ch 10 making capital investment decisions

Question 1

relevant cash flows

Answer 1

cash flows that should be included in a capital budgeting analysis are those that will only occur (or not occur) if the project is accepted

Question 2

incremental cash flow

Answer 2

relevant cash flow, as it is defined in terms of changes

Question 3

stand-alone principle

Answer 3

analysis of the projects undertaken in isolation from the firm simply by focusing on incremental cash flows

Question 4

types of incremental cash flows that are included

Answer 4

• opportunity costs
• side effects
• changes in net working capital
• inflation
• CCA

Question 5

types of incremental cash flows that are not included

Answer 5

• sunk costs
• financing costs

Question 6

erosion

Answer 6

negative side effect where sales may be lost due to another product

Question 7

pro forma financial statement setup

Answer 7

sales -
VC =
gross profit -
FC -
depreciation =
EBIT -
taxes =
net income

• no financing costs included

Question 8

project cash flow =

Answer 8

project operating cash flow - project additions to net working capital - project capital spending

Question 9

bottom-up approach

Answer 9

• works only when there is no interest expense
  OCF = project net income + depreciation

Question 10

top-down approach

Answer 10

OFC = sales - costs - taxes

Question 11

tax shield approach

Answer 11

OCF = (sales - costs)(1-T) + depreciation x T

Question 12

depreciation (CCA) tax shield

Answer 12

D x Tc