Once we have determined the incremental cash flows

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Contemporary Project Management
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Chapter 4 / Exercise 10
Contemporary Project Management
Kloppenborg
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Once we have determined the incremental cash flows from undertaking a project, we can view that project as a kind of minifirm with its own future revenues and costs, its own assets and of course its own cash flows. Evaluate the proposed project on its own merits, in isolation from any other activities. 10.2 Incremental Cash Flows Sunk Costs A cost we have already paid or have already incurred the liability to pay Pay this cost no matter what. Exclude sunk costs from our analysis Opportunity Costs The most valuable alternative that is given up if a particular investment is undertaken. Example: for the water-powered mill the opportunity cost that we charge the project would be what it would sell for today because this is the amount that we give up by using it instead of selling it. Side Effects
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Contemporary Project Management
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Chapter 4 / Exercise 10
Contemporary Project Management
Kloppenborg
Expert Verified
The negative impact on cash flows is called erosion and could occur for any multiline product producer or seller. The cash flows from the new line should be adjusted downwards to reflect lost profits on other lines. Erosion: the portion of cash flows of a new project that come at the expense of a firm’s existing operations. Erosion is only relevant when the sales would not otherwise be lost. Net Working Capital As a project winds down, inventories are sold, receivables are collected, bills are paid and cash balances can be drawn down These activities free up the net working capital originally invested. The firm supplies working capital at the beginning and recovers it toward the end Financing Costs In analyzing a proposed investment, we do NOT include interest paid or any other financing costs such as dividends or principal repaid, because we are interest in the cash flow generated by the assets from the project. The particular mixture of debt and equity that firm chooses to use in financing a project is a managerial variable and primarily determines how project cash flow is divided between owners and creditors. This is to be analyzed separately. Inflation Because capital investment projects generally have long lives, price inflation or deflation is likely to occur during the project’s life. Investors form expectations of future inflation which are included in the discount rate as investors wish to protect themselves against inflation. Given that nominal rates include an adjustment for expected inflation, cash flow estimates must also be adjusted for inflation. Ignoring this would lead to a bias against accepting capital budgeting projects. Capital Budgeting and Business Taxes in Canada Government offers grants, investment tax credits, more favourable rates for capital cost allowance, and subsidized loans to promote certain types of capital investment.

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