Table of Contents1. Components of NPV calculations1.1 Free cash flows, not accounting income1.2 Sunk costs1.3 Opportunity costs1.4 Side effects1.5 Working capital1.6 Company tax1.7 Finance charges1.8 Incremental cash flows1.9 Inflation2. Risk analysis in capital budgeting3. Projects with unequal lives4. Real option value consideration in capital budgeting2
1. Components of NPV calculations•To include–Use free cash flows, not accounting income–Ignore sunk costs–Include opportunity costs–Include side effects–Include working capital–Include taxation–Ignore finance charges(interest and loan repayments)3
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Example 5.1Compare accounting income and free cash flow for a two‐yearproject using a machine that costs $100m and yields EBDIT of $53m& $65m in years 1 & 2. Depreciation is on a straight‐line basis, andthe corporate tax rate is 30%_______________________________________________Step 1: Calculate the net incomegenerated by the project:Year12EBDIT5365Assuming cost of capital = 10%NPV=$1.9m1. Components of NPV calculations – 1.1 Free cash flows1.1 Free cash flows, not accounting income4Footnote 1 in p143 is incorrectLess depreciation5050Taxable income315Less tax (30%)0.94.5Net income2.110.5