Corp Fin #21: Capital Budgeting

Question 1

5 key principals of capital budgeting

Answer 1

1. decisions based on cash flows, not accounting income
2. cash flows based on opp costs
3. cash flow timing is important
4. cash flows analyzed on after-tax basis
5. financing cost are reflected in projects rate of return

Question 2

externality vs. opportunity cost

Answer 2

externality is effects/impact by accepting a project on the other firm’s cash flows.

opp costs are cash flows firm will lose by undertaking the project under analysis

Question 3

what are components of initial investment outlay

Answer 3

it’s the up front costs. components are price, including shipping and installation (FCInv) and investment in Net Working capital

Question 4

FORMULA: initial investment outlay

Answer 4

outlay = FCInv +NWCInv

Question 5

FORMULA: NWCInv

Answer 5

=change in non-cash current assets - change in non-debt current liabilities

Question 6

what is the cash inflow effect (positive or negative) when NWCInv is positive or negative

Answer 6

when NWCInv is positive, this is a cash outflow because it represents the cash needed to fund the net investment in current assets.

Question 7

FORMULA: after-tax operating cash flow

Answer 7

CF=(S-C)(1-T)+(DT) or (S-C-D)(1-T)+(D)

Question 8

FORMULA: TNOCF (terminal year after-tax non-operating cash flows)

Answer 8

TNOCF = Sal(of t) +NWCInv - T(Sal of t -B of t)

where Sal of t is pre-tax cash proceeds from sale of item and B of t is the book value of fixed capital sold