Chapter 10 Making capital investment decisions Flashcards
estimates the critical input in a net present value anlysis
cash flow
a change in the firms overalll future cash flow that cocmes about as a direct consequence of the decision to accept that project
a relevant cash flow
the difference between a firms future cash flows without a project
incremental cash flows
consists of any and all changed in the firms future cash flows that are a direct consequence of taking the project
- any cash flow that exists regardless of whether or not a project is undertaken is not relevant
incremental cash flows
the assumption that evaluation of a project may be based on the projects incremental cash flows
(only the incremental cash flows of that specific project)
stand alone principle
a cost that has already been incurred and cannot be removed and therfore should not be considered in an investment decision
- a cost we have already paid or have already incurred the liability to pay
- the firm will have to pay this cost no matter what
sunk cost
the most valuable alternative that is given up if a particular investment is undertaken
- it is not an out of pocket cost, but, rather, a benefit foregone
opportunity cost
the cash flows of a new project that come at the expense of a firms existing projects
- negative impact on the cash flows of an existing product from the introduction of a new product
erosion
- covers initial investment, expenses
- supplied by the firm at the beginning of a project and recoverd by the firm at the end of the project
net working capital
in analyzing a proposed investment, do not include interest paid or any other financing costs
financing costs
financial statements projecting future years operations
pro forma financial statements
a cash outflow that will occur regardless of the level of sales
fixed cost
is not deducted in calculating operating cash flow
interest expense
Cash flow from assets (projected cash flow) has 3 components
- Project operating cash flow
- project change in net working capital
- Project capital spending
is a noncash deduction, so it has cash flow consequences only because it influences taxes
accounting depreciation
a depreciation method under US tax law allowing for the accelerated write off of property under varius classifications
accelerated cost recovery system (ACRS)
(instituted in 1981)
Modified ACRS
MACRS
(enacted by the tax reform act of 1986)
- book value at the end of the project life equals zero
- need to know the lifespan of the asset or project
- depreciation expense is the same in each year
Straight line depreciation
the difference between market value and book value is _____ ______ and must be _______ when the asset is sold
- effectively the asset was overdepreciated and too little taxes were paid
excess depreciation
recaptured
if the book value exceeds the market value, the difference is treated as a _____ for tax purposes
loss
the tax saving that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate
depreciation tax shield
the present value of a projects costs calculated n an annual basis
equivalent annual cost (EAC)
utilize the EAC approach only when both of the following circumstances exist
- the possibilities under evaluation have different economic lives
- indefinite need (planned replacement at end of life)
when utilizing the EAC approach which possibility do we choose
the possibility with the smallest EAC
