Making Capital Investment Decisions FacStaff Home ….ppt

Making Capital Investment Decisions Key Concepts and Skills Understand how to determine the relevant cash flows for various types of proposed investments Be able to compute depreciation expense for tax purposes Understand the various methods for computing operating cash flow Chapter Outline Project Cash Flows: A First Look Incremental Cash Flows Pro Forma Financial Statements and Project Cash Flows More on Project Cash Flow Alternative Definitions of Operating Cash Flow Some Special Cases of Cash Flow Analysis Relevant Cash Flows The cash flows that should be included in a capital budgeting analysis are those that will only occur if the project is accepted These cash flows are called incremental cash flows The stand-alone principle allows us to analyze each project in isolation from the firm simply by focusing on incremental cash flows Asking the Right Question You should always ask yourself “Will this cash flow occur ONLY if we accept the project?” If the answer is “yes”, it should be included in the analysis because it is incremental If the answer is “no”, it should not be included in the analysis because it will occur anyway If the answer is “part of it”, then we should include the part that occurs because of the project Common Types of Cash Flows Sunk costs – costs that have accrued in the past Opportunity costs – costs of lost options Side effects Positive side effects – benefits to other projects Negative side effects – costs to other projects Changes in net working capital Financing costs Taxes Pro Forma Statements and Cash Flow Capital budgeting relies heavily on pro forma accounting statements, particularly income statements Computing cash flows – refresher Operating Cash Flow (OCF) = EBIT + depreciation – taxes OCF = Net income + depreciation when there is no interest expense Cash Flow From Assets (CFFA) = OCF – net capital spending (NCS) – changes in NWC Table 10.1 Pro Forma Income Statement Table 10.2 Projected Capital Requirements Table 10.5 Projected T