Lecture07_winter09

Lecture07_winter09 - CAPITAL BUDGETING NET PRESENT VALUE...

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CAPITAL BUDGETING
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NET PRESENT VALUE Last Lecture concluded that the method to use for accepting or rejecting projects is the NET PRESENT VALUE method Requires determining the Cash Flows of the Project Requires determining the correct discount rate to get the PRESENT VALUE of the Project
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CASH FLOW OF THE PROJECT We are only interested in Cash Flows that will only occur if the Project happens, i.e., the INCREMENTAL Cash Flows of the Project. We will start determining the rules to understand which Operations are INCREMENTAL to the Project Then we will learn how to determine the Cash Flows from those Operations.
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INCREMENTAL CASH FLOWS Sunk Costs : costs that already occurred. NOT INCREMENTAL . Ex: Marketing Studies already made to predict the impact of the new product to be launched. Opportunity Costs : the Value of the best alternative use to give to the Assets to be used in the Project. INCREMENTAL . Ex: The value of a property you would sell only if you don’t start the new project.
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INCREMENTAL CASH FLOWS Side Effects : The effect the Project will have on the other Projects the Firm already has running. Can be positive effects ( SYNERGY ) or negative ( EROSION or CANIBALISM ). INCREMENTAL Ex: The impact on the sales of the current lines of production from the addition of a new product
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INCREMENTAL CASH FLOWS Allocated Costs : The proportion of the cost of a COMMON resource to many Projects that is allocated to the new Project. NOT INCREMENTAL if the total value of the cost across all Projects does no change with the addition of the new Project. Ex: The electric bill of the plant is split equally among all the products. If adding a new product does not increase the electric bill, the changes in the allocated proportions are NOT INCREMENTAL to any of the products.
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CASH FLOW OF THE PROJECT OPERATING CASH FLOW CAPITAL SPENDING ADDITION TO NET WORKING CAPITAL
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OPERATING CASH FLOW Will represent the difference between the
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Lecture07_winter09 - CAPITAL BUDGETING NET PRESENT VALUE...

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