chapter 9

Question 1

what is capital budgeting?

Answer 1

decisions on how to allocate funds across potential new projects and which projects to accept

Question 2

what are 6 rules to keep in mind when capital budgeting?

Answer 2

use actual cashflows
use incremental cash flows
ignore sunk costs
include opportunity costs
use after-tex cash flows
capital cost allowance (CCA) tax shield

Question 3

why do we use actual cash flows?

Answer 3

because that’s what matter to shareholder since the firm pays dividends and makes new investments from actual cash flows, not accounting profit

Question 4

why do you ignore sunk costs?

Answer 4

because an expenditure that is made prior to a capital budgeting decision is irrelevant to that decisions as long as the expenditure cannot be reclaimed if the project is not undertaken

Question 5

what are some examples of sunk costs?

Answer 5

a company spends 10,000 on marketing in the past

Question 6

why is it important to include opportunity costs?

Answer 6

using previously idle resources in a new project means that these resources cannot be used elsewhere, this will ultimately change the cost of the resources of the new project

Question 7

what is an example of opportunity cost?

Answer 7

if a company is using 1,000 dollars to fund a project, the opportunity cost is what else they are losing out on funding with that 1,000

Question 8

why is it important to use after tax cash flows?

Answer 8

share holders only benefits from after-tax cash flows, dividends and capital gains are only from after-tax cash flows

different projects have different tax exposures so you can only properly compare investments if you consider after tax cash flows

Question 9

what is capital cost allowance (CCA) tax shield?

Answer 9

CCA reduces taxable income because the canada revenue agency considers it an expense, altho it is to an actual cash flow

Question 10

what is the Canada revenue agency “half year rule”?

Answer 10

a rule that places half of the assets value in the first tax year, and the next tac year

Question 11

how is the formula for net working capital (NWC)?

Answer 11

NWC=cash+inventory+receivables-payables

Question 12

what are the 3 things to remember when estimating the impact of NWC changes?

Answer 12

an increase in net working capital is a cash outflow, and has a negative impact on free cash flow

a decrease in net-working capital is a cash inflow, and has a positive impact on free cash flow

we generally assume that at the end of a project, all net working capital amounts revert to the pre-project levels