RW7eCh10RW7eCh10.doc

CHAPTER 10 Making Capital Investment Decisions Learning Objectives LO1 How to determine relevant cash flows for a proposed project. LO2 How to project cash flows and determine if a project is acceptable. LO3 How to calculate operating cash flow using alternative methods. LO4 How to calculate the present value of a tax shield on CCA. LO5 How to evaluate cost-cutting proposals. LO6 How to analyze replacement decisions. LO7 How to evaluate the equivalent annual cost of a project. LO8 How to set a bid price for a project. Answers to Concepts Review and Critical Thinking Questions ? 1. (LO1) An opportunity cost is the most valuable alternative that is foregone if a particular project is undertaken. The relevant opportunity cost is what the asset or input is actually worth today, not, for example, what it cost to acquire. ? 2. (LO1) It’s probably only a mild over-simplification. Current liabilities will all be paid presumably. The cash portion of current assets will be retrieved. Some receivables won’t be collected, and some inventory will not be sold, of course. Counterbalancing these losses is the fact that inventory sold above cost (and not replaced at the end of the project’s life) acts to increase working capital. These effects tend to offset. 3. (LO7) The EAC approach is appropriate when comparing mutually exclusive projects with different lives that will be replaced when they wear out. This type of analysis is necessary so that the projects have a common life span over which they can be compared; in effect, each project is assumed to exist over an infinite horizon of N-year repeating projects. Assuming that this type of analysis is valid implies that the project cash flows remain the same forever, thus ignoring the possible effects of, among other things: (1) inflation, (2) changing economic conditions, (3) the increasing unreliability of cash flow estimates that occur far into the future, and (4) the possible effects of future technology improveme