ffm11i12 - Chapter 12 Cash Flow Estimation and Risk...

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Unformatted text preview: Chapter 12 Cash Flow Estimation and Risk Analysis Learning Objectives After reading this chapter, students should be able to: Analyze an expansion project and make a decision whether the project should be accepted on the basis of standard capital budgeting techniques. Discuss difficulties and relevant considerations in estimating net cash flows, and explain how project cash flow differs from accounting income. Define the following terms: incremental cash flow, replacement analysis, sunk cost, opportunity cost, externalities, and cannibalization effect. Identify and briefly explain three separate and distinct types of risk. Demonstrate sensitivity and scenario analyses and explain Monte Carlo simulation. Explain how risk is incorporated in capital budgeting through either the certainty equivalent or risk- adjusted discount rate. Chapter 12: Cash Flow Estimation and Risk Analysis Learning Objectives 47 Lecture Suggestions This chapter covers some important but relatively technical topics. Note too that this chapter is more modular than most, i.e., the major sections are discrete, hence they can be omitted without loss of continuity. Therefore, if you are experiencing a time crunch, you could skip sections of the chapter. What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case solution for Chapter 12, which appears at the end of this chapter solution. For other suggestions about the lecture, please see the Lecture Suggestions in Chapter 2, where we describe how we conduct our classes. DAYS ON CHAPTER: 3 OF 58 DAYS (50-minute periods) 48 Lecture Suggestions Chapter 12: Cash Flow Estimation and Risk Analysis Answers to End-of-Chapter Questions 12-1 Only cash can be spent or reinvested, and since accounting profits do not represent cash, they are of less fundamental importance than cash flows for investment analysis. Recall that in the stock valuation chapter we focused on dividends, which represent cash flows, rather than on earnings per share. 12-2 Capital budgeting analysis should only include those cash flows that 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.took on the capital budgeting project; therefore, they must be included in the analysis....
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ffm11i12 - Chapter 12 Cash Flow Estimation and Risk...

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