Lecture 5 Flashcards
The Finance Function
By making __________ and _________ _________, the financial manager is attempting to achieve the following objective:
To ________ the ______ _____ of ____________ wealth.
By making INVESTMENT and FINANCING DECISIONS, the financial manager is attempting to achieve the following objective:
To MAXIMISE the CURRENT VALUE of SHAREHOLDERS’ wealth.
What is Capital Budgeting?
The process of identifying, analysing, and selecting investment projects whose returns (cash flow) are expected to extend beyond on year.
INCREASE SHAREHOLDERS WEALTH
The Capital Budgeting Process
- Generate __________ _________ consistent with the firm’s strategic __________.
- Estimate _____-___ ___________ operating cash flows for the investment projects.
- Estimate the ____ of _______.
- Evaluate project ___________ cash flows.
- Select projects based on a _____-__________ acceptance criterion.
- Re-evaluate implemented investment projects ___________ and _______ ____-_____ for completed projects.
The Capital Budgeting Process
- Generate INVESTMENT PROPOSALS consistent with the firm’s strategic OBJECTIVES.
- Estimate AFTER-TAX INCREMENTAL operating cash flows for the investment projects.
- Estimate the COST of CAPITAL.
- Evaluate project INCREMENTAL cash flows.
- Select projects based on a VALUE-MAXIMISING acceptance criterion.
- Re-evaluate implemented investment projects CONTINUALLY and PERFORM POST-AUDIT for completed projects.
The Importance of Cash Flow
Cash flow measures the ______ ______ & _______ __ ____, while profits represent merely an accounting measure of periodic performance.
A firm can spend its _________ cash flow but not its ___ income.
Cash flow measures the ACTUAL INFLOW & OUTFLOW OF CASH, while profits represent merely an accounting measure of periodic performance.
A firm can spend its OPERATING cash flow but not its NET income.
The Importance of Cash Flow
Some firms have net losses and yet can/can’t pay dividends from cash balances, while others show profit and may ___ have the cash available for even a small dividend to shareholders.
Some firms have net losses and yet CAN pay dividends from cash balances, while others show profit and may NOT have the cash available for even a small dividend to shareholders.
Relevant Cash Flows
The cash flows that should be included in a capital budgeting analysis are those that will ____ _____ if the project is accepted.
These cash flows are called ___________ ____ _____.
The cash flows that should be included in a capital budgeting analysis are those that will ONLY OCCUE if the project is accepted.
These cash flows are called INCREMENTAL CASH FLOWS.
Incremental Cash Flows
Look for Incremental costs and benefits
Would this cash flow exist if the project did not exist?
NO? YES?
NO?
Include the cash flow in the analysis.
YES?
Do NOT include the cash flow in the analysis.
What are the 8 important issues to be considered and valued?
- Sunk Costs
- Opportunity Cost
- Erosion
- Synergy Gain
- Tax Implication
- Working Capital
- Capital Allowance and Cost Recovery of Assets and Capital Expenditures
What is a sunk cost?
Expenses that have already been incurred, or that will be incurred regardless of the decision to accept or reject a project.
These costs although part of the income statement, should not be considered as part of the relevant cash flows when evaluating a capital budgeting proposal.
What is an opportunity cost?
Costs that may not be directly observable or obvious, but result from benefits being lost as a result of taking on a project.
What is Cannibalisation or erosion costs?
Costs that arise when a new product or service competes with revenue generated by current product or service offered by firm.
What is Synergy Gains?
The impulse purchases or sales increases for other existing products related to the introduction of a new product.
