Lecture 5: Capital Expenditure Decisions

What are the ways to estimate operating cash flows (step 2)?

1. bottom up approach (OCF = net income + depreciation) 2. top down approach (OCF = sales revenue - costs - taxes) 3. tax shield approach (OCF = (sales - costs)(1 - T) + [depreciation*T]

What are the three steps in capital budgeting?

1. estimate the initial investment 2. estimate operating cash flows 3. estimate ending cash flows

What is erosion/cannibalism?

when introducing a product decreases revenue in another product line

What are synergies?

when introducing a product increases revenue in another product line

When estimating the initial investment in a project what are some costs that must be included?

cost of equipment related costs (shipping, set up) opportunity costs changes in net working capital

Should allocated costs be included in capital budgeting decisions?

depends

What is the 50% rule for capital cost allowance?

in the first year you calculate depreciation based on only 50% of the value of the asset in the second year you calculate depreciation against the full value of the asset minus the amount you depreciate in the first year

What is capital budgeting?

it is the process by which a firm makes capital expenditure decisions

What is often used in the calculation of ending cash flows?

net salvage/resale value disposal costs, net of taxes release of net working capital

Should sunk costs be included in capital expenditure decisions?

no

Should interest expenses be included in capital budgeting decisions?

no, investment decisions should be kept separate from financing decisions

What is the Fisher equation?

real interest rate = nominal interest rate - inflation rate