Capital Budgeting Flashcards
Free Cash Flow (FCF)
The incremental effect of a project on a firm’s available cash is its free cash flow, i.e. by how much increase the cash flows that can be distributed to the claimholders due to the project? Thus, free cash flow is a firm’s extra cash after its operations and other areas.
- direct calculation
- calculation from earnings
Two forms:
- free cash flow to the firm (includes debtholders and preferred stockholders)
- free cash flow to equity
Forecasting earnings
Capital budget
- lists the investments that a company plans to undertake
Capital budgeting
- Process used to analyze alternative investments and decide which ones to accept (-> NPV rule)
Incremental earnings
- the amount by which the firm’s earnings are expected to change as a result of the investment decision
Opportunity cost
The value a resource could have provided in its best alternative use
Net (operating) working capital (NWC)
NWC = Current assets - current liabilities
NWC = Cash + Inventory + Receivables - payables
receivables - paypables -> trade credit
Adjustments to free cash flow
Other non-cash items
- amortization
Timing of cash flows
- cash flows are often spread throughout the year
Accelerated depreciation
- Modified accelerated cost recovery system depreciation
Liquidation or salvage value
- Include (after-tax) liquidation or salvage value of any assets that are disposed of
Terminal or continuation value
- market value of the free cash flow from the project at all future dates
Tax loss carryforwards or tax carrybacks
- allow corporations to take losses during its current year and offset them against gains in nearby years
Risk analysis
Break-even analysis
- computes the level of a parameter that makes the project’s NPV equal to zero
Sensitivity analysis
- Shows how the NPV varies with a change in one of the assumptions, holding the other assumptions constant
Scenario analysis
- Considers the effect on the NPV of simultaneously changing multiple assumptions
