Chapter 10_S - Chapter 10 Making Capital Investment...

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1 Chapter 10: Making Capital Investment Decisions Project Cash Flows: A First Look Incremental Cash Flow Pro Forma Financial Statements and Project Cash Flow More on Project Cash Flow Alternative Definitions of Operating Cash Flow Cost Cutting Example
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2 Relevant Cash Flows What are the relevant incremental cash flows for project evaluation? What is the stand-alone principle?
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3 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
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4 Incremental Project Cash Flows Sunk costs – costs that have accrued in the past and can’t be recovered Opportunity costs – the most valuable alternative that is given up if a particular investment is undertaken Side effects Positive side effects – benefits to other projects Negative side effects – costs to other projects Erosion: the introduction of a new project reduces the cash flows of existing projects Changes in net working capital Financing costs Taxes
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5 Pro Forma Statements and Cash Flow Capital budgeting relies heavily on pro forma accounting statements, particularly income statements
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