Lecture 6 Capital Budgeting

Question 1

When risk of project increases, what happen to the cost of capital and present value?

Answer 1

cost of capital increases, present value decreases

Question 2

is sunk cost incremental cash flow?

Answer 2

No, costs already incurred regardless of the investment or not

Question 3

what is included in the incremental cash flows?

Answer 3

opportunity costs: cash flows that could have be obtained from assets used by the project

side effects: project may reduce the cashflow of existing projects

finance cost: already included in the required rate of return

overhead costs: only extra expenses that would result from the project should be included.

salvage value: fixed asset of project that can be sold or used elsewhere when project finishes

• -> need to consider capital gain tax
• -> some project might have shutdown cost which is a negative cashflow

depreciation

• prime cost (straight line)
• diminishing value (reducing balance, accelerated depreciation) –> often used for tax purpose and more relevant

Question 4

Does inflation has effect on NPV?

Answer 4

NO

Question 5

what can a project be summarised by?

Answer 5

incremental after-tax cash flow

its cost of capital