of lost options Side Effects ¾ Positive side effects: benefits to other projects ¾ Negative side effects: costs to other projects Changes in Net Working Capital Taxes Financing Costs Sunk Costs: costs that have accrued in the past Which Cash Flow is Relevant? Slide 10 - 5 ± Computing Cash Flows: Refresher Operating Cash Flow (OCF) = EBIT + Depreciation – Taxes Cash Flow From Assets (CFFA) = OCF – Net Capital Spending – Changes in NWC Capital budgeting relies heavily on pro forma accounting statements, particularly income statements Pro Forma Statements and Cash Flow
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Slide 10 - 6 $ 21,780 Net Income 11,220 Taxes (34%) $ 33,000 EBIT 30,000 Depreciation ($90,000/3) 12,000 Fixed costs $ 75,000 Gross profit 125,000 Variable Costs ($2.50/unit) $200,000 Sales (50,000 units at $4.00/unit) Computing Cash Flow: Example ± Pro Forma Income Statement: Table 10.1 Slide 10 - 7 0 30,000 60,000 90,000 NFA 0 0 0 90,000 NCS 30,000 30,000 30,000 Depreciation $20,000 $20,000 $20,000 $20,000 NWC 3 2 1 0 Year ± Projected Capital Requirement Computing Cash Flow: Example Net Capital Spending = Change in net fixed assets + Depreciation
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Slide 10 - 8 $71,780 $51,780 $51,780 -$110,00 CFFA -$90,000 -Capital spending 20,000 -$20,000 -Change in NWC $51,780 $51,780 $51,780 OCF 3 2 1 0 Year ± Projected Total Cash Flows: Table 10.5 Computing Cash Flow: Example Slide 10 - 9 ± Make the Decision Now that we have the cash flows, we can apply the techniques that we learned in chapter 9. The required return is 20 percent. Using a Financial Calculator
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ch%2010%20(Making%20Investment%20Decisions)[1] - 10 Making...

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