Ch 9 Flashcards
Stand alone principle
Assumption that evaluation of project may be based
On project’s incremental cash flows
Incremental cash flows
Difference btw firm’s future cash flows with project
And those without the project
Consist of any/all changes in firm’s future cash flows
That are a direct consequence of taking the project
Sunk cost
Cost thats already been incurred + can’t be recouped
Should not be considered in investment decision
Opportunity cost
Most valuable alternative that is given up if
Particular investment is undertaken
Erosion
Cash flows of new project that come at expense of firm’s
Existing projects
Pro forma financial statements
Financial statements projecting future years’ operations
Project cash flow, equation
Project cash flow =
project operating cash flow - project change in Net Working C.
- project capital spending
Operating cash flow, equation?
Operating cash flow =
Earnings before interest and taxes + depreciation - taxes
Depreciation tax shield, definition? Equation?
Tax saving that results from depreciation deduction
Depreciation tax shield = Depreciation X corporate tax rate
Tax shield: operating cash flow equation?
OCF = (sales - costs) x (1 - Tax) + depreciation x tax
Accelerated cost recovery system (ACRS)
Depreciation method under US tax law allowing for
Accelerated write off of property under various classifications
Forecasting risk AKA Estimation risk
Possibility that errors in projected cash flows
Will lead to incorrect decisions
Scenario analysis
Determination of what happens to NPV estimates
When we ask what-if questions
Sensitivity analysis
Investigation of what happens to NPV when 1 variable
Is changed
Managerial options AKA real options
Opportunities that managers can exploit if certain things
Happen in the future
Contingency planning
Taking into account managerial options implicit in project
3 broad classes in contingency planning?
1 option to expand
2 option to abandon
3 option to wait
Option to expand, circumstance?
If we find a positive NPV can we expand the project
To get a larger NPV?
Strategic options
Options for future, related business products or strategies
Capital rationing
Situation exists if firm has positive NPV projects but
can’t obtain financing
Soft rationing
Situation occurs when units in business are allocated
A certain amount of financing for capital budgeting
Hard rationing
Situation when business can’t raise financing for
Project under any circumstances
