Ch. 9 Making Capital Investment Decisions

sensitivity analysis

investigation of what happens to net present value when only one variable is changed

Though depreciation is a non-cash expense, it is important to capital budgeting for these reasons

-it determines taxes owed on fixed assets when they are sold -it affects a firm's annual tax liability -it determines the book value of assets which affects net salvage value

What is the first (and most important) step when evaluating a proposed investment?

Decide which cash flows are relevant and which are not

tax shield approach

OCF= (Sales-Cost) x (1- Tc) + Depreciation x Tc

T/F: The incremental cash flows for project evaluation consist of any and all changes in the firm's future cash flows that are a direct consequence of taking the project.

True

sunk cost

a cost that has already been incurred and cannot be recouped and therefore should not be considered in an investment decision

Which of the following are fixed cost?

cost of equipment and rent on production facility

Accelerated Cost Recovery System (ACRS)

depreciation method under US tax law allowing for the accelerated write-off of property under various classifications

Operating cash flow=

earnings before interest and taxes+ depreciation- taxes

Cash flow from assets has three components:

operating cash flow, capital spending, and additions to net working capital

managerial options

opportunities that managers can exploit if certain things happen in the future. Also known as "Real options".

Erosion will _______________ the sales of existing products.

reduce

Opportunity cost are classified as _______________ cost in project analysis.

relevant

Which of the following are needed for cash flow estimation?

selling price per unit variable cost per unit unit sales per period

captial rationing

the situation that exist if a firm has positive net present value projects but cannot obtain the necessary financing

depreciation tax shield

the tax saving that results from the depreciation deduction, calculated as depreciation multiplied by the corporate tax rate

Two things we are interested in when it comes to measuring cash flow:

1. interested in measuring it when it actually occurs, not when it accrues in an accounting sense. 2. we are always interested in aftertax cash flow because taxes are definitely a cash outflow

Side effects from investing in a project refer to cash flows from:

erosion effects and beneficial spillover effects

Pro forma financial statements

financial statements projecting future years' operations

The difference between a firm's cash flows with a project versus without the project is called _______________________.

incremental cash flows

contingency planning

taking into account the managerial options implicit in a project

stand alone principle

the assumption that evaluation of a project may be based on the projects's incremental cash flows

erosion

the cash flows of a new project that come at the expense of a firm's existing projects

scenario analysis

the determination of what happens to net present value estimates when we ask what-if questions

opportunity cost

the most valuable alternative that is given up if a particular investment is undertaken

forecasting risk

the possibility that errors in projected cash flows will lead to incorrect decisions.