What are incremental cash flows?
Cash flows that will occur if a capital budgeting project is accepted, but that will not occur if the investment is rejected.
Do sunk costs count in incremental cash flows?
no, regardless if accepted or not, cost is incurred so don't double count for it
What are the three types of incremental cash flows?
Initial investment cash flows, operating cash flows, and shut down cash flows
Should you include the allocation of existing overhead when measuring incremental cash flows?
no, but do include additions to overhead tied to the proposed project
How do you calculate the depreciable basis?
The purchase price plus shipping and installation
With the depreciation basis, there are ___ tax deductions in the early years so what does this do to the NPV
bigger tax deductions in the early years, so you get more cash flows earlier, increases the NPV
t/f: with the depreciation basis, the actual cash flows aren't affected, just timing with acceleration depreciation vs. straight line
true
Beware to not subtract this anywhere as it is extra information
interest
Are financing costs included in our analysis of incremental cash flows of a project?
No, they are already included in the discount rate, k, If we also included them in the CF, we would be double counting.
If a firm's new product decreases the sales of the firm's other product lines, would this affect the analysis?
Yes, the effect on other projects' CFs is an "externality" a negative externality would reduce the NPV
-Real options: getting out a project in the middle could do what for the company?
reduct your losses, it is a valuable option
What are some other real options?
Opportunity to revise a project at a later date, this flexibility adds value to the project
How do you calculate the NWC at the end of the project?
current assets- current liabilities. bc you are getting rid of receivables and payables to get down to 0, so NWC will reverse itself
Sales-operating costs- depreciation =?
EBIT
Which of the following factors should be included in the cash flows when estimating the relevant cash flows?
a) all sunk costs that have been incurred relating to the project
b)Effects of the project on other decisions of the firm, but only if those effec
c
Which of the following should be considered when a company estimates the cash flows used to analyze a proposed project?
a) the firm would borrow all the money used to finance the new project, and the interest on this debt would be $1.5 million per year
b)
c.
T/f: Changes in net working capital should not be reflected in a capital budgeting cash flow analysis because capital budgeting related to fixed assets, not working capital
False
t/f: Any cash flows that can be classified as incremental to a particular project- ie: results directly from the decision to undertake the project should be reflected in the capital budgeting analysis
true
t/f: suppose Walker Publishing Company is considering bringing out a new finance text whose projected revenues include some revenues that will be taken away from another of Walker's books. The lost sales on the older book are a sunk cost and as such shoul
False
t/f: If an investment project would make use of land which the firm currently owns, the project should be charged with the opportunity cost of the land?
true
t/f: If debt is to be used to finance a project, then when cash flows for a project are estimated, interest payments should be included in the analysis
false!
Why do we focus on cash flows instead of profits when evaluating proposed capital budgeting projects?
We focus on cash flows instead of profits when evaluating proposed capital budgeting projects because it is cash flow that changes the value of a firm. You can spend cash buy you cannot spend profit.
When is a sunk cost? It is relevant when evaluating a proposed capital budgeting project?
A sunk cost it a cash flow that has already occurred, or that will occur, whether a project is accepted or rejected. It is irrelevant when evaluating a prosed project.
How do we estimate expected incremental cash flows for a proposed capital budgeting project?
We estimate expected incremental cash flows for a proposed project by estimating the changes in sales and expenses that are incremental to the project, adding back the incremental depreciation expense since depreciation expense is a non-cash expense.
What role does depreciation play in estimating incremental cash flows?
Depreciation expense is a tax deductible expense and therefore affects cash flow through its effect on taxes. Depreciation expense that is incremental to a proposed project therefore affects incremental cash flows
How do opportunity costs affect the capital budgeting decision-making process?
Opportunity costs reflect the foregone benefits of the alternative not chosen when a capital budgeting project is selected. Any decrease in the cash flows of the firm directly tied to the selection of a new project could be part of the opportunity cost va
How do you calculate an annual coupon interest rate with a semiannual coupon rate?
Semiannual *2/ par value
When dealing with semiannual, what do you do with the following:
n
i/y
n= *2
i/y, divide by 2
t/f: the total yield on a bond is derived from its dividends and changes in the price of the bond
false- total yield on a bond is derived from coupon interest payments and changes in the price of the bond
t/f: bonds from larger companies always have lower yields to maturity (less risk) than bonds rom smaller companies
false- large companies near bankruptcy often have high risk and high yields