Payback criterion used as well by more than half Least used are ARR and PI

Payback criterion used as well by more than half

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Payback criterion used as well by more than half. Least used are ARR and PI. Making Capital Investment Decisions Project Cash Flows – A First Look Relevant Cash Flows Incremental cash flows: difference between a firm’s future cash flows with a project and  without one. It consists of any and all changes in firm’s future cash flows that are a direct consequence of undertaking a project. Stand-Alone Principle Assuming that evaluation of project may be based on project’s incremental cash flows. Consequence is evaluating the proposed project purely on its own merits, in isolation from  any other activities or projects. Incremental Cash Flows Sunk Costs Expense previously paid by firm and cannot be recovered. Irrelevant in decisions at hand, as only relevant cash flows are incremental ones. Example: company pays $10 million on market research into Diet Tim Tams. Opportunity Costs Most valuable alternative that is given up if a particular investment is undertaken. Asset’s market value is an opportunity cost and an incremental cash flow. Example: a firm bought land, and wishes to build a factor on it. The opportunity cost is the  land cannot be used for alternative purposes. Side Effects Erosion: cash flows of a new project that come at the expense of firm’s existing project. o Only relevant when sales would not otherwise be lost. Financing Costs Interest payments and other financing cash flows shouldn’t be included because they would  be wrongly double counted. Goal in project evaluation: compare cash flow from a project to cost of acquiring the project  in order to estimate NPV. CFO’s take: identify a desirable project, and then make financing decision. Other Issues Interested in measuring cash flow – when it actually occurs, not when it accrues. Interested in after-tax cash flows. 14
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More on Project Cash Flow Net Working Capital Operating cash flows - Changes in NWC - Capital Spending = total cash flow and spending Depreciation Non-cash deduction, hence has cash flow consequence on tax bill. Income tax assessment Act 1936 and 1997 allows for: o Straight-line method: depreciation writes off a fixed % of original asset cost. o Diminishing Value Method: depreciation under a fixed % of tax book value of asset  is written off asset after each year. Depreciation Salvage value and expected economic life is not explicitly considered in calculation of  depreciation for tax purposes.
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