Final Exam - Chapter 8 Flashcards
Capital Budgeting Analysis
• Essentially we try to figure out?
Project costs & Project return.
Capital Budgeting Analysis
How Project costs & Project return.?
By estimating cash flows
from the project.
Principles of Estimating Cash Flows
What are the 2 Cash Flows
Initial Cash Outflow
Net Operating Cash Flows
Principles of Estimating Cash Flows
Cash Flows
Initial Cash Outflow
Net Investment
Project cost
Principles of Estimating Cash Flows
Net Operating Cash Flows
Project returns
Cash flows should be measured on?
on an incremental
basis
Cash flows should be measured on
an after-tax basis
All the _______ ______ of a project should be included in the cash flow calculations
indirect effects
____ _____ should not be considered
Sunk costs
______ ________ should be considered
Opportunity costs
Opportunity costs
use of the land owned/any assets held
Net Investment =?
Formula
new project cost ((inc. installation and shipping costs)
+
investment in net working capital initially.
- net proceeds from the sale of existing assets
(when make a replacement decision)
+
Taxes associated with the sale of the existing assets and/or the purchase of the new assets
Net (Operating) Cash Flows
Formula
Delta Revenue - Delta Cost - Delta Depreciation] x (1-T) + Delta Depreciation - Delta NWC
= Operating Cash Flow
Case 1
Sale = book value
No tax consequences
Case 2
Sale < book value
Tax savings =
Marginal tax rate x
Amount of loss
Case 3 Original cost >
Sale > book value
Tax liability =
Gain x
Marginal tax rate
Case 4
Sale > original cost
Tax liability =
(Gain +
Capital gain) x
Marginal tax rate
Recovery of Net Working Capital
The total amount of accumulated net working capital is usually recovered at the end of the life of the project
The recovery of net working capital would result in increase in what?
net cash flow
There are generally
no tax considerations associated with the
recovery of net working capital
Should you deduct the interest charges associated with a particular project?
No
It is generally considered incorrect to deduct the interest charges associated with a particular project for two reasons:
- Profitability of the project should be
independent of financing
2.The cost of capital (discount rate) already
incorporates the cost of funds used to finance a project.
Depreciation Method
Straight-line or various accelerated depreciation
methods can be used
Depreciation Method
For tax purposes
, the Modified Accelerated
Cost Recovery System (MACRS) is used
Straight-line depreciation methods
Formula
Annual deprciation amount =
Installed cost
/
Number of years over which the asset is depreciated
(3) Problems in Cash Flow Estimation
It is difficult to predict the actual cash flows
of a project
Cash flow estimates for different projects
may have varying degrees of uncertainty
The returns from asset replacement
projects are generally easier to forecast
than the returns from new product
introduction projects
