Capital Budgeting II Flashcards
what are the three parts that make up total cash flows
capital investment
operating cash flow
changes in working capital
is capital investment usually a positive or negative cash flow
negative
is operating cash flow usually positive or negative
positive
are changes in working capital usually positive or negative
can be both
examples of capital investment for a coffee shop
coffee machine
table and chairs
examples of operating cash flows in a coffee shop
revenue - costs
example of working capital in a coffee shpo
inventory
time in between selling to the customer and being turned into cash
what is working capital
cash tied up for a short time between buying and selling
what are the two fundamental elements for project evaluation
identify the relevant cash flows that are to be disounted
discount at the correct opportunity cost of capital
why should we focus on cash flows rather than profits
profits can be manipulated by accountants
how to identify a cash flow
would the cash flow still exist if the project does not exist?
if yes DONT include
if no DO include
what are incremental cash flows
cash flows that are subject to change if the project is implemented
what are the 8 rules for finding the relevant incremental cash flows
include indirect effects ignore sunk costs include all opportunity costs overheads terminal cash flows investment in working cpaital ignore financing costs include value of all of positive and negative externalities created by the project
indirect effects can also be called
incidental effects
what is an indirect effect
a new product may either increase or decrease sales of other products in the companu
example of an incidental effect
opening a second shop in the same town could draw sales away from the original shop
selling more printers means more printer ink will be sold
what are sunk costs
costs that have already occured
eg costs spent on market research
whether the project goes ahead or not, the money has already been spent
what is an opportunity cost
the cost of the best alternative forgone
example of an opportunity cost
the project under consideration may be taking resources away from another project
the loss of cash flows from these other projects are termed opportunity costs
what are overheads
costs that are not directly associated with any one part of the firm or one project
examples of overheads
rent
heat
electriicty
what overheads should be included
any that increase directly as a result of the new investment
what is an example of a terminal cash flow
selling of equipment
clean up costs
why can we ignore financing costs
accounted for in discount rate
example of positive and negative externalities created by investment that need to be accounted for
climate - carbon tax, lower costs due to more efficient energy
what does ESG stand for
environmental social governance
what are the quantitative factors of project analysis
NPV, IRR etc
what are the qualitative factors for project analysis
strategy, social context, potential problems, intangible benefits
what are some potential capital budgeting probelms
ensuring forecasts are consistent
eliminating conflicts of interest
reducing forecast bias
proper selection criteria
what are some potential capital budgeting probelms
ensuring forecasts are consistent
eliminating conflicts of interest
reducing forecast bias
proper selection criteria
for what industries would payback period not really be a suitable capital budgeting method
research and development as it may take longer to reep rewards
when is profitability index useful
when funds are limited as it tells us which project is most profitable
