Chpt 10
opportunity cost
the most desirable alternative given up as the result of a decision
Bottom up approach
start with the accountant's bottom line (net income) and add back any noncash deductions such as depreciation.
stand-alone principle
the assumption that evaluation of a project may be based on the project's incremental cash flows
Erosion
the cash flows of a new project that come at the expense of a firm's existing projects
incremental cash flows
the difference between a firm's future cash flows with a project and those without the project
Operating cash flow formula
= Earnings before interest and taxes + depreciation - taxes
Project cash flows formula
= Project operating cash flow- project change in net working capital- project capital spending
bottum-up approach net income
Because we are ignoring any financing expenses, such as interest, in our calculations of project OCF, we can write project net income as: EBIT- Taxes
Financing Costs
In analyzing a proposed investment, we will not include interest paid or any other financing costs such as dividends or principal repaid because we are interested in the cash flow generated by the asset of the project.
Net working capital
Normally a project will require that the firm invest in net working capital in addition to long term assets.
Tax Shield Approach to OCF
OCF = (sales-costs) * (1-Tc) + (Depreciation*Tc) where Tc = corporate tax rate
bottom up approach OCF
OCF= net income + depreciation.
Top Down approach OCF
OCF= sales-costs-taxes
Top down approach
We start at the top of income statement with sales and work our way down to net cash flow by subtracting costs, sales, and other expenses.
sunk cost
a cost that has already been committed and cannot be recovered
Accelerated cost recovery system
a depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications
EBIT
earnings before interest and taxes
pro forma financial statements
financial statements projecting future years' operations
Equivalent annual cost
the present value of a project's costs calculated on an annual basis
Depreciation tax shield
the tax saving that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate