FINA211 WK9 L17 Capital Budgeting and Risk Analysis Flashcards
What is a sunk cost?
A sunk cost is money that has already been spent and cannot be recovered.
Therefore, sunk costs are not relevant to capital budgeting.
What are opportunity costs?
The best alternative foregone.
Opportunity costs are only relevant when you have mutually exclusive alternatives.
For example, when choosing between selling or developing a peice of land. When evaluating the potential of developing the land, you must consider what you are giving up by not selling the land.
Another example is when you are using a garage space for a particular project. What are you giving up by not using that garage space for something else such as renting it if it was not being used for the project?
What is erosion?
A new project may negatively impact the cash flows from a previous project.
For example, when a large company releases a new flagship product like Samsung releasing the Galaxy S23 after the S22
What is synergy?
A new project may positively impact the cash flows of previous/existing projects.
For example, the release of the S20 which did not have a headphone jack and the Galaxy Buds
What is sensitivity analysis?
Sensitivity analysis is a financial model that determines how target variables are affected based on changes in other variables known as input variables. It is a way to predict the outcome of a decision given a certain range of variables.
Only on variable is changed
Sensitivity = Change in Dependent Variable/Change in Independent Variable
Sensitivity = Change in variable being measured/Change in variable being changed
What is scenario analysis?
Scenario analysis is the process of estimating the expected value of a portfolio after a given change in the values of key factors take place. Both likely scenarios and unlikely worst-case events can be tested in this fashion—often relying on computer simulations.
More than one variable is changed
What is the formula used to estimate units sold?
Units Sold = Market Share * Size of Market
What is the formula used to estimate sales?
Sales = Units Sold * Price
What is the formula used to estimate total variable costs?
Total Variable Costs = Variable Cost per unit * Units Sold
What is the formula used to estimate total costs?
Total Costs = Variable Costs * Fixed Costs
What is the formula for accounting break even?
Accounting Breakeven = (Fixed Costs + Depreciation)/(Sales Price - Variable Cost per unit)
Accounting Breakeven = (FC + DEP)/(SP - VCpu)
Accounting Breakeven = (FC + DEP)/MCpu
What is the formula for financial breakeven?
Financial Breakeven = (EAC + Fixed Costs(1-t) – Depreciationt)/((Sales Price – Variable Costs per unit)*(1-t))
