6. Capital Budgeting 2 Flashcards
What are the three steps in analysing capital investment decisions?
Calculate the tax effect
Calculate the cash flows
Discount the cash
What s incremental cash flows?
The difference between a firm’s future cash flows with a project or without the project
What is the standalone principal?
Evaluation of a project based on the projects incremental cash flows
What is a sunk cost?
A cost that has already been incurred and cannot be removed and therefore should not be considered in an investment decision
What is an opportunity cost?
The most valuable alternative that is given up if a particular investment is undertaken
What is erosion?
The cash flows of a new project that come at the expense of a firm’s existing projects
Is the interest on financing costs for projects included on the analysis?
No
Why isn’t interest on finance counted in the cash flow?
Because the cash flow is already discounted therefore it would be counting it twice. If the interest rate is less then the required rate of return the loan will be paid off and NPV still positive
What are the two methods of depreciation?
Straight-line (prime cost)
Diminishing Value
When is capital gains tax incurred?
If an asset is sold for more than it cost
What has to be accounted for with capital gains tax?
Cost base (purchase price) Acquisition costs Disposal costs Selling price Improvements and additions
What is a buy option?
It is an arrangement that gives the holder the right to buy an asset at a fixed price sometime in the future
What is annual equivalent cost? (AEC)
The present value of project’s costs calculated on an annual basis
