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Capital Budgeting 1. Flashcards

Cash Flows Related to Capital Budgeting

1
Q

What is capital budgeting?

A

Capital budgeting is a process for evaluating and selecting long-term investment projects.

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2
Q

The 3 effects of cash flow in capital budgeting?

A
  1. Direct Effect
  2. Indirect Effect
  3. Net Effect
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3
Q

What is the direct cash flow effect in capital budgeting?

A

When a company pays cash, receive cash, or makes cash commitments directly related to capital budgeting project.

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4
Q

What is an example of direct cash flow effect?

A

The initial investment that a company makes is a prime example of direct cash affect.

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5
Q

What is the indirect cash flow effect in capital budgeting?

A

Transactions that represents noncash activities that produces cash benefits.

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6
Q

What is an example of indirect cash flow effect in capital budgeting?

A

Depreciation expense is a noncash activity that produces cash benefits because it reduces taxes paid to the government.

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7
Q

What are the 3 stages of cash flows?

A
  1. Inception of capital budget project.
  2. Operations of the capital budget project. (Period in production)
  3. Disposal of the capital budget project.
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8
Q

What events occur in the inception stage?

A
  1. Acquisition
  2. Working capital assessment
  3. Replacing of Assets
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9
Q

What 4 cash flow considerations occur during the acquisition event in the inception stage of a project?

A
  1. Cost of item being acquired
  2. Shipping costs
  3. Installation costs
  4. Training or anything to get the asset ready for use
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10
Q

What is working capital?

A

Working capital is current assets minus current liabilities.

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11
Q

What is working capital equation?

A

WC = CA - CL

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12
Q

What is working capital assessment during the inception stage of a project?

A

Assess if a firm needs to increase or decrease working capital.

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13
Q

What is the outcome if additional working capital is required during the inception stage of capital budgeting?

A

Additional working capital requirements are indirect cash outflows.

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14
Q

What is the outcome if working capital requirements are reduced during the inception stage of capital budgeting?

A

A reduction in working capital are indirect cash in flows.

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15
Q

What is an example of additional working capital in the inception stage of capital budgeting?

A

An increase in payroll, expenses for supplies, or inventory requirements are reductions of working capital.

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16
Q

What is an example of decreasing working capital requirements?

A

Implementing a just-in-time inventory system represents a decreasing in working capital.

17
Q

What 3 cash flow considerations occur during the replacing an assets event during the inception of a capital budget project?

A
  1. Selling price after taxes
  2. Gain on sale
  3. Loss on sale
18
Q

What is the equation for computing the selling price after taxes effect on cash flows?

A

Selling price after tax= Selling price pretax * (1 - tax rate)

19
Q

What is the equation for calculation gain on sale effect on cash flows?

A

gain on sale effect on cash flow = gain * tax rate

direct cash outflow) (pay taxes to government

20
Q

What is the equation for calculating loss on sale effect on cash flows?

A

loss on sale effect on cash flow = loss * tax rate

indirect cash inflow) (reduces amount of taxes to pay to government

21
Q

What are some common cash flow considerations during the operations stage?

A
  1. Cash flow generated from operations

2. Depreciation tax shield

22
Q

What is cash flow generated from operations during the operations stage?

A

Cash flow generated is the annual cash added to net income from the results of the capital budget project.

23
Q

Types of cash flows generated during the operations stage?

A

Increased sales and reduction of expenses.

24
Q

Types of events that occur during the disposal of a project stage?

A
  1. Direct cash inflow on sale of asset after taxes
  2. Direct cash outflow for severance pay
  3. Indirect cash inflow if asset is donated (reduction in tax liability)
  4. Indirect cash inflow reduction in working capital
25
Q

What is pretax cash flow?

A

Pretax cash flow is cash generated before taxes are paid.

26
Q

What is after-tax cash flow?

A

After-tax cash flow is cashed generated after taxes are paid.

27
Q

What are the 2 equations for after-tax cash flow?

A
  1. Simplified Equation

2. Detailed Equation

28
Q

What is the simplified equation for after-tax cash flow?

A
  1. After-taxes CF
    = Pretax CF x (1 -tax rate)
  2. Plus depreciation tax shield
    = Depreciation x tax rate
29
Q

What is the detailed equation?

A
  1. Sales
  2. Expenses
  3. Pretax Income
  4. Taxes
  5. Net Income

Annual CF - depreciation = After tax cash flow

Financial Management (5 decks)

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