DFM1 Prepared by Susan Lim Email susanlimipkedumy Part 3 Relevant cash flow

Dfm1 prepared by susan lim email susanlimipkedumy

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(DFM1) Prepared by Susan Lim Email : [email protected] Part 3: Relevant cash flow Relevant costs of investment appraisal include opportunity costs, working capital costs and wider costs such as infrastructure and human development costs. Non-relevant costs include past costs and committed costs. (1) The cash flows that should be considered in investment appraisals are those which arise as a consequence of the investment decision under evaluation. This means that cash flows are only relevant if they are future incremental cash flows. (2) Any costs incurred in the past, or any committed costs which will be incurred regardless of whether or not an investment is undertaken, are not relevant cash flows. They have occurred, or will occur, whatever investment decision is taken. (3) Any costs which do not represent an actual cash flow should also be ignored. (4) Here are some examples of non-relevant costs: Centrally-allocated overheads that are not a consequence of undertaking the project Management costs and marketing research expenditure already incurred Depreciation (5) The annual cash profits from a project can be calculated as the incremental contribution earned minus any incremental fixed costs which are additional cash items of expenditure (that is, ignoring depreciation and so on). (6) There are, however, other cash flows to consider. These might include the following. Opportunity costs These are the costs incurred or revenues lost from diverting existing resources from their best use. Example If a salesman, who is paid an annual salary of $30,000, is diverted to work on a new project and as a result existing sales of $50,000 are lost, the opportunity cost to the new project will be the $50,000 of lost sales. The salesman's salary of $30,000 is not an opportunity cost since it will be incurred however the salesman's time is spent. Tax Will be discussed in CHAPTER 5 Residual value The residual value or disposal value of equipment at the end of its life, or its disposal cost.
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___________________________________________________________________________________________________________________ Page 5 of 13 IPK COLLEGE 1664, JALAN KULIM, 14202 BUKIT MERTAJAM, PENANG TEL : 012-5203212 / 0125113212 / 04-5512588 Subject: Financial Management (DFM1) Prepared by Susan Lim Email : [email protected] Working capital Working capital is the amount by which a firm s current assets exceed its current liabilities Changes in working capital often accompany capital expenditure decisions For example, if a firm acquires new machinery to expand its level of operations, it will experience an increase in levels of cash, account receivables, inventories, account payables and accruals. These increases result from the ended for more cash to support expanded operations, more account receivables and inventories to support increased sales, and more account payables and accruals to support increased outlays made to meet expanded product demand.
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