WFF5013_ReviewCBProcess - Making Capital Investment...

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1 Making Capital Investment Decision Identifying the relevant cash flows In capital budgeting analysis, cash flows to be included are those that WILL OCCUR IF the project is accepted. These cash flows are called INCREMENTAL CASH FLOWS The stand-alone principle allows us to analyse each project in isolation from the company simply by focusing on incremental cash flows
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2 Ask yourself this question – Will this cash flow occur ONLY if we accept the project? If the answer is yes, include in your analysis. If the answer is “part of it”, what should you do?
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3 What Cash Flows to use? Incremental after-tax cash flows - Cash flows only - Opportunity costs & sunk costs - Side effects, externalities - Changes in working capital - Ignore financing cost - Depreciation
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4 About Working Capital Why do we consider changes in NOWC separately? Generally Accepted Accounting Principle (GAAP) requires sales to be recorded in income statement when made, NOT WHEN CASH IS RECEIVED Record cost of goods sold when corresponding sales are made, WHETHER OR NOT WE HAVE ACTUALLY PAID our suppliers We have to buy inventory to support sales although we HAVE NOT COLLECTED CASH yet
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5 About Working Capital Net operating working capital Current assets minus non-interest-bearing current liabilities (more specifically, expressed as cash & marketable securities, AR and inventories less accounts payables and accruals 1 ) ( 1 This definition assumes that cash and marketable securities on the balance sheet are at their normal long-term levels and company is not holding any excess cash. Excess holdings of cash and marketable securities are generally not included as part of NOWC)
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This note was uploaded on 12/12/2011 for the course ECONOMICS 101 taught by Professor Thoman during the Spring '09 term at Abu Dhabi University.

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WFF5013_ReviewCBProcess - Making Capital Investment...

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