week 18 Flashcards
(21 cards)
what are incremental cash flows
consist of any and all changes in the firms current and future cash flows that are a direct consequence of taking the project
any cash flow that exists regardless of if the project is undertaken is irrelevant
how do you evaluate a proposed project
use estimated financial statements to forecast future operations
compute cash flow based from firm based on financial statements
evaluate project using techniques discussed in previous lectures
what are the common pitfalls of accepting a project
sunk costs
opportunity costs
side effects
changes in net working capital
financing costs
tax effects
what are sunk costs
a cost that has already occurred and cannot be recovered whether we decide to accept the project or not
not incremental to cash outflows
what are opportunity costs
the most valuable alternative opportunity that is forgone if a particular investment is undertaken
are incremental cash flows
what are side effects
negative or positive
both can are incremental cash flows
what is net working capital
the investment in NWC represents an incremental cash outflow
when the project is approaching its end all investment in NWC is recovered
how do you calculate NWC
cash + inventory + recievables - payables
what are financing costs
the goal of project evaluation is to estimate cash flow generated by the proposed project which is cash flow from assets (CFFA)
companies usually finance entire companies at once
taxes are a cash outflow, all cash flows should be after tax numbers
how do you calculate CFFA
CFs to creditors + CFs to shareholders
which common pitfalls have incremental cash flows
opportunity costs
side effects
NWC
tax effects
how do you evaluate a proposed project
get pro-forma financial statements
compute future cash flow from statements
evaluate using decision rules
how do you calculate operating cash flow (OCF)
EBIT + depreciation - taxes
net income + depreciation
how do you calculate cash flow from assets (CFFA)
OCF - net capital spending - changes in NWC
what are the three methods to calculate OCF
bottom up - EBIT + D - T x EBIT
top down - (S-C) - (S-C-D) x T
tax shield - (S-C)(1-T) + DxT
how can you avoid NPV mistakes
sources of value
forecasting risk
what are sources of value
able to articulate why this project creates value
positive NPV projects are rare in highly competitive arenas
if project has large positive NPV, need to understand where it is coming from
no good reasons for large positive NPV, estimates may be inaccurate or optimistic
what is forecasting risk
mistakes in forecasting cash flows or discount rate
estimate sensitivity of NPV to changes in cash flow estimates, more sensitive have greater forecasting risk
use scenario and sensitivity analysis
what is scenario analysis
examines NPV under several possible situations to assess the impact of cash flows which differ from forecasts
worst case - low revenues, high costs
best case - high revenues, low costs
what is sensitivity analysis
shows how changes in an input variable affect NPV
each variable is fixed except one
focus in the effect of specific variables on NPV
answers what if questions
what are the additional considerations in capital budgeting
managerial actions - managers can modify a project after it starts, real options, can underestimate project NPV by ignoring options
capital rationing - firms have limited resources and cant undertake positive NPV projects
