Chapter13solutions - Chapter 13 Capital Budgeting...

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Capital Budgeting: Estimating Cash Flows and Analyzing Risk ANSWERS TO END-OF-CHAPTER QUESTIONS 13-3 Since the cost of capital includes a premium for expected inflation, failure to adjust cash flows means that the denominator, but not the numerator, rises with inflation, and this lowers the calculated NPV. 13-4 Capital budgeting analysis should only include those cash flows which will be affected by the decision. Sunk costs are unrecoverable and cannot be changed, so they have no bearing on the capital budgeting decision. Opportunity costs represent the cash flows the firm gives up by investing in this project rather than its next best alternative, and externalities are the cash flows (both positive and negative) to other projects that result from the firm taking on this project. These cash flows occur only because the firm took on the capital budgeting project; therefore, they must be included in the analysis. 13-5 When a firm takes on a new capital budgeting project, it typically must increase its investment in receivables and inventories, over and above the increase in payables and accruals, thus increasing its net operating working capital. Since this increase must be financed, it is included as an outflow in Year 0 of the analysis. At the end of the project’s life, inventories are depleted and receivables are collected. Thus, there is a decrease in NOWC, which is treated as an inflow. SOLUTIONS TO END-OF-CHAPTER PROBLEMS 13-1 Equipment $ 9,000,000 NWC Investment 3,000,000 Initial investment outlay $12,000,000 13-2 Operating Cash Flows: t = 1 Sales revenues $10,000,000 Operating costs 7,000,000 Depreciation 2,000,000 Operating income before taxes $ 1,000,000 Taxes (40%)
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This note was uploaded on 12/11/2011 for the course FINC 3630 taught by Professor Jensen,m during the Summer '08 term at Auburn University.

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Chapter13solutions - Chapter 13 Capital Budgeting...

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