Making Capital Investment Decisions Flashcards
What do we do when considering a single project?
We discount the cash flows that the firm receives from the project
What do we do when valuing the firm as a whole?
We discount dividends - not earnings, because dividends are the cash flows that an investor receives
What is a sunk cost?
A cost that has already occurred. Because sunk costs are in the past, they cannot be changed by the decision to accept or reject the project
Are sunk costs relevant or incremental cash outflows?
Neither, they cannot be changed and are the same whether the project is accepted or rejected
What are opportunity costs?
Lost revenues that you forego as a result to making the proposed investment
What is a side effect?
Classified as either erosion (also cannibalisation) or synergy
When does erosion occur?
When a new project reduces the sales and, hence, the cash flows of existing products
When does synergy occur?
When a new project increases the cash flows of existing projects
What does side effects predict?
The spending habits of customers, which is necessarily hypothetical and difficult to estimate
What are allocated costs?
For capital budgeting purposes, it should be viewed as a cash outflow of a project only if it is an incremental cost of the project
What steps must be followed in a capital budgeting analysis?
Calculation of depreciation for each year, generation of the income statement to identify the tax that is due to be paid, construction of the cash flow forecast to generate cash flows, and investment appraisal analysis
What is inflation?
An important fact of economic life, and it must be considered in capital budgeting, it affects all economic decisions
What is nominal cash flow?
Refers to the actual money in cash to be received (or paid out)
What is real cash flow?
Refers to the cash flow’s purchasing power
What are the alternative methods for computing operating cash flows?
The general method, the bottom-up approach, the top-down approach, and the tax shield approach
