Stand alone Principle oAnalyse each project in isolation from the firm simply

Stand alone principle oanalyse each project in

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Any cash flow that exists regardless if whether or not a project is undertaken is not relevant. Stand-alone Principle o Analyse each project in isolation from the firm simply by focusing on incremental cash flows. Sunk Cost (Irrelevant) A cost that has already been incurred and cannot be removed and therefore should not be considered in an investment decision. Opportunity Cost (Relevant) The most valuable alternative that is given up if a particular investment is undertaken. E.g. Plans to convert an old rustic cotton mill bought years ago for $100,000 into upmarket condominiums. o Irrelevant Cost - $100,000 paid years ago (Sunk Cost) o Relevant What the mill would sell for today net of selling costs (Opportunity Cost) Side Effects (Relevant) Both positive and negative spill over effects. Erosion o The cash flows of a new project that come at the expense of a firm’s existing project. o Cash flows from the new line should be adjusted downward to reflect lost profits on other lines. (Note: Erosion is relevant only when the sales would not otherwise be lost. Net Working Capital Normally, a project will require that the firm invest in net working capital in addition to long-term assets. The firm supplies working capital at the beginning and recovers it toward the end. Financing Costs Interest paid or any other financing costs (E.g. Dividends or Principal Repaid) are not included. Regarded as cash flows to creditors and owners, not cash flow from assets. Taxes Interested in measuring cash flows when it actually occurs, not when it accrues in an accounting sense. Interested in after-tax cash flow. (After-tax incremental cash flows)
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