chapter 8 Flashcards
capital budget
lists the project and investments that a company plans to undertake during the coming year.
capital budgeting
the process of determining the capital budget by analysing alternative projects and decide which ones to accept. the ultimate goal is to determine the effect of the decision on the firm’s cash flows and evaluate the NPV of these cash flows to assess the consequences of the decision for the firm’s value.
incremental earnings
the incremental earnings of a project is the amount by which the firm’s earnings are expected to change as a result of the investment decision.
straight-line depreciation
the simplest method of depreciation, in which the asset’s cost (less any expected salvage value) is divided equally over its estimated useful life.
unlevered net income
net income not including any interest expenses associated with debt.
marginal corporate tax rate
the tax rate it will pay on an incremental dollar of pre-tax income. this is the correct tax rate to use for the unlevered net income formula.
opportunity cost
the opportunity cost of using a resource is the value it could have provided in its best alternative use. we include this as an incremental cost of the project.
project externalities
indirect effects of the project that may increase or decrease the profits of other business activities of the firm.
cannibalisation
when sales of a new product displace sales of an existing product.
sunk cost
any unrecoverable cost for which the firm is already liable. sunk costs have been or will be paid regardless of the decision about whether or not to proceed with a project. eg. fixed overhead costs and R&D.
overhead expenses
associated with activities that are not directly attributable to a single business activity but instead affect many different areas of the corporation.
free cash flow
the incremental effect of a project on the firm’s available cash, separate from any financing decisions. it is calculated on an unlevered basis (ie. it ignores financing items like interest expenses). free cash flows are cash flows available to financiers (debt and equity holders).
depreciation
is not a cash expense that is paid by the firm. it is a method used for accounting and tax purposes to allocate the original purchase cost of the asset over its life. it is not a cash flow, so it is not included in the cash flow forecast.
receivables
a firm’s receivables measure the credit the firm has received from its suppliers.
trade credit
the difference between receivables and payable is the net amount of the firm’s capital that is consumed as a result of credit transactions.