Ch 08: Fundamentals of Capital Budgeting Flashcards

1
Q

Capital budgetin

A

Capital budgeting is the process of analyzing investment opportunities and deciding which ones to accept.

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2
Q

capital budget

A

A capital budget is a list of all projects that a company plans to undertake during the next period

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3
Q

NPV rule in relation to capital budgeting

A

We use the NPV rule to evaluate capital budgeting decisions, making decisions that maximize NPV. When deciding to accept or reject a project, we accept projects with a positive NPV.

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4
Q

When do we accept or reject a project?

A

When deciding to accept or reject a project, we accept projects with a positive NPV.

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5
Q

the incremental earnings of a project…

A

the incremental earnings of a project comprise the amount by which the project is expected to change the firm’s earnings

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6
Q

Incremental earnings should include…

A

Incremental earnings should include all incremental revenues and costs associated with the project, including project externalities and opportunity costs, but excluding sunk costs and interest expenses

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7
Q

Project externalities

A

cash flows that occur when a project affects other areas of the company’s business

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8
Q

sunk cost

A

A sunk cost is an unrecoverable cost that has already been incurred

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9
Q

We estimate taxes using…

A

We estimate taxes using the marginal tax rate, based on the net income generated by the rest of the firm’s operations, as well as any tax loss carrybacks or carryforwards.

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10
Q

When evaluating a capital budgeting decision, we first…

Thus…

A

We first consider the project on its own, separate from the decision regarding how to finance the project. Thus, we ignore interest expenses and compute the unlevered net income contribution of the project

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11
Q

Unlevered Net Income

A

EBIT * (1 - T)

= (Revenues - Costs - Depreciation) * (1-Tc)

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12
Q

We compute free cash flow from incremental earnings by…

A

eliminating all non-cash expenses and including all capital investment

Depreciation is not a cash expense, so it is added back.

              Actual capital expenditures are deducted.
            
          
            
              Increases in net working capital are deducted.
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13
Q

Net working capital formula

A

Cash + Inventory + Receivables - Payables

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14
Q

Free Cash Flow Basic Calculation

A

Unlevered Net Income + Depreciation - CapEx - Change in NWC

= (Rev - Cost - Depreciation) * (1 - Tc) + Depreciation - CapEx - Change in NWC

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15
Q

The discount rate for a project is…

A

its cost of capital: The expected return of securities with comparable risk and horizon.

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16
Q

When choosing between mutual exclusive investment opportunities, pick the opportunity with the highest …

A

NPV

17
Q

Depreciation expenses affect free cash flow only through the…

A

depreciation tax shield. The firm should generally use the most accelerated depreciation schedule that is allowable for tax purposes.

18
Q

When an asset is sold, tax is due on the difference between…

A

the sale price and the asset’s book value net of depreciation

19
Q

Terminal or continuation values should reflect the present value…

A

of the project’s future cash flows beyond the forecast horizon.

20
Q

Break-even analysis computes the level of a parameter that makes the project’s NPV…

A

equal zero.

21
Q

Sensitivity analysis breaks the NPV calculation down into its

A

component assumptions, showing how the NPV varies as the values of the underlying assumptions change.

22
Q

Scenario analysis considers the effect of

A

changing multiple parameters simultaneously. It is common to consider multiple scenarios. We can weight the scenarios by their likelihoods to compute an expected NPV

23
Q
A
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A
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24
Q
A