Exam 3 11/10 chaps 2&9 Flashcards
incremental cash flows
The difference between a firm’s future cash flows with a project and those without the project.
The incremental cash flows for project evaluation consist of…
any and all changes in the firm’s future cash flows that are a direct consequence of taking the project.
stand-alone principle
The assumption that evaluation of a project may be based on the project’s incremental cash flows.
sunk cost
A cost that has already been incurred and cannot be recouped and therefore should not be considered in an investment decision.
opportunity cost
The most valuable alternative that is given up if a particular investment is undertaken.
erosion
The cash flows of a new project that come at the expense of a firm’s existing projects.
pro forma financial statements
Financial statements projecting future years’ operations.
project cash flow=
proj. OCF - proj. change in NWC - proj. capital spending
OCF=
earnings before interest and taxes + depreciation - taxes
OCF=
tax shield approach
(sales - cost) x (1 - Tc) + (dep x Tc)
depreciation tax shield
The tax saving that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate.
total cash flow=
OCF - change in NWC - capital spending
cash flow=
cash inflow- cash outflow
Accelerated Cost Recovery System (ACRS)
Depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications.
forecasting risk
The possibility that errors in projected cash flows will lead to incorrect decisions. Also estimation risk.
scenario analysis
The determination of what happens to net present value estimates when we ask what-if questions.
sensitivity analysis
Investigation of what happens to net present value when only one variable is changed.
managerial options
Opportunities that managers can exploit if certain things happen in the future. Also known as “real” options.
contingency planning
Taking into account the managerial options implicit in a project.
strategic options
Options for future, related business products or strategies.
capital rationing
The situation that exists if a firm has positive net present value projects but cannot obtain the necessary financing.
soft rationing
The situation that occurs when units in a business are allocated a certain amount of financing for capital budgeting.
hard rationing
The situation that occurs when a business cannot raise financing for a project under any circumstances.
balance sheet
Financial statement showing a firm’s accounting value on a particular date.
total value of assets
- current assets
- fixed assets
- tangible & intangible
total value of liabilities and shareholders equity
- current liabilities
- long-term debt
- shareholders’ equity
assets=
liabilities + shareholders’ equity
net working capital
Current assets less current liabilities.
liquidity
the speed and ease with which an asset can be converted to cash
Generally Accepted Accounting Principles (GAAP)
The common set of standards and procedures by which audited financial statements are prepared.
income statement
Financial statement summarizing a firm’s performance over a period of time.
income=
revenues - expenses
noncash items
Expenses charged against revenues that do not directly affect cash flow, such as depreciation.
average tax rate
Total taxes paid divided by total taxable income.
marginal tax rate
Amount of tax payable on the next dollar earned.
cash flow from assets
The total of cash flow to creditors and cash flow to stockholders, consisting of the following: operating cash flow, capital spending, and changes in net working capital.
operating cash flow
Cash generated from a firm’s normal business activities.
free cash flow
Another name for cash flow from assets.
cash flow to creditors
A firm’s interest payments to creditors less net new borrowings.
cash flow to stockholders
Dividends paid out by a firm less net new equity raised.
net capital spending=
ending fixed assets - beginning fixed assets + depreciation
net working capital=
current assets - current liabilities
change in NWC=
(current ass 1 - current liab 1) - (current ass 2 - current liab 2)
operating cash flow=
net income + change in NWC
OR
EBIT + depreciation - tax
fixed assets sold=
fixed ass 2 - fixed ass 1 - new + depreciation
cash flow to creditors=
beg tot liab - end tot liab + interest paid
OR
interest paid - net new borrowing
new net borrowing=
long term debt end - long term debt beg
depreciation=
sales - cost - taxable income
taxable income=
net income/ (1-0.%)
net income=
paid dividends + retained earnings
